Investors love Australia banks due to the income protection it provides and they were known as one of the consistent dividend stocks in the market. The fall in the big 4 share price recently is an ominous sign for the market and the Australian economy going forward.
The big four major banks historically made up one of the largest sector in the major market indices like the ASX 200. Any weakness in the performance of the share price of the banks will have implications on the market index.
The Australian banking sector will face the blowback from the increase unemployment and weaker property prices in the short and medium term. The increase in the banks non-performing loan book (i.e losses) will reduce earnings directly. In addition to this, the question on the health of the business and corporations will pile as an additional uncertainty component.
The weaker macro context will weigh on sentiment to the sector for the foreseeable future.
We consider these to be major factors which are playing in the minds of the boards of the banks and the key reason why the dividends has been cut. We don’t see any immediate resumption of dividends until the economic effects of the Coronavirus has felt through the economy.
Big 4 Bank Share Price Performance
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The performance of the cohort Australia bank shares shows relatively consistency in returns with exception of CBA and we think this is due to its stronger capital position.
Why is Macquarie’s performance different to the rest of the group?
We included Macquarie bank just to show a slight variation as result of exposure to capital markets and funds management.
Macquarie is Australia’s largest investment bank. Coming out of the financial crises it is also the only survivor out of all the listed financial engineering banks (Allco, Babcock and Brown).
Post crises, it has shifted its business to be less reliant on volatile parts of the market such as corporate finance and sold of the management rights of its listed infrastructure vehicles.
Now the business focus on the recurring nature of the asset management where it is one of the largest infrastructure asset manager in the world.
Macquarie’s earnings while less dependent than previous incarnations of the business are still reliant on the health and confidence of the global capital markets. It taps into London, Hong Kong and New York markets sourcing deals, advising clients and raising capital.
It is still Australia’s largest investment bank with a blue chip corporate finance contacts and cash equities business. Although the MQG tracks the performance of the broader banking sector. The company has a completely difference risk profile verses the likes of the big 4.
Why did the banks cut dividend and raising capital now?
Banks are a leveraged play on the economy as they borrow short and lend long with enormous amount of leverage. If you know earnings are going to be weak or expecting losses. The most conservative action is to preserve capital and raise money when you can rather than when you need to like in the depth of the GFC.
An optimist can see this as a more precautionary move rather than expecting actual losses like the last crisis. For the current shareholders the short term loss in income can be seen in the context of preserving the long term value of the shares.
Banks at its peak traded on two times it’s book value with a mid-teen ROE. The return on equity will decline following the capital raise and lower earnings but it increase the resilience of the business to handle the shocks which will undoubtedly come.
Don’t expect a repeat of last years earnings
Previous strong earnings is what you would expect from a booming residential real estate market and will not be repeated for a number of years and will not be a guide for earnings going forward. Cyclical stocks are cheapest at the peak of the cycle as investor discounts future decline in earnings. Most recent earning report shows evidence of increase provisioning in bad debts in Australia and offshore.
Previous regulatory pressure on loan book growth helped
The housing market already cooled off in 2018 and 2019 so it didn’t overshoot in the last boom. The banks previously raised capital in 2015 and 2016 to shore up their position in response to APRA raising capital requirements was a great move and prepared the big 4 banks going to this crisis.
The banks already responded by cutting lending to commercial real estate which can be considered one of the most riskiest form of lending. This led the rise of non-bank lenders debts funds which filled the gap and reduced some exposure off the books.
The overall condition of the lending can be as good as it could be given the Australian regulators already pressured banks to slow investor mortgage lending during the book to remove the risk of a housing bubble in Australia residential market.
Unemployment and Property Prices
We always considered unemployment and house prices go hand in hand. The resilient performance of the Australian economy during the financial crisis and the fast bounce back as result of the mining boom followed was the key reasons the property prices stayed relatively stable and took shortly after.
Unfortunately the 30 year uninterrupted run recession growth will not stand impact of the virus and its effectively over. This recession will be a domestic led recession where the cut back in spending as result of the lock down is already impacting the job market. The weakness in the job market will continue with a delayed but pro-longed impact on property prices.
The implication for the big four banks is that it well known the residential mortgage lending book is the largest component of the loan book and contributor to bank earnings, and any housing weakness will hit earnings materially going forward. This is not something that can be resolved in one or two reporting periods but we think a number of years.
What hasn’t yet been factored in is the expected increase in business loan losses as result of closures and upcoming bankruptcies. The residential loan book is an obvious segment given its size and visibility. The business losses as result of the prolonged economic weakness will be just as severe but will take time to play out.
The market has turned for bank shares. Investors will always be tempted for bottom fishing however with weak job growth and consumer sentiment will not turn anytime soon. Patience will be needed for a while before getting back in.