S&P: Aussie banks to struggle

Via Banking Day:

The recovery for Australia’s banks will be “a drawn-out affair”, and they will struggle to regain pre-COVID earnings metrics even as credit losses recede, according to a new report from S&P Global Ratings.

Weak business and consumer sentiment is likely to remain the main impediment to credit growth.

“In our base case, we expect the economic recovery in Australia to begin by the end of 2020. Until the recovery substantially progresses, economic risks facing the banks will remain tilted toward the downside, in our view,” S&P explained.

The report warns that credit losses are set to rise “multifold” off the historical lows of 13 basis points in 2019, with the ratings agency standing firm on a previous forecast that annual credit losses will peak at about 85 bps of gross loans.

“We expect a relatively muted jump in credit losses in 2020,” the report stated.

“Massive fiscal support by the government to businesses and households, together with accommodative loan repayment moratoriums by the banks, will cushion the blow to banks’ asset quality. In addition, accounting standards and prudential regulation will likely suppress recognition of bad and doubtful debts until mid to late 2021,” the ratings agency asserted.

“Overall, we believe that Australian banks should be able to preserve their creditworthiness in the next two years,” S&P’s analysts asserted in their report.

“This takes into account losses from mortgages and business loans,” said Sharad Jain, S&P’s financial institutions credit analyst.

“Banks with higher proportions of mortgages will experience slightly lower losses than the [sector] average.”

That means mutual banks, with their focus on mortgages will be lower down the scale, while regional banks, which do engage in business lending will be closer to the expected 85 bps.

Even so, he said that all banks – large and small – should be able to absorb these expected losses.

In addition, low interest rates, weak credit growth, and a drop in fee income threaten to curtail bank earnings. “However, we expect even the reduced earnings will remain sufficient to absorb the higher credit losses,” S&P said.

“‘In general, we expect that the banks have adequately raised their loan loss provisions, to the extent permitted under accounting standards and regulations. In current operating conditions, shareholders are likely to be tolerant of a bank aggressively raising loan loss provisions, despite the consequent drag on earnings.”

Indeed, in the six months to June 30, 2020, the four major banks have topped up their loan loss provisions by an average of 0.23 per cent of their gross loans.

Further, while conceding that headline loan deferrals appear high at 8.5 per cent of outstanding mortgages and 16.2 per cent of loans to small and midsize enterprises, these data could overstate the eventual credit losses. S&P made the point that many households and businesses took the deferral option “simply because it was available”.

And as SME loans form about 11.5 per cent of the Australian banks’ total loan books, deferred SME loans form only 1.85 per cent of the sector’s gross loans.

Rather than credit risk, the main risk to S&P’s ratings on the four major Australian banks and Macquarie Bank is through its “negative outlook on the sovereign” – that is, the Australian government.

“A lower rating on the sovereign would imply diminished capacity to support banks. Consequently, we have negative outlooks on these five banks,” S&P stated

Apart from the five larger banks, S&P’s outlooks for the other banks in Australia are stable, except for Suncorp-Metway, which has a “positive” outlook due to “improving group creditworthiness”.

That’s the bull case.

David Llewellyn-Smith

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