UBS: Australia's banks resilient in the face of recession (but this one leads the pack)

January 13, 2023 14:44

Livewire Markets

If there's one sector exposed to the economy, it's banking.

It simply can't escape macroeconomics. Inflation, cash rate, demographic shifts, consumer confidence, savings, business confidence; corporate earnings, the list goes on. All these things directly affect the core business model of taking money, lending it out and taking a cut in-between. And most of these things have been pointing in the wrong direction.

As we move towards almost certain global recession and the high chance of Australian recession, one could assume the banks to be on the precipice. But this isn't necessarily the case, according to UBS.

Inflation has provided a get out of jail card. While growth slowed, higher cash rates have provided a tailwind for net interest margins and top-line revenue.

This is one of many insights in the latest banking research notes, which I'll cover in this wire.

Pulse check

They're an optimistic lot over at UBS. Their current base case is for the terminal cash rate to hit 3.35% in Feb, before easing from the fourth quarter to 2.60% in 1H24. This is markedly less than the 3.76% terminal rate priced in by markets.

This is in turn based on their assessment that inflation has already topped out at roughly 8% y/y, in 4Q22, before decreasing to roughly 3.6% in 4Q223.

"RBA historically stops hiking the Cash Rate before CPI peaks and cuts despite CPI being above the target band," the broker notes.

While the broker doesn't see rates keeping pace with market expectations, that won't be enough to precipitate a crash in property values.

"The $500B Fixed Rate mortgage roll-off is expected to impact consumer cash flow in 2023.

House price are forecast to slump ~15%, if the RBA hikes in line with markets, then the housing market

will crash. Housing sentiment also remains weak."

Inflation getting in the way of cost-cutting

The banks have been on a cost-cutting tear for several years, now, but that agenda has fallen by the wayside of late.

ANZ Group (ASX: ANZ) was aiming to run its shop FY 2023 $8.6 billion cost base target before that was watered down, while Westpac (ASX: WBC) is still aiming to save $8.6b by FY24, while all but Westpac have abandoned their cost base targets, citing inflationary pressures or COVID-related issues as the reason for dropping the targets.

That said, cost pressures have been offset by declining head counts and productivity gains.

The money maker

Aussie banks make 90% of their money from net interest income - essentially the difference between the income a bank earns from lending activities and the interest it pays to depositors.

Generally speaking, the higher the cash rate, the greater the net interest. UBS calculates that for every 1% increase in the cash rate, net interest the net interest margin increases by 20 basis points.

To illustrate this point, net interest margins expanded collectively among the majors by 15 basis points. ANZ is leading the way here with an 11 basis point increase half-on-half.

"However, we see increasing competition in the sector, a risk to NIMs near-term and a potential offset to rate hikes."

In the worst case, UBS sensitivity analysis shows in the worst case banks would suffer a 1.2% to 2.0% drop in ROE.

Pick of the litter

The S&P/ASX 200 Financials index has shown remarkable resilience over the past year, losing just 1.41% over the last 12 months. And it's up 3.22% year to date.

UBS' top pick in the sector is ANZ on a value and growth basis. ANZ is also deemed to have the least sensitive ROE in a 100% downside economic scenario.

But it also remains BUY rated on Macquarie Group (ASX: MQG), Westpac, Bendigo and Adelaide Bank (ASX: BEN).

Bank of Queensland (ASX: BOQ), Commonwealth Bank (ASX: CBA) and National Australia Bank (ASX: NAB) are each rated NEUTRAL.

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