‘Unprecedented’ profits pull punters back to bank stocks

Holding deposit account returns at rock bottom rates is boosting the big four banks.

In a recent note on ANZ, broker Morgans had estimated the bank would pay an 8 per cent yield (after franking) this year. Picture: Arsineh Houspian.

Australian banks are sitting on “unprecedented profitability” as the sector defies a housing downturn and enters the new year making money from vast amounts of cash sitting in low yielding accounts.

Consensus broker forecasts for the year ahead suggest that bank stocks will manage a 20 per cent lift in revenues as the rate rise cycle continues to kick directly into bank profits.

At the heart of the rebound are bank interest margins, which improve every time the RBA lifts rates.

Moreover, as rates rise the gap between official rates – now at more than 3 per cent – and the rates that banks pay depositors widen, further boosting bank profit margins.

UK-based fund manager Martin Currie Ltd says Australian bank stocks have come full circle to enjoy a material tailwind. Matthew Davison, portfolio manager at Martin Currie Australia, says: “We are now seeing an almost unprecedented top line profit growth from the banks”.

Davison says the banks’ ability to leverage their deposit pricing power is an outstanding factor in the local market.

KPMG’s annual banking result review also points to the benefits of rising rates for local bank stocks: “Behind the improved profit performance, we are starting to see the impact of rising interest rates, driving an increase in average net interest margin (NIM) … demonstrating that the benefit of rising interest rates is only just starting to flow through to bank profitability.

“This comes after over a decade of extremely low interest rates which had created prolonged pressure on the majors’ margins, which are now beginning to rise from a low base,” says KPMG. The major banks posted cash earnings per share ranging between 6 and 12 per cent last year.

Westpac has been the biggest winner, with a share price improvement of 12 per cent over the last 12 months against a flat performance on the wider ASX 200.

Without a doubt, the “pick” of bank stocks among brokers for 2023 is ANZ, for the simple reason it did not get the lift its big four rivals received in the last six months.

ANZ remains 13 per cent below its price a year ago. The bank underperformed on many fronts in early 2022 and then received a mixed reaction from the market for its plan to buy Suncorp’s banking unit. However, there is clear support for the stock in the market among major brokers: In a recent note on ANZ, broker Morgans had estimated the bank would pay an 8 per cent yield (after franking) this year.

True to form, Commonwealth Bank is the most expensive of the banks and its modest increase over the last 12 months of just 6 per cent reflects its position as a quality stock in the sector.

It remains an open question how long the major banks can get away with offering such low deposit rates when official rates have risen so strongly. Bank analysts suggest that under these conditions the big four banks should be able to extract about 0.1 per cent margin improvement for every 0.5 per cent lift in the official cash rate.

The majority of bank deposit money is in at-call bank deposits which pay rock bottom rates. The sheer profitability of low-rate deposit accounts among the major banks has even led to key players being willing to lose customers rather than offer them competitive deals.

Bank industry data shows all four major banks have regularly lost market share for deposits – their combined share is down from near 80 per cent to around 75 per cent.

Research from the Australian Prudential Regulation Authority in the second half of 2022 shows that both ANZ and Westpac suffered a net outflow of deposits in the month of August as customers switched money to Approved Deposit Taking institutions that offer better rates.

Davison at Martin Currie says: “There is a sense that the very best stretch of this rebound may have passed and at some point the challenges of refinancing mortgages will kick in – but it looks pretty good until at least mid-year.”

The strong operating performance among the banks should ensure bank stocks deliver equally strong dividends during 2023 as payout ratios are considerably lower than they were three years ago.