Big banks primed for $11.7bn profit bonanza

Three of the major banks are set to report combined bumper interim profits, but investors will focus on how fast margins decline as higher interest rates drive mortgage stress.

Three of the major banks are set to report combined bumper interim profits of $11.7bn, but investors will instead focus on how fast margins decline as higher interest rates begin to drive mortgage stress.

Investors expect the first half of 2023 to be as good as it gets for the banks in this economic cycle, after the rapid increase in rates delivered the strongest revenue and profit growth in decades.

National Australia Bank, ANZ and Westpac are due to report in the next fortnight a combined $11.7bn in interim cash earnings, 27 per cent higher than the previous half and a 20 per cent jump from a year earlier, according to Visible Alpha consensus forecasts. NAB kicks off reporting season on Thursday.

“The banks’ results should be pretty strong,” said Brad Potter, head of Australian equities at Tyndall Asset Management. “The question in my mind is: are we close to peak margins across the sector? And if we are, how quickly will margins fall?”

Barrenjoey analyst Jon Mott said the interim bank results were likely to deliver the strongest underlying revenue and pre-provision profit growth in more than 30 years.

He noted, however, that while 30-day loan arrears were expected to rise, it was “too early” to gauge how the credit cycle would pan out.

Westpac’s costs are expected to fall 1 per cent, in line with its own cost targets. Picture: NCA NewsWire / Christian Gilles

The local results will also be released against an overseas backdrop of growing uncertainty in the sector, with the US Federal Deposit Insurance Corp preparing to put First Republic into receivership.

Meanwhile, Commonwealth Bank, the country’s largest and the only one with a June 30 year end, in February reported a record $5.15bn interim cash profit. It flagged, however, that its high net interest margins – what banks earn on loans less what they pay for funds – were facing pressure as depositors demanded the benefits from a higher Reserve Bank cash rate.

Consensus forecasts among banking analysts are tipping ANZ to report an annual cash profit of $3.8bn, NAB almost $4.2bn and Westpac $3.8bn.

Analysts expect first-half margins at ANZ, NAB and Westpac to have risen by 15bps, 16bps and 5bps, respectively, during the half to peak at 1.83, 1.83 and 2.01 percentage points. Goldman Sachs told clients in a note that “the speed of the descent (in margins) will be a key focus” of the result announcements.

Australian banks were quick to add the year’s 3.5 percentage point increase in the cash rate to the price of their mortgages, but have been slower to pay the higher rates to its depositors. This, combined with cheap funding that is also maturing in 2023 and 2024, has been a boon to profits.

Mortgage competition has also intensified in recent months as credit growth slows, while the bulk of the fixed-term loans the banks sold when interest rates were ultra-low mature.

“There’s a whole bunch of these low interest rate, fixed-term loans that are rolling off this year and next,” Tyndall’s Mr Potter said. “And there’s a lot of work going on that the banks are doing to be able to retain that business. That is going to hit their margins.”

Bank of Queensland last month said margins had peaked and were under pressure from mortgage competition so intense that it preferred to “sit out” an “irrational” market, where some banks were pricing loans below their cost of capital.

ANZ reports its earnings on May 5. Picture: NCA NewsWire / Sarah Matray

Citigroup estimates that about 11 per cent of all home loans are refinancing this calendar year at rates 3.6 percentage points higher, one of the largest single financial shocks Australian house­holds have ever faced.

And with cost of living concerns and financial hardship ­rising in recent months, investors will also be monitoring mortgage and business loan arrears, a leading indicator for bad debt charges.

Lenders currently have good levels of provisions for potential bad loans, but if economic conditions deteriorate and unemployment rises, banks could face an unexpected sharp increase in loan repayment arrears.

“The impact of higher rates is severe for recent and leveraged borrowers,” Citigroup told clients in a note on Friday.

“However, employment is looking well placed to manage the risk. We think the employment picture has been, and will be, a strong supporter of bank asset quality.”

Operating costs are expected to have been kept in check during the half, with ANZ and NAB forecast to report underlying cost growth of 3.6 per cent and 0.2 per cent respectively, while Westpac’s costs are expected to fall 1 per cent, in line with its own cost targets.

However, with high inflation remaining a challenge, the outlook for costs could be negative. “Labour costs are going up and about 70 per cent of banks’ operating costs are labour costs, so what that movement means for them is going to be important,” Tribeca fund manager Jun Bei Liu said. “We will be paying a lot of attention to their discussion about costs.”

With banking uncertainty building in the US, bank shares have come under pressure in recent weeks and could outperform if the banks’ announcements exceed the relatively pessimistic outlook expectations. “There is a lot of pessimism towards the banks, so I think that there’s a potential for (positive) surprise,” Atlas Funds Management chief investment officer Hugh Dive said.

NAB, ANZ and Westpac report earnings on May 4, 5 and 8 respectively.

Commonwealth Bank is due to release a trading update for the three months ended March 31, on May 9.

Macquarie Group, the country’s fifth largest lender, is expected to deliver a record $5bn annual profit on May 5.