Banks: FY22 reporting season preview

Author name:: By Nathan Lead
Job title:: Senior Analyst
Date posted:: 19 October 2022, 7:30 AM
Sectors Covered:: Infrastructure, Utilities, Banks

We expect financial performance over the short term to benefit from the sugar hit of rising interest rates, excess liquidity, and a benign credit risk environment. The outlook further out is increasingly uncertain given the speed (and lagged impact) of interest rate rises, inflation spike, and maybe weaker credit conditions.
Our order of preference is Westpac Banking Corp (ASX:WBC) (highest potential ROE improvement vs cheap multiples), National Australia Bank Ltd (ASX:NAB) (broad business momentum, ROE improvement), CBA (highest quality but expensive), and Australia and New Zealand Bankng Grp Ltd (ASX:ANZ) (business banking and NZ exposure but M&A uncertainty). Note a change of primary analyst on the sector.

Continued strong Australia system growth heading into FY22 results

RBA data indicates system housing and business credit growth of c.3% and c.7% respectively (Apr-Aug vs Mar-22), while APRA showed deposit growth of c.5% (households c.3%).

Of the major banks, within the household market NAB had the greatest growth albeit supported by the Citi acquisition, while Commonwealth Bank of Australia (ASX:CBA) grew deposits fastest. Macquarie outpaced them all in home loan and deposit taking, albeit off a lower base. We assume growth weakens through to 2024 before returning to trend.

Likely FY22 reporting season thematics

FY22’s stand-out thematic was the rise in RBA cash rates (increased on average by 100bps from 10bps, exited at 2.35%). Average 90 day BBSW had a greater lift (+160 bps), with even higher increases further along the yield curve. The yield curve implies a further significant rise into 2023 (our terminal rate is 3.8% pa).

The rise in rates should bring a sugar hit to net interest margins (NIM), as earnings on variable rate assets and replicating portfolios lift, while components of a banks’ funding base are either insensitive or have delayed reaction to higher market rates.

As the lagged impact of the RBA cash rate rises takes affect, it will likely slow system loan growth, increase potential for loan losses (we factor in earnings headwind beyond FY22 from reversion to long run expensing albeit asset quality is strong at present supported by low unemployment), and encourage a transition away from low cost at-call deposits towards term deposits (impacting NIM).

Other influences on the NIM will be the ongoing intense home loan competition (RBA data shows new fundings are 30-50 bps cheaper than the back book), the refinancing of the RBA’s TFF across 2023-24, the wave of low fixed rate expiries on home loans peaking in mid-late 2023, and the degree of system excess liquidity.

The banks will not be unscathed from the surge in CPI in 2022 that has driven the cash rate increase. Perhaps it won’t be as evident in 2H22 performance, but watch for comments on how it is expected to filter through to costs (particularly wage growth), risk (customer credit strength) and lending growth (lending confidence, borrowing capacity and serviceability).

Regulatory capital adequacy ratios will likely be affected by rising interest rates. We can see capacity for further buybacks through to FY25 for each bank, albeit these may be paused until the impact of both APRA’s revised capital adequacy framework (applicable Jan-23) and tighter monetary policy is absorbed.

Forecast and valuation update

Compared to previous forecasts, our modelling assumes a scenario of higher asset base, NIM, operating cost, and expected credit loss expensing growth. We also assume higher discount rates within our NPV estimates as well as give value to franking credits attached to forecast dividends.

Given current share prices, our dividend forecasts imply ANZ, NAB, and WBC may be yielding in the c.8% range and CBA at c.6% (with franking).

ANZ target price reduced to (login to view), CBA lifted to (login to view), NAB reduced to (login to view), and WBC lifted to (login to view) per share. Our valuations are DCF based which we cross check against PER and P:BV multiples implied in the current share prices.

Price catalysts

FY22 result dates are: ANZ (27-Oct), NAB (9-Nov), and WBC (7-Nov). CBA Q1 trading update and regulatory capital disclosures on 15 November.

Key economic data releases and RBA policy cash rate changes. Monthly APRA and RBA lending and deposit balance and interest rate data releases.

Risks

Interest, and inflation, and foreign exchange rates. Credit risk (key considerations being unemployment and value of collateral).

Competition for loans and deposits. Wage and cost inflation. Regulatory risk. Liquidity and funding risk.

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