Banks: With the RBA set to dance, we take a cautious stance

About the author:

Azib Khan
Author name:
By Azib Khan
Job title:
Former Senior Analyst
Date posted:
27 April 2022, 12:00 PM
Sectors Covered:

  • Shifting to more cautious sector stance with rate rises looking imminent.
  • National Australia Bank Ltd (ASX:NAB) elevated to preferred major bank exposure for time being.

Wary of risks associated with rising rates

While we expect a rising interest rate environment to generally be supportive of major bank margins in net terms, the next few points outline why we believe such an environment will not be a walk in the park for the banks.

Although a rising official cash rate will benefit bank Net Interest Margins (NIM) through interest-rate-insensitive deposits and free funds, we expect this tailwind to be partially offset as Term Funding Facility (TFF) drawdowns are refinanced with conventional sources of funding, term deposit rates normalise, the customer deposit mix shifts unfavourably due to migration from at-call deposits to term deposits, and deposits potentially flow out from the banking system.

Higher interest rates will likely place downward pressure on asset prices and credit growth.

Higher interest rates will increase the risk of asset quality deterioration.

Rising risk-free rates will place upward pressure on the cost of equity. ▪ From a dividend yield perspective, we expect downward pressure on valuations as we expect dividend yields to become less attractive relative to rising risk-free rates.

Changed order of preference reflects near-term stock-specific dynamics

We downgrade our recommendations on both Westpac Banking Corp (ASX:WBC) and Australia & New Zealand Banking GrpLtd (ASX:ANZ) from Add to Hold and elevate National Australia Bank Ltd (ASX:NAB) to our preferred major bank.

We emphasise that these changes have been driven by near-term factors, and we will monitor our ranking actively.

We continue to believe that WBC’s stock offers compelling long-term value despite share price strength over the last five months. However, it has been disappointing to see that WBC’s Australian investor home loan book has continued to shrink post FY21 according to APRA statistics.

We believe this contraction is being partially driven by WBC’s business bankers being focused on remediation issues; we had hoped these issues would be resolved by now. We suspect the remediation issues are also hampering WBC’s Australian business loan growth.

This is of particular concern in the near term as investor and business lending are two relatively high-margin areas of lending. We expect WBC’s share price to broadly track sideways until these issues are resolved.

Whilst ANZ’s Institutional business provides it with potentially strong leverage to rising rates, ANZ’s Australian home lending continues to disappoint in terms of growth.

Moreover, it appears the limited growth ANZ is achieving is being driven by less complex, low-margin home loans. We consequently see risk of ANZ disappointing in the near term by way of loan growth and margin performance.

Although we believe NAB is being priced for perfection at this point in time, good operational performance relative to peers will likely be supportive of relatively stretched valuation multiples in the near term.

We remain mindful of the risk of an AUSTRAC-related civil penalty for NAB, and we point out the risk of SME credit losses outpacing home lending losses upon a macroeconomic downturn.

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Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.

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