Morningstar bank analyst Nathan Zaia states there are three key results on his watch list when he scrutinises the earnings of banks: margins; bad debts and dividends.

He also looks at surplus capital and whether there will be any return to shareholders in the form of buybacks. This earnings season revealed solid numbers from the banks on all these fronts. However, these results are respective, as Morningstar head of equities Peter Warnes reminded us in his latest note. Looking ahead, will the relative bright outlook for the big banks continue?

Margin pressure growing?

On margins, Westpac’s (ASX: WBC) net-interest-margin (NIM) up 10 basis points in the first half to 2.06%, was a “welcome sight”. National Australia Bank (ASX: NAB) also reported a softening in its margin. National Australia Bank also reported a softening in its margin.

While the Australia and New Zealand Banking Group (ASX: ANZ) reported above market lending volume growth, it did not provide any detail on its margins. However, Zaia says that the margin pressure reported by the bank’s peers amid intense home loan competition and customers switching to term deposits will mean a softer outlook for ANZ’s margins. “The stronger loan growth for ANZ suggests weaker margins from greater discounting and cash-back offers”.

Zaia also believes that Westpac is making headway in growing its lending in line with the system, highlighting that the bank grew ahead of the market in June. Although he expects its NIM to soften further in fiscal 2024 due to funding cost pressures, as smaller banks also grapple with higher funding costs and weak margins, competition should ease for the majors. Margins have also peaked for the Commonwealth Bank (ASX: CBA). Its NIM slipped 5 basis points from the first half but Zai notes that at 2.05%, it's still a level which allows strong profits for the bank.

Bad debts rising

With ANZ holding loan-loss provisions steady, and CBA and NAB announcing share buybacks, the major banks appear more comfortable around loan-loss risks, according to Zaia.
But with a testy economic outlook and people under financial pressure from rising costs and interest rates, the level of bad debts rising was a hot button issue for this reporting season.

A closer look at the majors suggests that bad debts won’t mirror a rise in mortgage stress. Zaia did not pick up any “alarming results” from the numbers revealed by the big banks with an uptick in bad debts still low compared to previous fiscal years. For Zaia, “households appear to be coping to date by cutting back on discretionary spending and drawing down on savings”. Still CBA did report an increase in interest- only loans which “could be a sign some households are struggling to meet repayments”. Indeed, Warnes notes that “while the rate hikes are almost over, the pain will endure for a little longer”.

Can earnings support dividends?

In assessing the reporting season to date, Warnes also noted that dividends have been generally resilient. Both CBA and NAB did announce billion-dollar buybacks and CBA was the only bank to declare a dividend – given it reported its fiscal result. CBA’s bumper dividend did surprise Zaia, however, he believes the outlook for dividend growth for the bank remains positive with its surplus capital sitting above the top-end of its target range. Similarly, the other banks have healthy capital surplus levels. Both NAB and Westpac remain “well-capitalised” while ANZ’s “capital position is sound”.

Overall, Zaia believes bank dividends will grow modestly even if there is some short-term earnings pressure and emphasised that the banks remain well provisioned on the capital front. “This has also afforded them the ability to deliver investors with capital returns such as buybacks as they remain confident with managing their loan books”.