How a recession could impact Australia’s big four banks

ANZ, CBA, Westpac and NAB share prices in focus

The banks – acting as a proxy of sorts for the health of Australia’s economy – were always going to be impacted by the coronavirus (Covid-19) pandemic; the question was simply to what degree.

As a starting point, AMP’s Chief Economist Shane Oliver, last week argued that a recession is all but inevitable at this stage; and to Morgan Stanley it is now the ‘base case’.

And if we are to take the banks as a proxy for Australia’s economic health – their share price performance over the last month is a sobering reminder of just how quickly things can deteriorate. Indeed, in that period ANZ has seen its share price crash over 30%, CBA has dropped 23.18%, Westpac has fallen 28.85%, and NAB shares are down a hefty 31.83%.

Amongst this chaos though, some analysts have turned bullish on the banks, with Citi recently re-rating the whole sector to a Buy, noting that the recent sell-off looks overdone; others, like Morgan Stanley, remain unconvinced by such opportunities.

Volatility on all fronts

Ultimately, with Australia’s economy poised to materially slow, Morgan Stanley has argued that the banks are likely to experience loan losses comparable to the 2008 to 2010 period.

In technical terms (and on average), the investment bank is now forecasting 'cumulative FY20-FY22E impairment charges of ~340bp of non-housing loans, with a peak of ~150bp in FY21E.’

Positively at least, unlike in 2008-10, the investment bank believes that the banks are more well equipped to deal with such losses and assist struggling customers.

The capital question remains key

Secondly, while the Australian Prudential Regulation Authority’s (APRA) approach to capital standards has generally be regarded as ‘conservative’ – in the face of economic stagnation and uncertainty – the regulator recently relaxed its expectations around bank capital positions.

Specifically, on 19 March, APRA noted that ‘given the prevailing circumstances, it envisages [that the banks] may need to utilise some of their current large buffers to facilitate ongoing lending to the economy.’

Of course, just because you can do something, doesn’t mean you will. In the same way that the banks don’t want to see their loan losses blow out, they also don’t want to have to tap the markets to raise more capital, either.

By that very point, Morgan Stanley contends that owing to the highly uncertain environment, it is unlikely that the bank Boards will want their capital ‘ratios to fall below ~9.5%,’ while also avoiding ‘large capital raisings at deep discounts to book value should a more bearish scenario play out.’

The consequence here is likely what matters most to income-focused investors, with the investment bank positing that all of ‘this suggests larger and earlier dividend cuts than we previously expected.’

In step with that, Morgan Stanley is currently forecasting bank dividends will be cut by an average of ~11% in FY20e. Westpac is expected to be the worst hit of the big four, with an implied dividend cut of 12%; while CBA is set to be the least impacted (with an implied dividend cut of just 8%).

How to trade the ASX Financial Index

Not interested in buying or selling Australian bank stocks individually, but still have an opinion on Australia’s financial sector? You can use CFDs to trade the ASX 200 Financials Index long or short through IG’s world-class trading platform now.

For example, to buy (long) or sell (short) the ASX 200 Financial Index, follow these simple steps:

• Create an IG Trading Account or log in to your existing account
• Enter ‘Australia 200 Financials’ in the search bar and select it
• Choose your position size
• Click on ‘buy’ or ‘sell’ in the deal ticket
• Confirm the trade