Macro Intelligence: profitability peaks for Australia’s big four banks amid market shifts

Article written by Nadine Blayney (ausbiz)

Banking business

The ‘big four’ banks are a dominant force in the Australian market, as evidenced by Commonwealth Bank of Australia (ASX: CBA) recently becoming the most valuable company on the ASX, displacing mining giant BHP (ASX: BHP). Australian listed banks are major drivers of the country's S&P/ASX 200, making up 30% of the index.

Australia’s big four banks are amongst the biggest, safest, and most profitable in the world. In the last full year, Australian banks made $31.99 billion in profit, an increase of 8.2%. The economic backdrop has been mostly positive for the big banks, with borrower stress failing to dent bank earnings. Bank buffers against rising arrears are proving sufficient.

That—combined with low unemployment, a tight rental market, and rising house prices—is keeping loan losses at bay, according to Morningstar.

Market movements and ownership trends

Major bank share prices are up around 26% since November 2023. Offshore ownership of banks continues to rise, although incremental buying is moderating, according to Jarden analysts. Locally, they say institutions are net buyers of banks, which could be driven by index funds buying.

Meanwhile, Jarden reports that retail shareholders were net sellers of domestic banks in the June quarter, which leaves three of the four majors now having the lowest retail ownership on record.

Share price trends: major banks vs. Morningstar Australia Index

Competitive dynamics and profit drivers

The business of banking is volatile, and Australian banks have been through a period of intense competition for mortgages, offset by higher interest rates driving deposit profitability.

While still a competitive marketplace, it is expected that mortgage competition will ease with lower refinancing activity resulting in lower loan lives. Macquarie, for one, expects this to improve mortgage profitability amongst the big banks.

Deposit growth and profitability challenges

All banks have seen growth in customer deposit balances since 2019, with Macquarie forecasting that the competition for deposits will intensify. It lists normalising deposit spreads as the key headwind for retail banking returns over the next three years.

Goldman Sachs also points to a contraction in deposit spreads over the past 12 months, despite recent stabilisation. When it comes to deposit growth, Goldman Sachs reports Westpac (ASX: WBC) has gained the most market share at +25 basis points, with CBA the laggard at -51 basis points.

On the plus side, Goldman Sachs analysts expect the migration of fixed to variable-rate mortgages to provide a tailwind for net interest margins (NIM) in the second half of 2024. Profitability headwinds for the big banks include slowing business and credit growth, inflationary pressures driving up operating expenses, along with continuing competition in mortgages and deposits.

All in all, Macquarie analysts say the banks need to manage their expenses tightly to improve performance and generate returns above the cost of capital.

Projected retail revenue and earnings growth for ANZ, CBA, NAB, and WBC

Analyst Skepticism and valuation concerns

When it comes to Commonwealth Bank, some analysts call the premium “puzzling,” including Nathan Zaia at Morningstar, who calls the bank “expensive.” He says on a forward P/E of over 20 times and a fully franked dividend yield under 4%, there is little room for disappointment.

CBA daily chart

ANZ daily chart

Comparative Valuations and Market Share

Morningstar says the valuation divergence for Commonwealth Bank of Australia, ANZ (ASX: ANZ), and Westpac is “stark,” with the price-to-book discounts ripe for unwinding if ANZ and Westpac hold market share and deliver similar earnings growth on a cheaper price-to-earnings multiple.

Macquarie analysts point to CBA's retail banking dominance, which has it generating retail banking income similar to that of all its peers combined. However, it says CBA earnings appear to be peaking, and they expect National Australia Bank (ASX: NAB) to deliver more robust retail earnings growth.

Westpac daily chart

NAB daily chart

Revenue shifts and future outlook

Jefferies says CBA is priced "well beyond perfection" and is now earning more from deposits than home loans. The investment bank says it's 1% below consensus on core profit, ahead of the Australian major lender's FY result in August. It has an ‘underperform’ rating on the stock. Commonwealth Bank reports full-year earnings on August 14.

Market sentiment: Commonwealth Bank vs. banking sector