Expectations are building ahead of the ASX bank reporting season and experts are predicting that the sector will get a $1 billion plus earnings injection on top of operating profit growth.
The extra profit boost comes courtesy of the great COVID-19 unwind. While ASX bank shares had to cut profits to build a cash buffer during the pandemic, they are expected to return a chunk of this back to their bottom lines now.
This places the ASX bank shares in a good position to report higher profits and dividends over the coming few reporting seasons.
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ASX banks getting a free ~$1.6 billion profit kick
The extra cash buffer, called provisions, was meant to protect banks' balance sheet from a potential wave of loan delinquencies.
This never materialised during the COVID outbreak thanks to massive government and central bank support.
While most of us know this, the analysts at Macquarie Group Ltd (ASX: MQG) believes the market is underestimating the upside.
The broker is forecasting around a $1.1 billion to $1.6 billion release in provisions for ASX banks.
ASX banks still on an earnings upgrade cycle
"Only a year ago, we were examining the extent of potential credit losses, and now the focus has shifted to how low bad debts are likely to go," said Macquarie.
"With very little stress in the system, courtesy of highly accommodating policies and support measures, we continue to see upside risk to consensus expectations from a further reduction in BDD [bad and doubtful debt] charges."
The strong housing market and robust rebound in the Australian economy means that provisions can stay lower for longer. That puts extra money in banks' pockets, which can be used to pay dividends.
The ASX banks best placed to benefit
We may be entering a period where loan losses will track below the average in any given cycle thanks to the upswing.
In this regard, Macquarie is forecasting ASX banks to report credit charges of just 10 to 13 basis points a year for the next three years. In contrast, the five-year average is around 11 to 21 basis points.
This means further ASX bank profit upgrades could be on the cards.
However, some ASX banks will benefit more than others. The broker noted underlying loan losses relative to the mid-cycle are lower in recent years for National Australia Bank Ltd. (ASX: NAB) and Westpac Banking Corp (ASX: WBC) than for Australia and New Zealand Banking GrpLtd (ASX: ANZ) and Commonwealth Bank of Australia (ASX: CBA).
Upgrade cycle coming to an end?
Macquarie has upgraded its earnings forecast for ASX banks by between 1% and 5%. It doesn't sound much, but the broker has already upgraded the sector four other times this year alone.
The total earnings upgrade runs to around 15% to 25% and there could be more consensus upgrades coming.
The only thing is we are probably at the tail end of the ASX bank profit upgrade cycle, noted Macquarie.
While the easy money has been made, it's still too early to be trying to pick ASX banks' share price peak – not when the tailwinds are still blowing strong.
