Bank profits tipped to slide after RBA cuts

Analysts say big banks will take a profit hit from RBA interest slashing, lining up retirees for a potential triple hit.

A composite image of signage of Australia's 'big four' banks ANZ, Westpac, the Commonwealth Bank (CBA) and the National Australia Bank (NAB) signage in Sydney. Picture: Joel Carrett AAP

Investment analysts expect the major banks to take a profit hit from the Reserve Bank of Australia’s latest cut to official interest rates, placing further pressure on potential dividend payouts.

The Reserve Bank slashed the official cash rate further on Tuesday, taking it to a new record low of 0.5 per cent with a 25 basis point reduction.

Brokerage firms including JP Morgan, Macquarie Bank, UBS and Morgan Stanley have cut their earnings estimates for the sector following the RBA’s decision.

The development comes after increased headwinds induced by slow credit growth and the ongoing coronavirus dampened growth in the banking sector, which makes up approximately 19 per cent of the ASX.

The big four banks moved swiftly on Tuesday to pass on the full rate cut to mortgage customers, amid political pressure and growing expectations the coronavirus outbreak will dent economic growth in 2020.

The downward pressure on interest rates is expected to be a triple hit to retirees, with analysts forecasting bank shares will decline, deposit rates will be cut and dividend payouts at their current levels will be harder to sustain.

JPMorgan estimates the decision by banks to pass on the full March rate cut will reduce net profits by 3 per cent to 4 per cent over the next three to five years.

The recent cut is also likely to place pressure on the management of deposit spreads, putting pressure on dividends, JPMorgan analysts said in a note to clients.

JPMorgan forecast Westpac would cut dividends, with a payout of 76c per share to 74c per share for the second half of the current financial year.

Macquarie analysts maintained an “underweight” rating on the sector, foreseeing a two to four basis point reduction on margins as a result of the RBA’s latest cut.

“With ongoing earnings headwinds, we expect bank returns to continue to decline, diminishing their ability to sustain dividends,” they said, noting an expected 5 per cent negative impact from mortgage rate reductions to their expectations for major bank earnings.

Macquarie analysts also forecast Bendigo and Adelaide Bank would feel an even bigger impact, likely to see an aggregate decline in earnings by about 9 per cent.

“We expect the regionals to potentially smooth out the earnings impact through repricing initiatives, but then suffer more churn and higher front-to-back book spread in the medium term,” Macquarie analysts said.

UBS analysts said with interest rates likely to stay near zero for the foreseeable future the banking sector’s return on equity would probably fall towards low single digits.

The broker cut its earnings-per-share estimates across the sector by 1.6 per cent for 2020 and 3.2 per cent for next year.

UBS also sees more pressure on bank dividend payments given a “very challenged” operating environment.

“We believe the significant revenue pressure the banks are facing as interest rates fall and NIMs (net interest margins) decline may force the banks to further review their dividend policies,” its analysts said.

Morgan Stanley expects to see banks remain in an earnings-per-share and return-on-equity downgrade cycle during 2020.

The brokerage said the low rates and reinvestment burdens, alongside a fragile economic outlook will likely drag down the potential of a dividend payout.

“We think the combination of margin pressure from lower rates and the potential for higher loan losses (linked to the coronavirus fallout) increases the probability that payout ratios will remain above target levels in 2021, making further dividend cuts more likely.”

Morgan Stanley had previously assumed the big banks would hold onto a portion of the RBA’s next rate cut.

Bell Potter analyst TS Lim was an outlier to the pessimism on one bank stock, though, on Wednesday.

He raised his rating on Commonwealth Bank to “buy” from “hold”, saying it was the “best placed” among rivals to navigate current challenges, given the strength of its retail banking business. But he Nevertheless lowered his estimate for CBA’s cash net profit over the next three years by 2 per cent, reflecting pressure on net interest margins and slower domestic economic growth.

On Wednesday, ING joined the rush of banks cutting mortgage interest rates by the full 25 basis point reduction executed by the Reserve Bank.

Suncorp and Macquarie Bank were also among lenders to reduce home loan rates by 25 basis points on Tuesday.