Banks yet to feel economic pain as higher rates lift profits

PwC’s banking and capital markets leader Sam Garland says: “With rising interest rates, all else being equal you would expect that 2023 is going to be a good year for the banks.”

Portfolio manager at Opal Capital Management, Omkar Joshi, says conditions are unlikely to get much better for the Australian banks, though lenders could continue benefiting from rate rises for a while yet. “It can stay good for a while, but we’re definitely close to as good as it gets, if we’re not already there,” he says.

There are of course some pressures on profits as well, such as the stiff competition for mortgages. NAB’s digital offshoot UBank last week launched a cashback deal of $6,000 – despite CEO Ross McEwan’s comments not to pursue aggressive growth mortgages – in a sign of the battle to woo borrowers.

The market expects that as interest rates continue rising, more consumers may hunt down better deals interest rates for savings accounts or term deposits, which will cost banks more.

But Morningstar analyst Nathan Zaia says he assumes margins will be higher in a year’s time, even if more people move money into term deposits. “The benefit they got from rising interest rates – we’ve only seen part of that flow through to their earnings results. I think there’s still some upside.”

Low bad debts

Another striking feature of the recent results is the very low level of delinquent loans. Westpac, for example, said a tiny 1.07 per cent of its total loan portfolio was stressed, even though this number would inevitably rise.

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Over the long term, big banks have on average worn annual expenses of $3 billion to $4 billion for bad loans. But this year, PwC reports provisions for bad debts delivered a $133 million benefit to the banks’ profits, rather than being a cost.

Again, this trend is bound to change. Experts say the sharp interest rate rises this year will inevitably cause bad debts to rise – but that might not become apparent until about mid-way through next year.

Morningstar’s Zaia highlights the lag between interest rates increasing and banks experiencing rising bad debts, which generally tends to happen when unemployment rises. Reflecting the views of many in the market, he tips bad debts to return to a more normal level, rather than rise dramatically.

Whether the market’s relatively upbeat view turns out to be accurate will depend largely on economic conditions, which are widely expected to slow into 2023.

All up, however, investors appear to be betting that even if the economy does weaken notably, the banking giants will be able to ride it out without feeling too much pain.

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