Table of Contents
Australian Banks See Robust Growth Amid Easing Competition
Recent analysis from Morgan Stanley indicates that Australia’s leading banks are currently experiencing their most favourable operating conditions in years, characterised by strong loan growth and reduced competitive pressures, particularly noticeable in their performances for the June quarter.
The analytical team at Morgan Stanley expressed confidence in the current operational landscape, suggesting it could sustain elevated trading multiples. They adjusted their target prices for the Big Four banks, raising them by 7-10%, predicting an average price-to-earnings (P/E) ratio of approximately 16.5 for FY26. Within this context, National Australia Bank (NAB) has emerged as the analysts’ top pick, whereas Westpac has been relegated to the least favoured position due to a concerning earnings outlook and heightened execution risks.
Resilience in Margins Bolsters Bank Profitability
The June quarter showcased a significant resilience in bank margins, defying previous expectations amidst ongoing competitive pressures from deposits and unrealistic lending mix shifts.
Both NAB (ASX: NAB) and Westpac (ASX: WBC) reported substantial margin performance, exceeding analysts’ predictions by around 5 basis points, owing to a combination of a less aggressive mortgage competition landscape, successful deposit repricing (notably at Westpac), and a decline in business lending competition impacts.
Moreover, Australian mortgage growth has surged to a 6% run-rate, with all major banks—ANZ, CBA, and NAB—mirroring this broader upward trend. Business lending also exceeded forecasts, driven by lower interest rates, improved consumer sentiment, and robust government spending.
NAB: The Preferred Choice
Identified as the only bank rated Overweight, NAB’s strategic approach rests on three core priorities:
- Maintaining dominance in SME banking
- Enhancing deposit gathering capabilities
- Growing proprietary mortgage origination
NAB’s recent third-quarter trading update allayed critical investor apprehensions by indicating that the competitive environment for business lending is manageable and showcasing stabilising credit quality within the SME sector. With expected earnings growth of 6% and a projected 11.5% return on equity for FY26, NAB presents an attractive option, particularly as it trades at a 9-point P/E discount to CBA.
Challenges Mount for Westpac
In stark contrast, Westpac’s outlook has dimmed, leading to its downgrade to Underweight. Although Westpac had previously benefited from early deposit repricing compared to its peers, analysts foresee this advantage diminishing, compounded by projected below-system mortgage growth and persistent margin pressures. The bank’s new CEO, Anthony Miller, seems poised to accept short-term sacrifices to reclaim market share in proprietary mortgages and SME lending; however, this strategy introduces uncertainty regarding immediate earnings results.
Credit Quality Remains Stable
Impairment charges across the Big Four banks totalled a mere $630 million during the June quarter, representing 7 basis points of loans, which aligns with recent quarterly norms. Non-performing loans rose slightly, with NAB highlighting early signs of business credit stabilisation.
Morgan Stanley anticipates an increase in impairment charges from an average of 20 basis points of non-housing loans in FY25 to 29 basis points in FY26. However, they also note the potential for another year of lower-than-expected losses if credit conditions continue to improve.
Improved Dividend Sustainability
Concerns previously surrounding dividend sustainability for several banks have subsided, particularly concerning Westpac and NAB, as stronger earnings and robust capital positions have mitigated the risks of dividend cuts. Westpac is expected to maintain its dividend payout ratios at the upper end of the 65-75% target range due to enhanced capital flexibility. Conversely, ANZ faces a heightened risk regarding dividends due to a smaller capital buffer, an above-target payout ratio, and transitions in leadership.
Market Valuations Signal Caution
Despite the upbeat operational environment, Morgan Stanley advises caution regarding current valuations, suggesting they reflect a high probability of an optimistic outlook, with average FY26 P/E multiples predicting 16.5x alongside a price-to-book ratio of 1.9x—both figures exceeding post-COVID averages of 15.5x and 1.7x, respectively.
For investors, the challenge will lie in whether these banks can consistently meet elevated expectations while adjusting to lower interest rates and intensifying competition within the lending landscape.
In summary, while Australian banks are thriving in a robust environment, navigating the forthcoming challenges will be essential to sustaining their progress and profitability.
