Major Banks Back in Favour But A Long Road Ahead

Summary

• Banks have been under the scanner for potential loan defaults and dividend cuts to build capital buffers with their shares underperforming by 19% in the last 3 months
• Lately, shares of all major banks have been performing well, giving a push to ASX amid renewed optimism amongst investors
• APRA has flagged a long road to recovery for the financial sector
• Near-term seems optimistic, while medium-term challenges remain for the sector

Banking stocks pay relatively high dividends that attract investors to part their funds in them. In the past few months, significant parts of the Australian economy remained in lockdowns due to coronavirus pandemic, which rendered many jobless and increased the risk of bad debts. However, this did not bode well for banks’ earnings. Consequently, several banks either deferred or slashed their dividends to save capital as a buffer while reporting fall in profits due to increasing bad debts during past months.

Coronavirus posed several forward earnings risks of slower forward credit growth, net interest margin pressure, dropping fees and increasing loan losses to banks. Hence, they have been under the scanner for potential loan defaults and credit buffers, and because of which, they were smashed on ASX for some time during this pandemic.

Australia took several measures to protect the financial system with RBA providing unparalleled support to banks’ liquidity and government giving wage subsidies to lessen mortgage stress, which has come up as a great help to the economy. Moreover, the Australian Prudential Regulation Authority (APRA) eased bank capital ratio expectations to make sure lenders remain well placed during these challenging times to provide credit.

However, it seems banks are back in action with strengthened balance sheet and capital buffers.

Major banking stocks soared on the Australian share market with the benchmark index advancing higher by 0.12% from the previous close to settle the day at 5,998 on 5 June. Big 4 Australian banks have resumed back robustly after being struck by coronavirus fallout on renewed optimism, as things start returning to normal.

On 5 June, stocks of the big 4 banks led the rally with National Australia Bank Limited (ASX: NAB) surging 2.96% to $19.48, Australia and New Zealand Banking Group Limited (ASX:ANZ) rising to $19.77 (up 2.92%), Westpac Banking Corporation (ASX: WBC) increasing to $18.79 (up 3.36%) and Commonwealth Bank of Australia (ASX:CBA) going up by 1.58% to $68.73.

Stocks of regional players like Bank of Queensland (ASX: BOQ) rose 8.95%, Bendigo and Adelaide Bank (ASX: BEN) went up by 4.72% and Mystate Limited (ASX: MYS) advanced by 0.5% on 5 June.

Investors’ appetite for banking stocks has risen due to a better than expected economic data and positive sentiment across the market, as restrictions eased. This reflects that worst of the coronavirus phase is over now, and a big discount on ASX-listed banking stocks is beginning to unravel.

Westpac and CBA Under the Scanner

Through a market update on 4 June, Westpac published findings of an investigation into the bank’s Anti-Money Laundering and Counter-Terrorism Financing compliance matters and child exploitation scandal. The bank has been alleged to have failed to report about $11 billion worth of transactions during late-2013 to 2018 to AUSTRAC. Due to the seriousness of the issue, former Westpac CEO and managing director Brian Hartzer and chairman Lindsay Maxsted had stepped down.

Based on the investigation results, the bank has reported that this failure occurred due to a combination of technology and human error. Moreover, in relation to the allegation of facilitating child exploitation, WBC has stated that the failure to correctly abide by AUSTRAC regulations happened because of scarce financial crime procedures, aggravated by inadequate individual findings.

Recently, CBA also came into the news. A review of its digital banking platform has highlighted that 8k plus customers were sent multiple low-value deposits with possibly abusive or offensive messages in the transaction descriptions. As a result, the bank rolled out an Acceptable Use policy, owing to which any customer found to be sending abusive, harassing, or unlawful messages is likely to face a refusal of transactions and withdrawal of their banking services altogether.

APRA Warning to Banks

APRA Chairman Wayne Byres has stated that there lies a long road ahead for the financial sector, alerting that things will take a long time to go back to normal after the coronavirus crisis eased. While addressing international bankers in a speech, Mr Byres highlighted that if someone thinks that by implementing some temporary measures, we will take the economy back to normal, it is very naïve one on which to ground the choices.

Mr Byres has been urging banks to fall into their capital buffers and stated that APRA always faced challenges on allowing banks to lower their capital ratios below 10% of risk-weighted assets and the banks need to work on how to reset that expectation. These comments outlined the challenging phases banks are likely to witness, as investors bet on an upsurge in bad debts in future. However, these worries took a backseat after positive news on economic data.

According to UBS analyst, Mr Jonathan Mott, banks underperformed by 19% in the last 3 months, but this can change after recent data roll out that highlighted some recovery in credit card spending and revision of JobKeeper subsidy. He is more optimistic in the near term; nevertheless, medium-term challenges remain for the sector.

Expectations Ahead for Banks

Australian economy shrank 0.3% in the three-month period to March, less than the market expectations of a fall of 0.4%, reflecting that the Australian economy is in a much better position than many developed countries on its path to economic recovery.

ALSO READ: Weekly Roundup on Economic Front: Trends Shaping Future Developments

On 5 June, the Australian dollar rose above US70 cents for the first time since January 2020, reflecting high hopes and optimism among investors towards a quicker recovery. These events have helped the share prices of several banks to surge.

However, there is still considerable uncertainty ahead on how the economy fares amid stimulus measures and consumer behaviour. There are expectations of bleak economic indicators in the June quarter, which can act as a critical risk on the market. And, with rising bad debts and possible withdrawal of stimulus by the government in the coming period, outlook remains challenging for banks.

(Note: Currency denoted in AUD unless otherwise specified)