Are Bank Provisions Sufficient?

Australia | Jun 30 2020

Are bank provisions sufficient to cover the extent of the downturn in the economy? What happens when government stimulus is removed at the end of September?

-Impairment provisions could, potentially, rise in FY21
-Major banks likely to regain market share in home lending
-Banks less likely to require additional capital


By Eva Brocklehurst

What will happen to banking in the December quarter, when a substantial policy stimulus in response to the outbreak of coronavirus is removed? Are bank provisions sufficient to cover the extent of the downturn?

The Australian Bureau of Statistics has delivered a sobering assessment that 30% of businesses don't have liquidity in place to support operations for more than three months. The worst hit industries are accommodation & food services and retail trade. The same survey indicates that in around 70% of businesses which have experienced a weakening of revenue, the declines are by more than -25%.

Around 10% of the bank mortgage books and around 15% of small-medium enterprise (SME) loans have had payments deferred, and this payment holiday will expire from late September, with a great deal of uncertainty in the lead up to this date.

As a result, with limited information, UBS acknowledges bank credit impairment charges may fall sharply up to September but then provisions could potentially rise in FY21 as households and SMEs feel the pressure of having to meet repayments.

A large cohort is being supported by the federal government's JobKeeper package and rent relief yet, as Citi points out, banks will only offer support as long as these business operations are viable over the longer term.

Banks are well aware that, when interest rates do start to rise, if there is too much debt on a company's books this only compounds problems. Citi suspects defaults will be dominated by the SME sector because of this viability issue.

Banks have resorted to calling customers at the three-month deferral point - around now, UBS notes - to find out their financial position, but this may be of limited use as many could be worried about telling the truth.

Industry estimates state that around 20% of deferred books are unlikely to meet contractual requirements from October and the broker assesses this to be a fair estimate. This would imply mortgage delinquencies could rise significantly.

Significant credit charges are likely to be required in FY21 as the full impact of the downturn is experienced and particularly as Australia faces a “fiscal cliff", given $100bn of policy stimulus will be removed in the December quarter.

Bad Debts

Morgans asserts the bad debts being factored into major bank share prices are overdone, with the exception of Commonwealth Bank ((CBA)), which is why it is the broker's least preferred of the major banks. Westpac ((WBC)) is preferred because its bad debt provisions are greater than during the GFC.

Morgans has upgraded ANZ Bank ((ANZ)) to Add and believes the bad debt experience during the current crisis will not be as severe for the banks as that experienced during the GFC as the Australian government and the Reserve Bank of Australia are cushioning balance sheets to an extent never seen before.

Moreover, the broker suspects that if enough businesses and individuals are in stressed positions at the end of September then government and bank support measures will be extended.

Offsetting the headwinds to net interest margins are improvements in institutional lending margins, strong growth in transaction deposits and less reductions to home loan variable rates in the aftermath of the last cut to the cash rate. System credit growth is subdued and Morgans expects the major banks will regain market share in home lending during a period of funding stress for non-bank lenders.

Given changes to economic forecasts, for which the 2020 trough in the economy is now expected to be more shallow and the rebound smaller, Credit Suisse points out the expected credit losses (ECL) for the banks are also likely to change.

The rebound year has the greater influence on this measure, and the broker estimates that for every additional 10% probability weighting towards the downside scenario (from the base case of a gradual recovery), it means ECL increases $200-350m per bank.

A complete move to the downside scenario would mean an increase of $2-3bn per bank. Credit Suisse has relatively higher bad debt charges in its estimates for ANZ Bank and National Australia Bank ((NAB)) in the second half of FY20.

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