The 2016 reporting season suggests underlying fundamentals are becoming positive for the banks. These include slowing margin decline as competition for new customers and the chase for deposits begin to ease, sustained cost discipline, normalising loan losses that would remain manageable, further strengthening in prudential buffers and no reduction in dividends. We can expect these trends to continue into 2017. In this wire, we outline two developments that we expect would build upon these positives, then explain why Westpac is our pick of the big four.
Firstly, capital requirements will continue to rise but we believe the banks will have time to achieve these through their DRP. The upcoming Basel 4 pronouncements on capital and funding may prove to be restrictive but these would be tempered by ongoing uncertainty in Europe and the need to preserve economic stability at the very least.
Secondly, higher interest rates are inevitable and this will be good for the banks. Loan losses may increase but historical loss rates on mortgages tend to be low (averaging 2-3bp) providing unemployment remains low. The stress points belong in the unsecured personal lending and highly leveraged commercial property space (loss rates around 300bp) but the banks have generally de-risked their exposures since the GFC. It should come as no surprise the major banks would be beneficiaries in a rising rate environment given their lending book composition and scale.
Our pecking order starts with WBC given better margins and scope to further rationalise its branch network, followed by NAB (well positioned to close the ROE gap with its peers), ANZ (capital upside from divesting legacy investments in Asia and Wealth) and CBA (fully valued).
Exclusive article for Livewire by TS Lim. You can also read TS’ recent bank sector report here, including his reporting period summary. (VIEW LINK)