Tailwinds are all blown out for Australia’s big four banks, says Morgan Stanley

Morgan Stanley says the outlook for Australia’s big four banks has dimmed, with the earnings upgrade cycle of the last 12 months having run its course.

There were headwinds aplenty called out in the investment bank’s recently released banking sector update. The all-important net interest margin is expected to peak earlier than previously thought and at a lower level, as all four face declines throughout 2023 and into 2024.

This margin decline is exacerbated by tighter competition in the lower interest rate environment. The Morgan Stanley equity analysts – Richard E. Wiles, Sally Hong, Charlie Hall, Andrei Standnik, and Sally Zhou – expect the average margin of the big four to increase around 17 basis points in FY2023 but see a fall of around 8 basis points in FY2024.

“Key headwinds include ongoing home loan discounting and refinancing, mortgage cash-back and broker commissions, increasing deposit competition, an unfavourable mix shift, and Term Funding Facility (TFF) maturities,” write the analysts in the Morgan Stanley update, which is ominously titled, No More Tailwinds.

The prospects of loan growth aren’t likely to improve in 2023 or 2024, as the strong business loan and housing loan growth of 2022 rolls off. Downward pressures here are driven by a combination of:

• The economic slowdown

• Ongoing rate hikes

• Falling house prices

• Higher mortgage serviceability hurdles.

Costs are still high across major banks, with only Westpac pursuing a meaningful shift in its approach via a “Cost Reset” initiative. Morgan Stanley expects average expense growth of around 5% across the big four banks in FY2023.

Loan losses are also tipped to rise, even given Morgan Stanley’s base case for a soft landing in Australia. The investment bank sees double-digit earnings headwinds in each of the next two financial years, with forecast loss rates of 16 basis points and 29 basis points in FY2023 and FY2024.

Unsurprisingly, dividend payout ratios are also expected to remain static and large buybacks look unlikely.

Westpac Banking (ASX: WBC)

Rating: Overweight

Price Target: $23.70

WBC 12-month share price. (Source: Market Index)

Morgan Stanley is positive on Westpac’s expanding margins in FY2023 in response to higher rates and the steeper yield curve. The broker also emphasises the bank’s:

• focus on improving franchise performance,

• cost reductions,

• lower risk profile relative to peers,

• recovery of earnings and return on equity,

• lower investor expectations.

But challenges include the need for strong execution, the difficult economic environment, and the impact of higher inflation on costs.

Westpac’s share price closed at $22.38 on Thursday 9 March.

ANZ Group (ASX: ANZ)

Rating: Equal-Weight

Price Target: $26.20

ANZ 12-month share price (Source: Market Index)

With the lowest exposure to mortgages among its big bank peers, Morgan Stanley also it is currently trading at a discounted PE multiple. 

But on the downside, the team also points to challenges, including:

• Margin headwinds

• Higher cost growth

• Potential for some nasty surprises, including acquisition risks and management changes

• Weaker economic outlook, including from its New Zealand exposure.

ANZ shares closed at $24.49 on Thursday 9 March.

Commonwealth Bank (ASX: CBA)

Rating: Underweight

Price Target: $85 

CBA 12-month share price (Source: Market Index)

Key considerations underpinning Morgan Stanley's view on CBA include:

• High PE multiple, despite lower growth and the higher interest rate environment

• Elevated investor expectations, and

• An outlook for slower earnings into FY2024.

But on the upside, Morgan Stanley points to the bank’s strong track record, well-positioned digital banking business, solid capital position, and sustainable payout ratio.

The CBA share price closed at $98.72 on Thursday 9 March.

National Australia Bank (ASX: NAB)

Rating: Equal-Weight

Price Target: $30

NAB 12-month share price (Source: Market Index)

Morgan Stanley outlook for NAB is underpinned by the bank’s clear strategy, medium-term focus, and growing track record of execution. It sets a price target of $30 a share.

The broker cites the bank’s improving return on equity, good recent operating performance and margins, and healthy provisioning. It is also buoyed by the bank’s ongoing $2.5 billion buyback.

On the downside, Morgan Stanley calls out elevated investor expectations, slowing loan growth outlook for FY2023 and higher costs ahead. It also cites NAB’s business mix, which leaves it more exposed than peers, and full trading multiples.

NAB shares closed at $29.89 on Thursday 9 March.