Australian Banks: Upside From Higher Rates Limited by Competition but Some Opportunities Remain

The short-term outlook for Australian banks is challenging with margins under pressure, loan losses expected to rise, and inflationary cost pressures unable to be offset by cost-cutting initiatives. Industry returns on equity are suppressed, hence we expect loan and deposit-pricing changes in the medium term to lift margins to a level that allows wide-moat-rated major banks to generate returns above our 9% cost of equity.

We think Westpac and ANZ Group are the best value of the majors. Commonwealth Bank shares underperformed major bank peers in the September quarter but remain expensive given industry-leading share and profitability. Bank of Queensland shares lifted modestly during the quarter but fell after its fiscal 2023 result, we think the market is too pessimistic on margins and costs beyond fiscal 2024. MyState is the cheapest name we cover. Despite material margin pressure, we think earnings growth will come from market share and cost-efficiency gains.

ANZ Group continues to grow ahead of the market in home loans, with Westpac’s quarterly performance a notable turnaround. The improvement is driven by price and cash-back offers, with broker approval process enhancements still in progress. Commonwealth Bank appears focused on margins over volumes. But we suspect if competition remains elevated, Commonwealth Bank will price to hold share.

Major banks comfortably meet capital requirements with common equity Tier 1 ratios between 11.9% and 12.3%, well above the 10.25% minimum and top end of an 11.5% target. Banks are likely to take a conservative approach to balance sheet risk and capital management given the prevailing economic and regulatory uncertainty. Despite this, Commonwealth Bank and National Australia Bank are buying back shares.

For more details please see our “Industry Pulse: Australian Banks 2023 Q3″ published Oct. 12, 2023.