Christopher Niesche: Market jolt suggests golden weather is over for banks

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ANZ has indicated its bad debt provisions will be much higher than forecast as resources companies struggle to repay loans. Photo / Dean Purcell
ANZ has indicated its bad debt provisions will be much higher than forecast as resources companies struggle to repay loans. Photo / Dean Purcell

Australia's banks have taken a hammering on the stock market over the past month or so.

Westpac is down 13 per cent from its recent high a month or so ago.

National Australia Bank (owner of bnz, which seems to have taken the KFC approach to branding) is down 11 per cent. The Commonwealth Bank is down 9 per cent and ANZ is down 14 per cent.

What has spooked the market is the recent announcements by Westpac and ANZ that more of their customers might be unable to repay their loans.

Just before Easter ANZ warned its bad debt provisions for the current half will be at least A$100 million ($111 million) more than the A$800 million it had expected only six weeks earlier, as a result of some resources companies being unable to repay their loans.

Westpac also flagged a A$25 million increase in its bad loans, mostly from the resources states of Queensland and Western Australia.

These are only small numbers in Australia's multibillion-dollar banking system, but the reaction on the share market was anything but small. In the two days following the announcement, shareholders wiped A$25 billion off the value of Australia's big four banks and pushed the stocks into correction territory - that is 10 per cent or more below their recent peaks.

The provisions - and an earlier one by CBA - might be small, but investors are worried that they are a harbinger of future bad debts. It's been five years since the mining boom ended and banks are now beginning to feel the fallout as some resources companies and those other business that service them struggle to repay their bank loans.

Loan defaults have been running at historic lows for several years thanks to historically low interest rates and low unemployment. Businesses have also been borrowing less due to the collapse in confidence accompanying the end of the mining boom - there have been fewer corporate defaults because there have been fewer corporate loans.

The cost of bad debts to the Australian banking sector in the 12 months to September was just 0.15 per cent of total loans, a record low, according to analysis by PwC.

So even if bad debts do rise a bit, they're coming off a very low base.

The resources sector is perhaps the greatest worry and even there the banks' exposure to the mining sector is just 3 per cent of loans, according to credit rating agency Moody's. Of more concern, says Moody's, is the risk the resources downturn could prompt a sharp downturn in the broader Australian economy.

But as is the wont of credit ratings agencies, Moody's hedges its bets, noting low unemployment and strong corporate balance sheets.

Australian banks are among the strongest and most profitable in the world. They weathered the global financial crisis well while other banks collapsed, were taken over by rivals or bailed out by governments.

What's really got investors worried is the prospect banks might cut their dividends.

There is a keen interest in bank stocks in Australia. The big four banks make up about a quarter of the share market and as such just about every Australian owns bank stock in one way or another, either as a direct holding or via their superannuation fund.

Banks have long been regarded as a core element of a blue chip share portfolio. Their reliable and steadily increasing dividends have made them a firm favourite of investors of all sizes.

The fall in bad debt expenses added A$1.6 billion to the banks' after-tax profit in 2014, according to PwC. A rise in bad debts could eat into banks' profits and hence the funds they have available for dividends.

Returns and dividends from the banks are already under pressure.

Banks will have to raise extra capital to satisfy new requirements to make them stronger and safer. From July, banks will be required to hold an extra 50 per cent of capital against their home loans than they did previously.

They have already started raising the extra cash, by lifting mortgage interest rates and tapping investors for more money. Ultimately the higher capital requirements will eat into the returns that banks are able to make and hence into dividends.

There might yet be further capital demands on the banks.

Banks are also coming under increased political scrutiny in the wake of several scandals which have damaged their reputation. Prime Minister Malcolm Turnbull recently took Westpac's 199th birthday celebrations as an opportunity to rebuke the banks for poor treatment of customers, while opposition leader Bill Shorten has promised a Royal Commission into the banking sector.

Last week the corporate regulator ASIC announced it was taking action against Westpac for allegedly manipulating the bank bill swap rate - a key interest rate which is used to price mortgages and other loans.

It is already taking similar action against ANZ. Both banks have denied the allegations.

All of this suggests that after several years of record profits, the good times might be coming to an end for the banks.

- NZ Herald

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