Bank profit margin crunch to continue as customers shift deposits

Bank profit margins will continue to dwindle in the first half of this financial year according to analysts who point to customers shifting their savings into higher-interest offerings, as well as robust mortgage and deposit competition.

National Australia Bank, Westpac and ANZ Bank will rule off the first half of their financial year at the end of this month, capping off a six-month period in which competition for deposits and loans has squeezed returns while share prices have surged.

Morningstar senior equity analyst Nathan Zaia said the next set of bank results would see margins coming down for the big four banks.Credit: Paul Rovere

As banks jostle for position in the mortgage market, figures this week from the Australian Prudential Regulation Authority also showed ANZ continued to expand its mortgage book faster than rivals in February, while maverick competitor Macquarie also lifted its share in home loans.

UBS head of Australian bank research John Storey said while the degree of competition in home loans had lessened there would likely be a continued decline in bank margins, especially as larger swathes of customers moved their money into higher interest rate products such as term deposits.

“Competition for mortgages and deposits is still incredibly intense, so there will continue to be margin pressure across the banks,” he said, noting consensus estimates among analysts were for margins to contract by roughly 9 to 10 basis points.

Banks’ net interest margins – a measure of profitability comparing banks’ funding costs with what they charge for loans – have been under pressure for some time amid intense competition for home loans including heavy discounting and a period in which banks were offering ultra-cheap mortgages.

Despite this, shares in NAB, Westpac and CBA have risen by close to 20 per cent in the last six months, while ANZ shares have gained almost 15 per cent over that period. As bank share prices continue to nudge record highs, all eyes will be on their profit margins when NAB, ANZ and Westpac report their half-year results in May. CBA, which runs on a June financial year, reported a decline in margins at its half-year results last month.

“There’s definitely a bit of a disconnect between underlying and expected financial performance of banks and their share prices,” Storey said.

Morningstar senior equity analyst Nathan Zaia said the big four banks were generating decent returns, but that credit growth remained in the low single digits and that their margins remained squeezed. “The next set of results will still see margins coming down for the major banks,” he said.

Zaia said the pressure on margins came from both robust competition in both mortgages and deposits.

“Mortgage competition will still be a factor,” he said, looking ahead to the next set of bank results. “And I think we’re still going to see a bit more switching on the deposit side out of transaction accounts and into higher-interest customer deposits.”

In February, Australian household deposits grew by $6.2 billion to a record high of $1.46 trillion. Since the beginning of the interest rate hiking cycle by the Reserve Bank of Australia, household deposits have risen by more than 15 per cent according to RateCity.

Household deposits are a major source of funding for the banks, but are more expensive relative to some other types of funding, including the Term Funding Facility (TFF) which offered low-cost funding to banks in response to pandemic, and is expected to be paid off by July.

While mortgage competition has remained relatively intense, Zaia said at some point, it would probably soften, especially as smaller, regional banks such as Bendigo and Adelaide Bank and Bank of Queensland have struggled to grow their home loan books in line with the market.

Late repayments – an indicator of borrower stress – remain lower than pre-COVID levels.Credit: Peter Rae

“I don’t think home loan competition has gotten any worse,” he said. “But I think at some point we’ll see the level of competitiveness on mortgages ease.”

Zaia said smaller banks more broadly were having a tougher time compared to the major banks.

“Their returns on equity have always been lower,” he said. “But in this period where margins have been squeezed, they’re below what we think is reasonable for shareholders.”

Zaia said late repayments – an indicator of borrower stress – remained lower than pre-COVID levels as a result of cash buffers saved up by households during the pandemic, low unemployment and strong house prices, but that arrears were ticking up.

“I would expect arrears to normalise at some point,” he said. “People are cutting back spending to be able to repay their loans, but it’s not sustainable forever.”

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