Banking stocks still have long-term potential?

  • Apr 03, 2020 AEDT
  • Team Kalkine
Banking stocks still have long-term potential?

Banks usually move consistently with the economy and when the economy is trending downwards, there are no reasons why banks would be insulated by the potential ramifications of a recession. Which is why banks and financials are considered to becyclical, meaning these sectors perform better when economic conditions are robust and as economic conditions deteriorate the risks also increase in the space.

However, a recession is also followed by recovery and expansion, which means a recovery as well as an expansion for the banking and financial services industry.

And, the recent market value erosion in the banking stocks is reflective of above facts. Since the beginning of the year to 1 April 2020, (ASX:ANZ) has cracked 30.55%, (ASX:WBC) is down by 30.96%, (ASX:NAB) has lost 31.01% of value in its share price, and (ASX:CBA) slid down by 20.29%.

Australian banks are one of the strongest in the world

Australian banks have decent capital in their pockets, and the big four banks had capitalised very well when borrowing costs were down before the coronavirus epidemic made ways into the Australian economy.

In the December 2019 quarterly ADI performance card, APRA noted that capital adequacy ratio of the Authorised Deposit-taking Institutions stood at 15.7% which was up from 14.9% in the same period previous year.

ADIs held 16.2% of the capital in minimum liquidity holdings ratio, up from 15.1% in the December 2018 quarter, while the liquidity coverage ratio was 131.5%, increasing from 129.4% in the same period last year.

Impaired assets and past due items stood at $30.9 billion, up by 10.9% from $27.9 billion in the same period last year. Total provisioning also increased by 10.3% to $12.3 billion as compared to $11.6 billion in December 2018.

Within mortgage lending, non-performing term loans were lower by 1.6% at $15.8 billion from $16 billion in the same period last year. Owner-occupied mortgages increased by 1.6% to $1,101.1 billion from $1,083.4 billion in the same period last year, and investment based mortgages were down by 0.1% to $615.5 billion.

ADIs had exposure to the commercial property of $291.5 billion, which increased by 0.9% from $289.1 billion during the period.

Regulator is embracing softening

Since coronavirus halted the economic activity across the world, the businesses as well as households have been facing dire consequences. In response to maintain stability in the economy, the banks had introduced a range of support for the customers.

As banks extended support and launched measures like moratorium on debt repayments, enhancing credit etc, the balance sheets of the banks are likely to face stress given the that repayments and interest payments would be delayed by the customers of the banks.

It would lead to higher credit losses, provisioning and maybe defaults in some cases, thereby hurting the health of the banking sector as a whole. Moreover, additional capital would be required to meet the stringent requirements of capital prudence by the regulator.

In response to this, during March, APRA had taken some very bold steps. It announced that there would be ‘temporary changes’ to the capital ratios of the banksin an effort to ensure that banks remain flexible to serve the economy amid this unprecedented pandemic.

APRA noted that the Australian banking systems have built a strong reserve of CET1 capital that was $235 billion at the end of 2019, and the banks have been maintaining capital levels well above the minimum requirements.

The regulator said that the bank might need to utilise the large buffers of capital held by the banks as a result of COVID-19 led implications to mobilises credit in the economy. It now expects banks to maintain severalminimum capital requirements, and questions would not be raised when banks are able to meet requirements announced in 2019 during the pandemic.

More recently, the regulator has deferred the plans of implementing Basel III reforms by a year, which is consistent with deferral announced by the Basel Committee on Banking Supervision (BCBS).

As a result of more stringent capital requirement announced in 2017, the Australian ADIs are sufficiently capable of meeting the new requirements. APRA has deferred the date of various requirements by a year, including new requirements in APS 110, 112, 113, 115, 116, 117 and 330.

In addition, the regulator has tweaked some of the ration calculation for the ADIs in response to accommodate the term funding facility announced by the RBA for lenders.

RBA’s measures to enhance operational capabilities

The Reserve Bank of Australia had announced a term funding facility for the banks to mobilise credit in the economy, with intentions to have a lower cost of credit for the households as well as businesses.

The Central Bank also revealed this funding to provide the incentive to the lenders that are extending credit to business customers, specifically small and medium businesses. It would be providing funding for a three-year period at 0.25% - materially below the funding costs of the lenders – the size of the facility is $90 billion.

In addition, the bank also announced that the Exchange Settlement balance would beincentivised at 10 basis points rather than zero, as the cash rate was 0.25% after the latest policy rate reduction.

Besides, the RBA is also targeting a yield for the 3-year Government bond, which alleviate the pressures on the yield curves and credit spreads in the sovereign debt markets, wherein banks are also investors.

Dividends to be lower is likely, but eviction is unlikely

Dividends by the major banks as well as the Australian blue-chip companies are bread butter for may senior Australians, especially the ones that did not have superannuation systems in their times.

Dividends byCorporate Australia are associated with socialism as well as capitalism. Intriguingly, the big four banks of the country are among the ones with the largest dividend pay-outs.

If dividends were to be suspended by the big four banks at a time when a large part of Corporate Australia is embracing dividend cuts to preserve cash amid an unexpected dent to cash flows, the consequences could be detrimental, including cashing out holdings to make up for the lost – inducing additional sell-offs.

Across the Tasman Sea, the kiwi banks’ regulator demanded to suspend dividends by the banks in an effort to maintain prudence – this means that the NZ-based subsidiaries of the big fours would not pay them dividends, thereby leaving dents in cash flows of big four banks.

But the dividends of the big four banks have been under pressure already, owing to Haynes Royal Commission led costs and fines, lower interest rates, and more recently – the looming recession.

Nonetheless, the big four may not suspend dividend because many individual investors have been relying on these dividends,to maintain their long-standing legacy of paying dividends, and various other reasons, including the ones on ethical grounds.

We may have to witness something extremely draconian that could force the big four banks to suspend dividends.

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There is no investor left unperturbed with the ongoing trade conflicts between US-China and the devastating bushfire in Australia.

Are you wondering if the year 2020 might not have taken the right start? Dividend stocks could be the answer to that question.

As interest rates in Australia are already at record low levels, find out which dividend stocks are viewed as the most attractive investment opportunity in the current scenario in our report.

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