After the uncertainty of 2023, could 2024 be better for the ASX bank share sector? I'm going to consider that question in this article.
There are three main things that investors should focus on because that's what could drive the profit and dividends in the year ahead. The first two are linked, so I'll address them in one point.
Loan growth and margins
The size of the loan book is very important for ASX bank shares because that's the balance it earns interest from borrowers. If margins are consistent, the bigger the loan book the more net interest income that a bank makes.
However, I'd argue that most lenders offer a very similar loan structure, so prospective borrowers or refinancers may be influenced by whichever lenders are offering the lowest rates.
There are so many lenders – just on the ASX there's a long list including Commonwealth Bank of Australia (ASX: CBA), Westpac Banking Corp (ASX: WBC), ANZ Group Holdings Ltd (ASX: ANZ), National Australia Bank Ltd (ASX: NAB), Macquarie Group Ltd (ASX: MQG), Bank of Queensland Ltd (ASX: BOQ), Bendigo and Adelaide Bank Ltd (ASX: BEN) and Suncorp Group Ltd (ASX: SUN).
To maintain or grow their loan book, lenders have to offer competitive rates. In the current weakening environment, there may be limited loan growth for the overall system, so banks have to compete more than normal to grow.
We've heard from various banks that the landscape is very competitive and this is putting pressure on the net interest margin (NIM), particularly because banks need to compete for deposits from savers as well.
BOQ's FY23 result was an example of the challenges that banks are facing – its NIM declined 2 basis points to 1.69%, yet its housing loans saw a 1% decline as well. After announcing the report, BOQ said the following, which sums up the situation:
The Australian economy has remained resilient, supported by low unemployment and strong cash savings. We anticipate increasing risk into FY24 due to the elevated cost of living, lagged impact and sustained higher interest rates. We will continue to support our customers through this challenging economic cycle.
We anticipate continued revenue and margin pressure to continue in FY24 from slower credit growth and competition. We anticipate that mortgage pricing will need to adjust at some point to provide returns above banks' cost of capital. Heightened deposit competition is expected to remain across the industry through the refinancing of the TFF. Inflationary pressures will be partially offset by our simplification program and we anticipate low single digit cost growth to our underlying cost base, plus investment spend and amortisation as we continue to invest.
Inflation and interest rates to hurt ASX bank share arrears?
Borrowers have been hit by lots of interest rate hikes, so it'd be understandable if arrears rise.
Higher arrears could mean more provisions and bad debts for banks, which would be a hit to profitability and could hurt their ability to pay big(ger) dividends.
ASX bank shares benefited from lower arrears during the COVID-19 period of ultra-low interest rates – a normalisation of arrears would be understandable, but it'd hurt profit.
The future is unknowable, but a key question is how long is the RBA rate going to be above 4%. It could be a tricky period for borrowers and lenders until then.
Not only is inflation hurting borrowers, but it's leading to cost increases for banks too. Higher wages are helpful for employees, but it does mean cost growth for banks.
I think a lot of the ASX bank shares will report lower profit in FY24 than in FY23 because of a combination of a lower NIM and higher arrears.
The dividend is decided by the board, so some banks may deliver a slight increase, though I wouldn't be surprised if multiple banks decide to pay the same dividend as last year (or even cut). However, their balance sheets remain in good shape to weather a potential storm, if things become tricky.