How are the Big 4 Banks Placed?

  • Jun 27, 2020 AEST
  • Team Kalkine
How are the Big 4 Banks Placed?

Summary

  • Big four banks have rallied from their March lows, majorly over the past month, indicating that investors are potentially discounting better-than-expected recovery.
  • IMF has recently downgraded the global economic outlook for this year, but Australia has seen its outlook upgraded by the body.
  • Investors are also concerned about the picture of the economy when most of the life support comes to an end, including loan deferrals and income support payments.

Share prices of banks also reflect underlying conditions in the economy, which is why they have been on free fall, as COVID-19 unravelled its damage to the economy.

It is worth noting that shares of big four banks have risen over 10% in the past three months – most of this happened since late-May 2020 – indicating that investors now believe economic pain may not have a similar intensity, as they had thought earlier.

Since May, Australians are embracing reopening after successfully containing the virus transmission initially. But health authorities continue to trace new COVID-19 cases, and efficient management of new infections will be crucial in minimising the possibility of a second wave.

No one wants to have another country-wide shutdown, which will disrupt the real economy once again, translating into repercussions for employment, production, and trade, thus on the markets as well as banks.

International Monetary Fund (IMF) has updated its forecast for the global economy. The organisation now expects the global output to contract further by 1.9 percentage points, taking the forecast to -4.9% in 2020 with a rebound of 5.4% in 2021.

More importantly, IMF has upgraded forecast for Australian output, and it now expects Australia to contract by 4.5% this year, indicating an improvement of 2.2 percentage points over the April forecast at -6.7%.

Pre-COVID-19 profitability is Viable, But It Would be a Long Way

Return on equity, a key metric for banks, has been under pressure for some time now. As far as dividends are concerned, banks are liable to pay their bondholders and preferred shareholders first, the leftover is for equity shareholders.

Legacy issues with compliance, wealth management, and instances unveiled by Haynes Royal Commission have weighed upon banks’ return over the recent years. A material contributor to the income of banks, which is non-interest income, will likely be lower from now on, as big four banks have been divesting non-core businesses.

Although a recovery could be well underway as leading indicators show a better picture, there will be uncertainty with this recovery unless we have a medical breakthrough, which would be a widely accessible vaccine for COVID-19.

Since recovery is there yet uncertain, banks will continue to run with the risk of deterioration in credit quality that could be inflicted with a sudden stop in economy – should there be a second wave, forcing legislators to impose shutdowns.   

These factors, combined with lower interest rates, make an unfavourable case for banks to recover in the near term. But banks are likely well placed to produce decent shareholder returns over the long term, owing to their market dominance and ability to get better off the competition with gigantic capital allocation budgets.

Digital Investments Need More Attention Now

Stay-at-home economy has taken a mainstream stage in the COVID-19 world. With casinos closed and curtailed sports entertainment, stock markets became like a wagering shelter for many as gamblers do like easy money. Moreover, this rapid shift to digital channels is not only limited to shopping or trading but banking as well.

Big four banks need to increase their spending on digital investments, and they would be inclined to undertake further investments that would improve technological capabilities. Investments in digital banking infrastructure will likely drive cost benefits to the banks as well.

The pandemic has accelerated the market penetration of digital payments, as people are now less comfortable to pay a bill through cash. So, we may not need the same number of ATMs over the next ten years as we have now.

Consumers may also not feel the necessity to visit a bank branch when they can do it all with their fingers on mobile phone applications. Alternatively, banks have opportunity to lower costs incurred in occupancy and labour.

What Happens When Support Comes to an End?

Australian banks have given moratorium on loan repayments and interest payments to their customers, who had faced distress due to the COVID-19 crisis. Until 19 June, total amount of business loans deferred by the banks stood at around $60 billion, according to the Australian Banking Association.

Similarly, the banking sector has also deferred mortgages worth $175.6 billion. Banks are lending heavily to the economy currently, and sole traders have received loans worth $4.5 billion, disbursement to SMEs stood at $18.85 billion, and large corporations have received $104.36 billion worth of loans.

In September, the moratoriums will come to an end, and borrowers will need to resume making repayments and interest payments. Earlier this month, the Australian Bureau of Statistics (ABS) conducted a survey of 2,000 businesses, highlighting that 14% of business owners suffered over 75% fall in revenues.

Likewise, 17% of businesses experienced revenue contraction between 50% and 75%, around a quarter of respondents noted revenues fall of up to 25%, and a majority (37%) saw their revenues fell between 25% and 50%.  

COVID-19 has hurt areas like tourism, accommodation, and dine-out, and there remains a challenging time for these businesses. But as domestic activity continues to improve, consumers are likely to return to their normal behaviour.

Even households have applied for loan repayment holidays, and mortgage deferrals stood at $175.6 billion. Unemployment is expected to be higher as we move further into this year, which will likely impact the ability of consumers to service their mortgage debt.

But since the economy is reopening, there is a possibility that a lot of jobs and businesses would be saved now, as cashflows for businesses will likely return. Many Australians are also on welfare support, with a number of grants being paid by the Government, including JobKeeper and JobSeeker.

Perhaps Australians in financial distress are eligible to opt for an early release of super funds to cope up with burgeoning financial pain. All of this has provided a breather for households in extreme financial distress, but it remains unclear what happens when these support systems come to an end.

 


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