Via Moody’s:
Outlook changed to negative as coronavirus raises risks to asset quality and capital
We have changed our outlook for the Australian banking system to negative from stable, reflecting our view that the broad and growing scope of economic and market disruption from the coronavirus outbreak will increase the strain on Australian banks‘ operating environment and loan performance. Increasing loan-loss provisioning and record low interest rates will push profitability lower. Australian banks’ sound capitalisation will provide a solid buffer against stress losses, but in the event of a deep and prolonged economic slowdown, their banks’ capital ratios are likely to deteriorate. Yet, large stimulus measures from the Australian government to support domestic companies and consumption will at least partly mitigate the risk of loan defaults. In addition, the Reserve Bank of Australia’s (RBA) monetary measures, including government bond purchases, a bank term funding facility to support credit intermediation and long-term repo activity, will help sustain banks’ liquidity and funding.
» The Australian economy will slow in the first half of 2020. The outbreak of the coronavirus and the subsequent confinement and lockdown measures that have been in place since late-March will materially disrupt economic activity. The longer the outbreak persists, the greater is the risk of a recession. The government has announced a substantial economic support package that will provide financial assistance to companies and individuals, which will likely partly mitigate the negative impact of reduced activity.
Fiscal measures and partial government guarantees to facilitate credit to small and medium-sized enterprises, wages subsidies and debt rescheduling efforts by banks, will relieve immediate pressure on borrowers and help minimise a potential wave of bankruptcies. The magnitude of deterioration in the economy will ultimately depend on the length of the disruption.
» Asset quality will deteriorate despite the government’s support measures. While we expect the economic slowdown will affect most sectors, the impact will be most severe on the retail trade, hotel and restaurant, entertainment, education, tourism and airline sectors. In terms of employment, the retail trade, accommodation and food sectors will be among the most vulnerable, representing nearly 17% of the Australian workforce.
While Australian banks’ current asset quality is very strong, it will deteriorate significantly if disruptions persist for a prolonged period and push up the unemployment rate, which will lead to more impairments of residential mortgages, which comprise approximately two thirds of banking system loans.
» Capital levels provide a solid buffer but capital ratios could deteriorate. Capital ratios are likely to decline as a result of higher loan loss provisions and weaker organic capital generation due to profitability pressures. At the same time, a deterioration of asset quality will increase risk-weights and hence lower banks’ regulatory capital ratios. The largest Australian banks currently hold comfortable buffers above regulatory requirements, while the regulator has eased pressure on them to maintain Common Equity Tier 1 ratios of at least 10.5%, in order to facilitate lending during the crisis. New Zealand’s ban on bank dividend payments will restrict capital accumulation for the large Australian banks, who in past have received dividends from their New Zealand based subsidiaries.
» Pressure on profitability will intensify. Loan-loss charges will increase and revenue will decline as net interest margins narrow in the low interest rate environment. Loan volumes will decrease as economic conditions deteriorate, offering little room for revenue growth. While banks may save costs by pausing projects, this is unlikely to fully offset the negative impact of lower revenue.
» Funding structure and liquidity will remain sound despite high reliance on volatile market funding. Australian banks are dependent on confidence-sensitive capital markets for their funding. Mitigating this risk, however, Australian banks have been lengthening the term structure of their wholesale market funding for a number of years. Also, they raise wholesale market funds well before the maturity of existing securities or the emergence of other funding requirements. Further, slower credit growth, combined with weaker spending, will reduce banks’ wholesale funding needs. The RBA’s committed liquidity facility, combined with its bond purchases and term-repo operations, will underpin system-level liquidity. A temporary reciprocal swap line arrangement between the RBA and the US Federal Reserve will facilitate access to US dollar liquidity.
» The government support will continue to be strong. Also, we view the current economic support packages, including fiscal stimulus, enhanced financial market liquidity and term funding to support credit intermediation, as measures that are temporarily increasing the level of indirect government support for the banking system.
