Australian Economy

Australian banks expect better margins as interest rates rise

Australian banks can expect margins to improve further as interest rates rise from near-zero, but inflationary pressures will drive up costs and their asset quality could deteriorate if the economy slows.

Australia and New Zealand Banking Group Ltd., or ANZ, Westpac Banking Corp. and National Australia Bank Ltd., or NAB, reported year-over-year increases in their cash profit for the fiscal second half ended Sept. 30, helped by higher net interest margins compared to the previous six months. ANZ’s NIM rose to 1.68% in the second half of the fiscal year, versus 1.58% in the first half. NAB said its NIM in the half-year to Sept. 30 was 1.67%, from 1.63% in the previous half.

All three banks, however, reported lower NIMs for the fiscal year compared to the fiscal year ended Sept. 30, 2021.

The Reserve Bank of Australia cut rates in 2020, bringing its benchmark cash rate to a record-low of 0.10% by the end of the year to boost an economy that the COVID-19 pandemic has dragged down. It has raised the rate seven times in 2022, with the latest hike on Nov. 2 taking the benchmark to 2.85%. The rises came as global central banks tightened monetary policy to curb inflation. The U.S. Federal Reserve on Nov. 2 raised interest rates by 75 basis points for the fourth consecutive time this year, bringing the benchmark federal funds rate to between 3.75% and 4.00%.

“Margins are beginning to benefit from recent cash rate increases and better returns on equity and deposit investments, inflationary pressures are driving operating expenses higher, and credit stress remains low,” Nathan Zaia, equity analyst at Morningstar told S&P Global Market Intelligence. “We expect margins will continue to improve as rates continue to rise and fixed rate loans mature. Revenue growth should exceed both operating expense growth and a gradual increase in loan losses,” Zaia said.

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Rate cycle

Australian banks will likely benefit from the rate increase cycle “for a period of time,” ANZ CEO Shayne Elliott said during the bank’s Oct. 27 earnings call. The environment in the first half of the year that started on Oct. 1 will be supportive for margins, but “we expect any change from here to be more modest,” Elliott said.

NAB also expects further gains from higher interest rates in fiscal 2023. “We expect the benefit to NIM from cash rate increases to peak in the first half of 2023 with more modest upside thereafter,” NAB CFO Gary Lennon said during the bank’s Nov. 8 earnings call. NAB reported that its NIM rose to 1.72% in the fourth quarter, from 1.62% in the previous three months.

Still, banks flagged the possibility of the rapid increase in rates crimping loan demand, especially if the economy slows. With inflation still a concern the world over, most analysts and banks expect central banks to keep hiking, even if the pace of increases deteriorates.

“Cost-of-living pressures are starting to have a meaningful impact and the next six months will be testing,” ANZ’s Elliott said. “This is particularly an issue for first-time homeowners who are only starting to build up their equity as well as those with less stable employment.”

Inflation pressures

Westpac CEO Peter King warned in the bank’s Nov. 7 full-year results announcement that the impact of higher rates will be felt by consumers in 2023. “Housing prices have fallen in recent months and this will continue into 2023. Credit growth is expected to ease. GDP growth will slow and unemployment will rise,” King said.

The IMF expects economic growth to slow to 1.7% in 2023, from an expected 3.7% this year, and advised the nation’s authorities in a Nov. 15 report to continue with monetary and fiscal tightening to rebalance domestic demand and keep inflation expectations anchored.

“Inflation is likely to also continue to place pressure on the majors’ cost bases and, should interest rate rises continue at pace, the potential economic slowdown, increase in unemployment and falls in house prices could present a more challenging landscape for the majors,” audit and advisory firm KPMG said in a Nov. 9 report on the major banks’ full year results.

The Australian economy is strong and households have enough savings buffers to withstand the effects of higher rates, KPMG said. “These buffers may be tested in the coming months as the impact of rate rises begins to impact borrowers,” the report said.

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