What is causing banks to be worried yet not too worried
As the chaos of the COVID-19 crisis lessens, banks remain worried about some things, but not so worried about others.
But a cheery bottom line for everyone who has anything to do with banks - shareholders, borrowers and would-be borrowers – is that the Reserve Bank of Australia (RBA) concludes in its biannual Financial Stability Review published last month that the nation’s major lenders are all up to the task of supporting economic recovery and continuation of credit flows.
However the review expresses “significant uncertainty” about the level of losses banks may suffer in an extended crisis as loan repayment deferrals and government financial support for customers are withdrawn – one of the reasons Macks Advisory would like the Federal Government to consider extending JobKeeper beyond March 2021 (See, accompanying article “Why extending JobKeeper can be such a good thing for us all”.)
However, countering this concern is the RBA’s opinion “the economic downturn would need to be much more severe than is currently envisioned, for banks’ capital ratios to approach regulatory minima”.
Banks’ prognosis is good
The RBA’s review predicts the nation’s banks will face minimal short-term costs from dipping into capital buffers to weather the crisis, but they “should be able to build capital organically” as it recedes.
There are already signs this will happen, that there will be no need to seek capital from investors. Banks are benefiting from strong deposit growth and the RBA’s Term Funding Facility (TFF) that offers three-year funding to authorised deposit-taking institutions (ADIs).
The number of borrowers desperate for loan relief is falling sharply as States emerge from the pandemic-driven recession which technically no longer exist. Macks Advisory understands that privately bankers are conceding that between 55% and 60% of home loan borrowers have indicated a willingness to resume payments.
Commonwealth Bank, the nation’s biggest lender, has seen a pleasing recent improvement in its home loan book. By the end of August 9.8% of these loans (in value) were in deferral, and by the end of September it was 8% (93,000 home loans valued at $3.7b). Although we haven’t seen last month’s final figures, expectation was there’d be a further steep reduction of loan deferrals to the value about $11b.
But here’s a worry
Borrowers most likely to resume repayments are lower-risk borrowers, owner-occupiers paying principal and interest on loans where mortgages are below 90% of a home’s value, but banks are worried about what they perceive as their greatest current vulnerability, namely exposure by way of SME loans – especially in hard hit sectors such as tourism, hospitality and accommodation.
This is because so many small business owners have homes involved in financial structures of businesses, therefore increasing the risk profiles of many home loans still being deferred. In a worst case scenario, these loans would never be repaid after the forced sale of a business.
It’s doubly concerning for a bank when small business customers come to grief, because their failures can be compounded by effects on creditors – organisations, other businesses and their employees – who as a consequence may also face insolvency and as customers of the same bank.
Commonwealth Bank shareholders will however, be pleased by the on-going reduction in SME loans on life support.
In September there was a 23,000 drop in the net number of deferred loans to these customers (worth $8b) as the bank’s automatic deferrals on small business loans of up to $5m reached expiry date. Another 28,000 of SME loan deferrals (worth $2.8b) were due to expire last month, the continuing downward trend suggests this month the bank will have reduced its portfolio of such loans to about 7%.
Banks can take heart from the RBA’s review which says “the majority of businesses are well placed to service their debts, given the extent of income support as well as low levels of gearing and falls in interest rates over recent years”. The review also points out the government’s decision to allow companies to claim back previously paid taxes “will further support cash flows for many businesses”.
The future’s yin and yang
S&P Global Ratings predicts a prolonged recovery of banks from the pandemic-induced downturn, but while low interest rates, weak credit growth and a drop in fees income threaten the earnings of Australian lenders, income will nonetheless be “adequate to absorb credit loses”.
In fact major and mid-sized banks have together put aside $8b to deal with such loses.
Although S&P forecasts these will peak around 85 basis points of gross loans next year, it believes banks will be able to “preserve credit worthiness over the next two years”. However, any drop in Australia’s sovereign rating could be a threat to the welfare of the nation’s four major banks and the Macquarie Group’s banking division.
Finally the RBA has in its stability review has urged financial institutions to keep improving culture and governance, particularly where these are relative to customer hardship stemming from COVID-19, otherwise profitability could suffer through remedial costs (such as Westpac’s recent $1.3b settlement with Australian Transaction Reports and Analysis) as well as tighter restrictions on operations.
