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Australia's banks to face margin pressure from low rates as cheap funding ends


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Australia's banks to face margin pressure from low rates as cheap funding ends

Australia's biggest banks are flush with surplus capital from asset sales and government support in the pandemic year, but they cannot outrun the drag from low interest rates, analysts say.

The nation's big four — Commonwealth Bank of Australia, Australia and New Zealand Banking Group Ltd., National Australia Bank Ltd. and Westpac Banking Corp. — accumulated surplus capital in 2020 and have now started to returning some of it to shareholders via higher dividends and share buybacks. The Reserve Bank of Australia's Term Funding Facility, or TFF, provided A$200 billion in cheap funding to the banks and the sale of many noncore businesses brought in cash, greatly boosting their capital ratios and profits.

Their earnings will likely reflect the effects of weakening net interest margins through this year amid record-low interest rates that are likely to stay as the COVID-19 pandemic continues.

"The low lending rates have been offset by a flood of cheap customer deposits and access to the TFF, but that tailwind is running its course. All banks pointed towards margins being under pressure in the next 12 months, especially if demand for fixed-rate loans remains so high," said Nathan Zaia, an equity analyst at Morningstar.

Earnings drag

Commonwealth Bank of Australia, or CBA, which reported its full-year results on Aug. 11, said it expects "a number of headwinds to impact group NIM in the next financial year." The biggest Australian lender by assets identified the continuing low-rate environment, increased competition, customers switching to fixed-rate home loans and higher deposit rates as factors that would drag on NIM. Its NIM slipped to 2.03% in the fiscal year that ended June 30, from 2.07% in the previous year.

Westpac, which follows a different calendar, said in its third-quarter trading update on Aug. 17 that its NIM in the second half of fiscal 2021 may be lower than in the first. It earlier reported that NIM in the first half ended March 31 was 2.06%, down from 2.21% in the prior-year period.

The banks' profits got a boost from the TFF support, despite the overall fall in margins, said Martin North, principal at Digital Finance Analytics. "[The] truth hurts with these results," North said.

Funds under the TFF window came at the benchmark lending rate. The Reserve Bank of Australia had reduced its benchmark cash rate by 70 basis points to 0.10% over 2020. The TFF window closed in June.

Strong balance sheets

CBA plans to buy back up to A$6 billion of shares, while Australia and New Zealand Banking Group, or ANZ, and National Australia Bank, or NAB, offered to purchase A$1.5 billion and A$2.5 billion of shares respectively. Westpac said it will consider a return of capital, with an update at its full-year results. ANZ also released a provision charge of A$32 million.

The drag on NIMs notwithstanding, the Australian lenders' financial health remains robust. The banks believe the economy is set for a strong rebound once lockdowns in some parts of the country end, as companies are well capitalized and liquid. Pressures on the housing market have also eased with fewer home loan customers seeking deferrals. The central bank has decided to press ahead with its planned tapering of bond purchases to A$4 billion per week from September, from A$5 billion at present, on hopes of an economic recovery.

"It looks like all of the banks are quite well capitalized and there hasn't been any meaningful uptick in loan losses so far," said Omkar Joshi, principal and portfolio manager at Opal Capital. "Obviously, the current lockdowns do pose an element of uncertainty, but for now the banks appear to be in a good position," Joshi added.