RBA rate cut will crimp big four bank margins: analysts

The bottom line of the big banks won’t fare well if the RBA slashes rates, warn analysts.

A pedestrian walks past the Reserve Bank of Australia in Sydney. Picture: AAP

The major banks’ earnings won’t fare well if further official interest rate cuts are deployed to stimulate a slowing economy, banking analysts have found.

Easing economic growth and competition for mortgage customers amid slower demand for housing do not bode well for the sector, analysts at Macquarie Group and Morgan Stanley pointed out in separate research notes on Friday.

Macquarie’s macro strategy team expects two rate cuts in 2019 by the Reserve Bank of Australia. The cash rate already sits at a record low 1.5 per cent, but the central bank has signalled it is open to easing rates further if challenging economic conditions warrant it.

Macquarie’s analyst Victor German cautions rate cuts are not conducive to bank earnings growth.

“Our analysis highlights that higher bond yields and stronger economic growth have generally been accompanied by robust banks earnings growth. Conversely, in a low-growth environment, banks’ earnings growth moderated,” he said.

“Banks’ earnings grew by an average of about 11 per cent between 1996 and 2007, while the growth rate between 2008 and 2018 averaged about 2 per cent. In our view, this should be reflected in banks’ valuations, and therefore a higher level of discount relative to the broader market is justifiable.”

Even so, Mr German expects relatively higher dividend yields than industrial stocks will maintain interest in bank stocks.

“Banks’ dividend yields of about 6.5 per cent appear highly attractive in the current low- interest rate environment,” he said.

“Banks currently offer a circa 2.5 per cent yield premium to industrials, which is about 1.3 per cent above the long-term average and above global peers (excluding Sweden) …

“While we continue to expect Australian banks to maintain their return superiority to global peers, fragile economic outlook and ongoing competitive tension leave them at risk.”

Morgan Stanley banking analyst Richard Wiles is also treading cautiously on the sector, estimating 2019 net interest margins will be 5 basis points lower than a year earlier due to customer switching and official interest rate cuts.

“The market is now fully pricing in a cut by August this year, although our Macro+ team expects a more reactive response with the first cut in November 2019 and another in February 2020,” he said.

“Rate cuts would increase margin pressure due to lower earnings on equity and no/low-cost transaction accounts. All else equal, we calculate every 25 basis point rate cut reduces margins by about 2 basis points to 3 basis points and earnings by circa 1.5-2.5 per cent, although hedging via replicating portfolios delays the full impact.”

Morgan Stanley is also closely watching the banks’ pricing of term deposits, as rate cuts may crimp margins on those products.

“With interest rates already at record lows and the savings rate falling to about 2.5 per cent, banks risk weaker deposit growth if they cut TD rates further. In fact, we doubt that the majors would cut Australian TD rates by a full 25 basis points in response to an RBA rate cut, resulting in some squeeze of TD spreads.”