Weekly Broker Wrap: AUD Outlook, Banks And Resources

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Australian dollar likely to lift near term; bank churn, loan losses and challenges; and resources making a comeback.

-Downside factors looming for AUD but unlikely to go that much lower
-Morgan Stanley: higher probability of loan-loss driven downgrades at NAB
-Challenges for bank revenue growth in wealth management: Credit Suisse
-China no longer the driver of steel consumption growth
 

By Eva Brocklehurst

FX Outlook

The Australian dollar could lift to US78.4c near term, retaining its tendency to appreciate, Commonwealth Bank strategists maintain. While the current economic environment and terms of trade are stable the strategists perceive that by year end, a number of downside factors are looming, which could return the currency back to US73c.

The strategists contend that the Reserve Bank of Australia is in the throes of reducing the cash rate because inflation is low, not because of an upcoming economic downturn. This difference in approach is relevant for the exchange rate.

In the near term the strategists find it hard to make a strong case for the US dollar to strengthen enough to push the Australian currency lower. While the US dollar tends to rally each time the US Federal Reserve gets closer to raising rates, and the Fed is expected to act in December, the US dollar is not expected to strengthen significantly because the US economy is likely to slow.

With the RBA anticipated to be cutting the cash rate to 1.25% in November and the Fed to lift the upper bound of its funds target rate to 0.75% in December the combination of the two should narrow the Australian/US 2-year bond spread. Furthermore, if expectations for another RBA cut and another Fed hike of 25 basis points apiece are borne out, the spread could turn negative for the first time since 2000.

The strategists maintain that in the past a negative spread has put downward pressure on the AUD/USD rate because of Australia’s current account deficit. A negative spread eventuating because inflation is low is unlikely to generate significant downward pressure on the AUD, unless it is accompanied by a material lowering of Australia’s terms of trade and a significant deterioration in the economy.

In that context, the economy is set to get a boost from rising LNG exports late this year and in early 2017 and a narrowing in the trade and current account deficit should therefore limit the downside for the AUD.

Banks

UBS has surveyed Australian retail bank customers and looked at factors which make them change their banking services. The analysis suggests 12% of the survey are now seriously considering changing banks in the next six months, up from 7% a year ago, and all major banks have increased risk of churn.

The main reasons customers would change banks are for lower fees and more attractive interest rates, while bad service is also an important factor. Over the past year migration towards mobile banking has continued to occur.

The number of customers surveyed who use branches on a weekly basis has fallen to 16% from 19% in 2015, ATM use to 55% from 56% and desk top/lap top to 43% from 45%. Mobile banking, meanwhile, has risen to 19% from 12%. A preference for face-to-face sales continues to fall across transaction types.

Management statements regarding an intention to reduce the use of price incentives to stabilise share are wishful thinking, UBS contends.

Morgan Stanley observes bank loan losses in the June quarter were 7% above forecasts and did not fall relative to the first half quarterly average, despite the lack of  “single name” losses.

Comparing the bank non-housing loss rates for the majors, Morgan Stanley highlights that ANZ Bank's ((ANZ)) loss rate has been more than 50% above its peer average over the past 18 months and assumes this remains the case.

National Australia Bank’s ((NAB)) Australian loss rates fell to 31 basis points in FY16 from 57 basis points in FY13 as a result of de-risking and Morgan Stanley’s forecasts imply it will be the lowest risk bank in FY17. Westpac ((WBC)) suffered more than either Commonwealth Bank ((CBA)) or NAB from single name exposures in FY16 and the broker conservatively assumes its loss rates will remain higher in FY17. Overall, the broker envisages a higher probability of loan-loss driven FY17 downgrades at NAB than at ANZ or Westpac.

Revenue growth may have been disappointing during the latest bank reporting season but Credit Suisse believes many fears which weighed on bank multiples were not realised. Bad debt charges were modest, asset quality stable and margins held up, while distributions were maintained.

The challenges for revenue growth are in wealth management and more broadly within the non-interest income segment. Other trends the broker foresees include a slowing in housing lending growth and lower costs from restructuring. Bad debts remain stable but asset quality is modestly deteriorating.

The broker has elevated NAB to its top pick, switching from Westpac which is now second, followed by CBA and then ANZ.

Deutsche Bank finds the asset quality is deteriorating, but not at any faster pace. While there was little impact from direct mining exposures or commercial property in the quarter the indirect impact from weakness in the resources sector was evident in rising arrears and loans on watch lists in both the retail and business segments.

The broker notes troublesome loans rose materially for Westpac and CBA, the only banks that report these ratios on a quarterly basis. Overall though, while the quality metrics did deteriorate, the rate of deterioration appears no quicker than Deutsche Bank had already incorporated into forecasts.

That said, New Zealand dairy continued to deteriorate and bad debts rose sharply in New Zealand for ANZ and CBA, while NAB’s NZ dairy impaired assets rose another 10%. Commercial trends appear reasonably benign to Deutsche Bank.

Resources

Morgan Stanley observes the resources sector is making a comeback, albeit not in the same way as the previous cycle. This time it is more subdued, with large companies coming back into view following attrition, survival and some stability emerging in the sector. Moreover, profits are improving, a significant driver of the share price.

The broker believes commodity prices have bottomed and China is again in focus with new supply-side reforms to address the imbalance between supply and demand. The government has primarily targeted the steel and coal industry for reform and, while changes have been announced before, this time the broker observes real action is occurring.

Also, the demand outlook has changed. China is no longer driving consumption growth as other countries have stepped up to the plate. These include Thailand, Vietnam, Philippines and India as the new buyers of steel.

Morgan Stanley recommends companies with low costs and long-life assets with little debt and proven management, suggesting BHP Billiton ((BHP)), Evolution Mining ((EVN)), Whitehaven Coal ((WHC)), Alumina ((AWC)) and South32 ((S32)).

China’s steel-intensive infrastructure programs have required a higher output rate from the industry, underpinning iron ore demand, Morgan Stanley also observes. This has created upside rise to 2016 price expectations. The broker still anticipates a pull back in September/October as China’s steel demand abates ahead of the winter.

Beyond this, prices are expected to be capped by ongoing supply growth. Rio Tinto ((RIO)) has just approved its Silvergrass development, bringing an additional 10mtpa to confirm forecasts of 340mtpa over several years, while Fortescue Metals has guided to 164-170mt for FY17, 25-30mt above the broker’s forecasts.

Morgan Stanley’s base case iron ore price forecast for the second half is US$40/t.
 

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