Australia | Mar 26 2020
Analysts argue Australia's banks are in a much better position to weather this storm than they were in 2008, and have been oversold on that basis.
-Australia’s banks will cope with COVID-19 better than the GFC
-Bank stocks have been oversold compared with current valuations
-Analysts diverge on whether corporate loans or home mortgages face greater risk
-Regional banks under pressure but well placed to weather the storm
By Nicki Bourlioufas
Australia’s banks solid, but uncertainty ahead
The coronavirus pandemic and its impact on the world economy have prompted comparisons with both the Global Financial Crisis (GFC) over a decade ago and the Great Depression of the 1930s. But analysts agree the Australian banking sector is in a much stronger position than it was during the GFC. Several maintain that, for now, bank stocks have been oversold.
While analysts agree that the big banks’ balance sheets are in a better position to handle the current crisis, analysts are split on whether home loans or corporate loans will be harder hit. Much will depend on the size and shape of government support for businesses and individuals, which is substantial and evolving day by day. Other important factors include the responses of other national governments, particularly the US, and central banks such as the US Federal Reserve and the European Central Bank.
Recession coming fast, but banks oversold
Goldman Sachs’ economics team estimates the Australian economy will shrink by -6% in 2020, the sharpest contraction since the Great Depression, with unemployment peaking at 8.5%. But from the point of view of funding, liquidity and capital, the team says, “Australian bank balance sheets leave them significantly less vulnerable than compared to any point in our recent past”.
Similarly, Goldman Sachs says corporate balance sheets – which have historically been the source of loan losses for the banks – enter this downturn “in a better condition than at any point in the last 40 years”, with gearing levels close to their all-time lows and debt servicing ratios already at all-time lows. Even so, a mild to mid-case recession would reduce bank earnings by -20%, while a hard landing would cut earnings by -50%.
Despite this, Goldman Sachs believes the banks have been oversold. The banking sector lost -$150bn on the market since previous forecasts a month ago. But this is more than the -$100bn loss that it predicts would result from a hard-landing recession – the broker’s worst-case scenario.
Citi is also relatively optimistic, arguing that “COVID-19 remains a transitory economic shock, which is not expected to develop into an existential threat that triggers a fall of more than -40% in the property market”. Citi analysts predict banks’ Net Profit After Tax (NPAT) will fall this financial year and again in 2020-21, but “lower ultimate losses and improving revenues will make for a sharp recovery” in 2021-22.
Given the underlying strength of the sector, Citi says the “the current sell-off is well overdone”. It notes bank share prices had been sold off by more than -45% and many banks stock are trading below book value, implying that their capital is insufficient for the ultimate impact of the coming downturn.
Morgans, however, is more pessimistic, saying it has downgraded its cash earnings per share (EPS) forecasts and dividend forecasts for the big four banks. The stockbroker forecasts lower net interest margins (NIMs), lower credit growth and more pronounced deterioration in asset quality. “There remains significant downside risk to our revised cash EPS forecasts”.
Corporate loans or mortgages – which are under greater pressure?
Analysts disagree on what types of loans are most vulnerable in this downturn. Morgans predicts losses on institutional credit will arise first, followed by losses on unsecured business and unsecured personal lending, and then by losses on secured business lending. “We expect meaningful home lending credit losses to arise last,” Morgans says. Based on this analysis, Commonwealth Bank ((CBA)) and Westpac ((WBC)) “are most defensively positioned” because their loan books are more skewed to Australian home lending, it says.
Based on valuations, Westpac is Morgans’ preferred major bank, followed by National Australia Bank ((NAB)), ANZ Bank ((ANZ)) and CBA. However, assuming a focus on risk profiles, its preferred major bank is CBA, followed by WBC, NAB and ANZ. Taking into account both valuation and risk profile, Morgans’ preferred major bank is WBC.
By contrast, Goldman Sachs argues that, with unemployment projected to peak at 8.5%, “it is too simplistic to say household loan books are vastly more defensive than corporate loan books”. Partly for this reason, the analysts’ preferred stock is ANZ. Other factors in ANZ’s favour are the fact that it is relatively better capitalised than its rivals and its “more aggressive approach to costs”, which makes it better placed to face the deteriorating revenue environment.
Citi says that COVID-19 “will affect people-oriented, service-based industries, which typically have lower debt” than capital-intensive industries. It is these capital-intensive industries that were worse affected during the GFC. As well, mortgage borrowers now have significant equity in their houses, which will limit losses on housing loans, Citi says.
It predicts losses on non-housing loans will triple from current levels to about ~1.2% of all non-housing loans. Although the rise is significant, Citi says this is meaningfully lower than the figure of ~1.8% that was reached during the GFC, when the main impact was felt in housing loans. “ANZ is our new top pick, as exposure to high grade corporates becomes an advantage,” Citi says. Its revised order of preference is ANZ, WBC, NAB, CBA, Bendigo Bank ((BEN)) and Bank of Queensland ((BOQ)).
Regional banks can take the pressure
In a note on four major regional banks, Bell Potter downgraded its target prices for Auswide Bank ((ABA)), Bendigo & Adelaide Bank, Bank of Queensland and MyState ((MYS)). Nevertheless, the new target prices are higher than the bank’s recent share prices on the market and Bell Potter maintained its Hold ratings on all four stocks.
The analysts say the fallout from COVID-19 will exacerbate the pressure from an already slowing economy, which is hindering credit growth. As well, softening business conditions will increase credit impairment charges, and falling interest rates are compressing NIMs.
Nevertheless, Bell Potter says regional banks’ balance sheets remain in good health, with stronger capital positions. Bendigo & Adelaide and Bank of Queensland have recapitalised, and Auswide and MyState are operating with surplus capital. In addition, the four banks have stronger funding and liquidity positions.
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