Big Four Banks’ Battered Positions; How to determine on buying the dip?

Stock markets all across the globe experienced a major hit on Monday morning, 16 March 2020, a day after the US Federal Reserve took an emergency step, lowering its benchmark interest rate close to zero and launching a massive quantitative stimulus program (US$700 billion).

The new fed funds rate, which is used by banks as a benchmark rate both for short-term lending for financial institutions and forming the base for many consumer rates, is now to be targeted between 0% and 0.25%, down from an earlier target range of 1% to 1.25%.

There is already pressure on the Reserve Bank of Australia (RBA) to cut rates further next month, and it has now become more probable after its US counterpart has taken the emergency step to cut its interest rate. Consequently, the market is pricing the 100% probability of a rate cut to 0.25%, which is anticipated at the Reserve Bank’s April meeting.

Meanwhile, RBA announced an extra liquidity of A$5.9 billion (US$3.62 billion) into the banking system on 16 March 2020 through its market repo operations. The central bank has already stated that it is ready to purchase government bonds to infuse liquidity and plans to announce further policy measures on 19 March 2020. There are lingering speculations in the market that the RBA will also take a step now only to cut its rates.

As on 17 March 2020, as per the WHO, coronavirus outbreak is spreading rapidly, causing more than 7,000 deaths all over the world, harming many communities, disrupting life and bringing the economic activity still in many countries, including the United States. As a result, global financial conditions are now significantly affected.

Impact on Australian Banking Sector

The yield on the 10-year US bond has already fallen to a new all-time low of 0.318% (intraday on 9 March 2020) and Aussie 10-year bonds have already fallen below 0.60%.

The Australian banking sector is also facing headwinds, on the back of very low interest rate environment. Low rates impact banks in a negative manner, as the margins that banks can get from housing loans and banking accounts are now lowered, which is source of profit of the sector. Therefore, with rate cut, the banks will have low profits.

Currently, this ultra-low interest rate environment is expected to prevail for some time. It may stay low even for the upcoming few years, which is a real challenge for the big 4 banks of Australia like Commonwealth Bank of Australia (ASX: CBA), Westpac Banking Corporation (ASX: WBC), Australia and New Zealand Banking Group Limited (ASX: ANZ) and National Australia Bank Limited (ASX: NAB).

Meanwhile, the current dividend yields of the ASX bank shares have now become even more attractive due to corrections in their share prices.

A broad-based market sell-off is likely to hurt most of the equities in the market. And, the market value erosion in big four banks is reflective of the fact that interest rates have come down, awaited economic recovery is at a risk, which could create a spike in bad loans, thereby hurting profitability of the big four banks.

Third Class Action Against WBC

Westpac Banking Corporation has been significantly affected on the back of a third shareholder class action recently filed against the bank. The corporate law firm Johnson Winter & Slattery filed the lawsuit on behalf of shareholders who had taken the interest in Westpac securities or equity swaps over the duration of six years that had started from 16 December 2013 to 19 November 2019.

Also Read: Class Actions & proceedings are here to stay, Westpac appoints veteran banker

The lawsuit, which alleges that the bank failed to disclose the risk properly as much required, relates to market disclosure issues connected to Westpac’s monitoring of financial crime over the relevant period and matters which are the subject of the AUSTRAC proceedings and covers similar subject matter to the claim filed by Phi Finney McDonald, which was announced in December 2019.

This is the third shareholder class action filed due to the fallout, after suits filed by specialist law firm Phi Finney McDonald and international investor firm Rosen Law Firm. As a result, WBC stock has fallen the most as compared to other major banks.

How to determine on buying the dip?

Australia was able to sail through the global financial crisis, which occurred a decade ago. Currently, the world is facing acute economic crisis and this time Australian economy is likely to face more, as the biggest trading partner China is the first one that is heavily affected, but recovery is underway.

Meanwhile, the Australian Prudential Regulation Authority (APRA) has asked major banks to increase their CET1 ratio at least, as it is systemically important for banks in Australia to have strong capital position during this crisis. Currently, the required CET1 capital ratio for the major banks is at a minimum of 10.5% and the major banks have only reached the 10.5% or higher level recently.

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