How are the banks performing now?

In May 2020 we posed the question – are banks worse than in February? As we stared down the abyss into a coronavirus recession and major Australian bank shares dramatically declined, there were concerns that the banks were in trouble.

But as we noted, prior to the pandemic, our banks were in an unquestionably strong position and the stress tests we reviewed indicated that while profits might drop, their capital ratios would still be above the APRA minimum requirement.

Graeme Quinlan, Senior Adviser and Head of the First Financial Investment Committee, discusses the recent financial performance of Australian banks and how they are recovering as we work our way out of the COVID recession.

The article we wrote last year highlighted key points of action that the prudential regulator APRA took to minimise the potential of our banks collapsing under a COVID induced recession. We also looked at modelling to determine how bad things needed to get before the worst would happen. Graeme explains:

“Our consultants, Andrew Doherty and Tim Farrelly, provided us with a lot of information. Back then of course it was difficult to know what was going to happen with the banks through COVID in 2020. It looked like we were heading into recession, and nobody knew how deep it was going to be… but what we did know was that the banks entered the crisis in a very strong capital position.

Our modelling suggested that even if we experienced a five times GFC event, the banks would of course take a hit on their profit, but their capital ratios would still be above the APRA minimum requirement.

If you can imagine, a five times GFC event is almost Armageddon… so we understood that the big four definitely are an oligopoly and have significant competitive advantage over the smaller rivals and foreign banks. In particular, their cost of funding is a lot lower, and they have better pricing power. They have excellent customer retention… there’s a saying that you are more likely to change your partner than your bank!

As the crisis unfolded, APRA gave a clear warning to the banks… they must not pay executive bonuses and they should think very seriously about dividend payments.

When APRA says something like this the banks need to listen – no CEO would ignore it. So, the banks put in large provisions for bad and doubtful debts, they cut their dividends and they went through a period of austerity and prudence.”

These actions coupled with a pending recession impacted bank shares and prices dropped sharply, but this is where we saw value. Graeme continues:

“When we looked at the numbers, we realised there was no way the banks were really going to need all those provisions… it was more like they were trying to appease the regulators.

Their share price dropped mainly on face value of what they were doing, so we thought they were good value. As it’s panned out, it’s proven to be relatively accurate. And now the banks are writing back all of the provisions they made last year. We expect that there might be increased dividends coming through from the big four banks. They held off last year and they might be able to provide an increase now.

The markets have realised they didn’t need to write the banks down so heavily and they have bounced back considerably. The price being paid today is a lot more than it was last year so naturally future returns look more modest because of what you will pay now.

The banks have proven once again that they are fairly strong businesses with significant competitive advantage, but a lot of the steep gains are probably in the past. From April and May 2020 through to now some banks are up 60%-70% so it’s unlikely that will repeat again in the near future.”

“Overall, we expect that the COVID recession will go down as a short sharp shock. It definitely could have been a whole lot worse. In broad terms we believe we will come out of this with fairly minimal long term damage.

From our point of view, we didn’t know what was coming but we knew it would have had to be something close to the end of the world for the big 4 banks to go under.

What’s really happened is that the market has priced in lighter impact from COVID and banks have enjoyed a strong recovery.

Some people might suggest that the property market and lending could be an issue. Certainly, household debt is something that’s higher and there is some element of risk there… but the banks are still in a good position.

Even if we had a property market crash, the banks have solid buffers on their loan to value ratios (LVR) – the amount that’s owed compared to the value of the property. The property value would need to drop dramatically for them to be in a negative position where the banks made losses.”

If you have any questions or if you’d like to speak with an adviser, please contact our team today.