Goldman Sachs: What’s ahead for the banks (and which 2 are rated BUY)

Australia’s big four banks remain well-capitalised but NIMs and credit growth are yet to trough and cost pressures are sticking around, according to Goldman Sachs' latest review of the major banks.

The report preceded the Westpac (ASX: WBC) full-year 2023 earnings result, which is due on 6 November 2023. Westpac is followed by National Australia Bank (ASX: NAB) on 9 November, ANZ Group (ASX: ANZ) on 13 November and Commonwealth Bank (ASX: CBA) on 14 November.

Goldman Sachs Australia analysts Andrew Lyons and John Li believe the following six themes will dominate the upcoming results:

• Margins – expects these to be about 6 basis points lower in the second half of FY23, expecting commentary on mortgage competition.
• Bad debts – costs from these to rise to 13 bps, up from 9bp in the prior half.
• Expenses – Rising costs are the big four’s greatest risk for FY23, with Goldman Sachs forecasting an average 5% increase in the three years to FY2025.
• Volumes – Housing and business credit growth to “trough” at around 4% in calendar year 2024.
• Capital management – No buybacks expected from CBA or National Australia Bank, ANZ awaiting the finalisation of its Suncorp acquisition, and Westpac is tipped to favour reinvestment into its franchises over buybacks.

“Across the majors, we currently forecast margins to trend lower by 6 bp in 2H23 sequentially driven primarily by headwinds from competition and higher funding costs,” said the Goldman Sachs analysts.

They expect ongoing falls across net interest margins (a metric that reveals the amount of money earned on loans versus what is paid out in interest on deposits).

Further highlighting the importance of this metric, the analysts noted that: “every 5-basis point move in our Australian/group NIM forecast moves sector FY24E NPAT by between 4% and 5%.”

Across the banks, excluding CBA, they anticipate NIMs to fall a further 4 basis points for both ANZ and Westpac and 8% for NAB.

The effect of rate rises defied expectations

With the rising cash rate remaining a key focus in 2023, GS noted that the broadly held view that this would benefit the banks hasn’t played out as many anticipated.

“To date, this benefit has been muted by the intense competition across the sector in both asset and deposit pricing,” said the Goldman analysts.

In essence, the intense competition for mortgages meant banks were barely recouping their cost of capital on new loans – in some cases, issuing mortgages below the cost of capital.

This is reflected in recent commentary from each of the banks, including:

• ANZ: “Competition for Australian deposits has become as, if not more, competitive than Australian home loans,” was a recent standout for the Goldman analysts.
• CBA: “While there has been some improvement in mortgage profitability…margin pressure from home lending will continue in FY24.”
• NAB: The most positive of the three in this regard, “some very tentative signs in the early part of 2H23 that this back-book pressure was alleviating.”
• WBC: “Competition on mortgages will have the highest impact on margins in 2H23 and expects there will be continued deterioration”

In business lending, the Goldman report notes competition was far less intense for banks than within consumer lending. This means the fee banks earn on business loans will be only a small “headwind” in the second half of FY23 and should become a tailwind in FY24.

Bad debts also surprised

We all read about the looming “mortgage cliff” as the RBA began hiking rates last May. But the Goldman Sachs report noted that longer-term averages of bad debt charges have held up better than many anticipated.

“Asset quality has continued to outperform expectations across virtually all metrics and provisions levels have generally remained well above pre-COVID levels,” the Goldman analysts said. They highlighted the following commentary:

ANZ: “No material signs of a deterioration in housing asset quality, which management put down to high savings buffers, manageable debt servicing (with over 60% of customers being ahead on mortgage repayment)”

NAB: Anecdotal evidence indicated “only a very small number of borrowers are actually having difficulty with debt serviceability in the face of higher rates.”

WBC: Only 0.6% of loans were experiencing “negative equity,” down from 0.8% in the March quarter, and 31% of loans were more than two years ahead on mortgage payments.

Costs are banks’ biggest concern

The Goldman analysts noted underlying cost growth of 0.9%, 2.9% and 4.7% across Westpac, NAB and ANZ.

“Our recent rounds of meetings with bank management teams have highlighted that pressure on costs is likely to continue through FY24.”

Goldman anticipates cost growth will average 5% across the banks in the next three years through to FY2025.

“In our view, the key to offsetting these inflationary pressures will be the banks’ ability to deliver productivity improvements, (NAB appears to have had the strongest performance in recent years).”

Credit growth outlook across mortgages, business lending

The Goldman Sachs report noted that August 2023 marked the tenth consecutive monthly slowdown of credit growth across Australia’s banks, falling to 5% from 8.9% in October 2022. And the analysts’ base case of one more cash rate increase from the RBA “should drive housing credit growth down even further.”

The report alludes to recent ABS data showing that new mortgage approvals were down around 22% in the 12 months to the end of July 2023.

“We, therefore, remain comfortable with our system forecasts, where we expect to see year-on-year growth trough at 4.0% in Dec 2023, before recovering to 4.4% by Sep-24, and thereafter settling at our long-term forecast of 3.6% by Sep-26,” said the Goldman Sachs analysts.

Capital remains in surplus

In terms of capital, each of the big four remains in surplus and well ahead of their Common Equity Tier 1 requirements.

ANZ: 3Q23 CET1 ratio was tracking at 13.5%. “Management…is considering the best use of capital, including investing in additional growth opportunities or returning excess capital to shareholders (above its regulatory requirements)”

NAB: 3Q23 CET1 ratio was 11.9%. Into the second half of 2023, Goldman analysts forecast NAB’s CET1 at 12.21%, and expect it to pay 83 cents a share final dividend, reflecting a payout ratio of 68% (inside management’s target of between 65% and 75%).

WBC: “3Q23 CET1 was 11.9% and management continues to target an operating range of 11.0-11.5%...into 2H23, we forecast WBC’s CET1 at 12.02%, expect it to pay a 70-cent final DPS (payout 79%)”

How Goldman Sachs rates the banks

ANZ Bank remains Goldman Sachs’ pick of the big banks, with a BUY rating and a price target of $27.38. ANZ shares were trading at $24.87 at the market close on Wednesday 1 November.

National Australia Bank is also a BUY, with a price target of $28.32. NAB’s share price closed at $28.16 on Wednesday 1 November.

Westpac is rated NEUTRAL, with a price target of $20.80. WBC shares closed at $20.74 on Wednesday.

Commonwealth Bank is rated SELL, with a price target of $81.68, a 16% discount to its $96.87 closing price on Wednesday.