- After 25 years of double-digit mortgage growth, Morgan Stanley says the big banks face a challenging period ahead.
- The sector must now navigate margin pressures, regulatory uncertainty and the threat of disruption.
- Those headwinds are partly reflected in current valuations, but not enough to offset the “structural and cyclical headwinds” facing the industry.
Australia’s big banks have had a great run, but Morgan Stanley reckons the next couple of years will be tough.
Amid house prices in decline and ongoing fallout from the financial services royal commission, the challenges facing the industry have been well-documented.
As a result, the MS banking team sees “downside to expectations for earnings growth, profitability, and dividends”.
It’s a view shared by the broader market, if the major banks’ share prices are anything to go by.
Collectively, the big four have lost around 15% so far this year. And prior to a small rally today, they’ve fallen by almost 8% in the month of October alone:
But looking at the sector in a historical context, the headwinds are a pretty recent development — particularly when it comes to mortgage profits.
From 1992-2017, Australia’s big banks enjoyed a 25-year run of double-digit mortgage growth.
They also used their size to price out smaller competitors and leverage the benefits of cheaper funding costs.
In that time, housing debt as a percentage of disposable income rose from around 30% to 140%.
“However, we believe the 25-year mortgage bull market has now ended owing to a combination of more-onerous capital rules, tighter lending standards, higher mortgage rates, and credit rationing,” Morgan Stanley said.
More recently in the 25-year “super-cycle”, the major banks used their dominant position to price out smaller lenders and win market share.
Between 2007 and 2017, their slice of the new-mortgage pie increased 10% to around 77%.
That pricing advantage was driven in part by the 2008 financial crisis. Following the GFC, the major banks were able to utilise their implied government guarantee and larger size to gain cheaper access to wholesale funding markets — an option that wasn’t available for smaller banks.
So far this year it’s been a slightly different story, as the whole industry has been forced to respond to a complex range of factors which are driving up wholesale funding costs.
But over the last decade, the major banks have also benefited from their “oligopoly pricing power, particularly in the mortgage market,” Morgan Stanley said.
So when one big bank cut mortgage rates, the others typically followed suit.
However, MS noted the price action in September indicated a possible shift. Three of the big four banks raised rates on new standard variable mortgages, but NAB didn’t follow suit.
In addition to new (front-book) loans, Morgan Stanley said NAB’s decision also “calls into question the sustainability of back-book re-pricing as a way to manage margins”.
“Given the need to repair relationships with key stakeholders and the potential for adverse outcomes from the RC and the ACCC, we believe pricing power is reaching a peak.”
In addition, the overall trend in mortgage growth has now reversed, as APRA enforces tighter standards with stricter debt-to-income limits and caps on interest-only lending.
Increased scrutiny from the royal commission is also “creating a competitive disadvantage,” Morgan Stanley said.
So for the next two years, the big banks are likely to lag their smaller competitors in growing the mortgage book.
Outside of the mortgage market, Morgan Stanley also said the banks also face disruption from technical innovation and limited opportunities for capital investment to add value.
Viewed in aggregate, it’s perhaps not surprising that the big banks now face a “difficult transition”. And the analysts noted that all those headwinds haven’t gone unnoticed.
In fact, the big banks have “under-performed the broader market over over 1, 2, 3, and 5 years based on total shareholder returns”.
However, “they do not yet provide sufficient valuation support to offset the structural and cyclical headwinds to growth that have emerged at the end of the super cycle”.
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