Margin squeeze drives rotation out of financial stocks

Australia’s equity benchmark fell 0.8 percent as Commonwealth Bank of Australia (ASX:CBA) posted a quarterly profit of AUD 2.6 billion, slightly below consensus amid margin compression and elevated funding costs. Despite robust capital metrics, investors read the result as evidence of peak sector profitability, prompting rotation toward defensives and exporters. The bank’s net-interest margin declined 8 basis points to 2.05 percent, pressured by deposit competition and subdued loan expansion.

This development underscores a transitional phase in Australia’s financial cycle. Following two years of monetary tightening, credit growth has slowed to 4.2 percent y/y from 7.1 percent in 2023, while mortgage volumes have plateaued. The yield curve has flattened, with three-month bills yielding 4.35 percent — roughly the cash rate — limiting spread income. Asset quality remains solid at 0.7 percent NPLs, but provisions rose 9 percent q/q as banks pre-empt potential arrears if unemployment edges above 4.5 percent.

Market reaction reflected sector-specific repricing rather than systemic stress. The ASX 200 Financials Index dropped 2.4 percent versus the broader market’s 0.8 percent decline. Bond yields fell 5 bps as traders reassessed earnings durability and the odds of earlier RBA easing. The AUDUSD slipped 0.3 percent to 0.687, reflecting a mildly dovish interpretation.

Structurally, profitability is capped by stringent regulation — CET1 ratios near 12.3 percent and tight mortgage-pricing oversight — yet funding resilience remains strong, with liquidity-coverage ratios above 135 percent. Historically, margin squeezes of this nature have preceded cyclical normalization, not crisis; after a similar episode in 2016, bank valuations recovered within three quarters once policy clarity improved.

The macro spillover could prove constructive. Softer bank profits compress lending margins, reducing capital costs for corporates and improving access to credit. Investment-grade spreads tightened 4 bps, suggesting healthier funding conditions outside the banking sector. Healthcare (ASX:CSL +1.7%) and consumer-staples (ASX:WOW +1.1%) shares attracted inflows, helping stabilize the index.

Looking forward, the sector’s path depends on RBA guidance and global yields. If disinflation endures, margin stabilization could align with renewed loan demand by mid-2026. Analysts forecast EPS down 3 percent in FY 2025 before rebounding 4–5 percent in 2026, consistent with post-tightening recoveries. The key variable remains the bank-funding spread — now 70 bps over sovereigns — which will serve as a leading indicator of valuation inflection.