Citi and Macquarie debate the future of the Big Four’s earnings

The recent decision of the Reserve Bank of Australia to pause rate hikes was greeted with cheers in living rooms around the country. But the end of rate hikes also poses an issue for the major banks, who rely on those rate increases to fuel margin growth. In a sector that is already incredibly competitive, this should not be good news for bank shareholders… or is it?

In two notes published this week, Citi and Macquarie are decidedly at odds about whether the peak in net interest margins will translate to the end of the best times for banking earnings at all. This article will summarise their views.

Citi’s argument: Revisions are due but won’t be massive

Citi is forecasting the RBA to have halted cash rate hikes for this cycle at its current level (3.6%), adding it expects them to keep it there until rate cuts arrive next year. This is a view decidedly shared by the rates market, as the ASX OIS curve demonstrates.

If this is borne out, that would imply the next set of Big Bank earnings (due next month) are likely also going to be the peak for net interest margins.

“The peak cash rate signals an end to the material benefit from low-rate deposits,” argue Citi analysts.

But unlike its compatriots, Citi believes the impact of stable to lower net interest margins will only come in FY24/25 for technical reasons.

“We expect a more meaningful NIM decline from 2H24-2H25, as asset yield compression persists, TD margins and switching reverts, and TFF is repaid with more expensive wholesale costs,” analysts wrote.

For now, the downward earnings revision is anywhere between 5 to 10% with smaller banks taking a larger hit. They also argue that the higher quality bank earnings will come down to asset quality.

Citi’s favoured plays are ANZ (ASX: ANZ), Westpac (ASX: WBC), and newly upgraded Bendigo and Adelaide Bank (ASX: BEN) on valuation grounds. In contrast, today’s $200 million writedown from the Bank of Queensland (ASX: BOQ) supports Citi’s view that the regional lender may miss expectations on margins and earnings. Only Commonwealth Bank (ASX: CBA) has a SELL rating attached to its name.

Macquarie: Forget FY24, the downgrades will come later this year

Macquarie’s note, aptly entitled All Quiet on the Banking Front, argues that earnings downgrades could come as soon as the second half of this year. Its main reason is because margin pressures have already been bubbling under the surface despite what should have been a rosy time.

“Ongoing mortgage competition, increased deposit pricing, and reduced benefit from replicating portfolios led to downgrades beyond 1H23,” analysts wrote.

The sector already attracts an underweight view, but analysts accept there is potential upside risk to these share prices come the reporting period.

“We expect banks to guide to lower margins in 2H23 (we are ~5-10% below consensus in FY24). Tactically, with exit margins possibly looking better than the readthrough from CBA (given different management pricing tactics), we see potential upside risk to share prices in the upcoming reporting season,” analysts said.

Their order of preference is ANZ, NAB (ASX: NAB), WBC, CBA. Only ANZ has an OUTPERFORM rating, with the rest attracting NEUTRAL or UNDERPERFORM ratings.

This article was first published on Market Index on Friday 14 April 2023.