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04 Apr 2022

Shaken Investors Seek Shelter in Australian Banks

By Sandy Su, Investment Specialist for Citi Rising inflation is dominating the national conversation as it drives up the cost of living, but how may it translate into a profit engine for banks?

Rising inflation and its expected impact on interest rates raised market expectations for a period of solid global economic growth as we entered the new year. It was an outlook that favoured banks, but events are overtaking that expectation, and forecasts are changing.

Inflation in Australia was not expected to reach the more dramatic increases experienced in the United States since the start of the year, and was anticipated to plateau out over 2022 to within the Reserve Bank of Australia’s (RBA) tolerance levels, even if it spiked higher over shorter periods.

However, the conflict in Eastern Europe, and its impact of pushing inflation higher as key commodity markets were disrupted has increased fears global economic growth could be derailed, as rising inflation slows consumer demand and exacerbates already strained supply chains.

While banks generally moved higher before the conflict broke out, they have come under selling pressure in recent times as investors shift away from risk sectors to more safe-haven environments.

Australian banks had lagged that earlier out-performance of the global banking sector, as the RBA had made it clear it would approach interest rate hikes cautiously, as it did not anticipate runaway inflation.

However, the RBA has indicated it could raise rates more aggressively if needed since the outbreak of the conflict, as it has become apparent the Russian/Ukraine war will have impacts on the broader global economy, one of which is rising inflation pressure, particularly in energy markets.

In this new environment, Australian banks are again moving out of synch with the global banking sector. While a general sell-off is in process, Australian banks have gained investor favour, likely due to our commodity dependent economy, stringent capital adequacy requirements, and limited non-performing loan books.

Key forward focused points:

1. Australian Bank Performance Resilient to Recent Market Turmoil

The Russia-Ukraine conflict has shaken investors globally. As risk increases and rattles equity markets, investors across Europe, Hong Kong, and Singapore have shifted from cyclicals to defensive stocks. This has affected large banks, particularly those that serve their domestic markets.

Australian banks have been amongst the highest performing recently as they are being isolated by local factors and our commodity driven economy.

2. Banks Benefit from Commodities and Rising Inflation 

A number of factors are driving the Australian bank prospects. Firstly, the Australian economy’s exposure to commodity upside is a significant tailwind as trading partners seek to cover sanctioned supply. This also benefits local economic activity through higher domestic incomes and improved Federal government revenues.

The business investment recovery is underway:

  • It could benefit further on the back of sustained higher commodity prices.
  • The recovery has boosted business lending, creating potential benefits to bank revenues.
  • Those benefits could be boosted by improved earnings from higher interest rates.

 

3. Stronger Capital Requirements Benefit Banks

The recent market turmoil has reminded investors of the importance of asset quality. Australian banks have extensive capital reserves that have been built up by key events, including:

  • Regulator imposed capital requirements stemming post the global financial crisis of 2008-09. • The reduction of bank dividends during the initial economic impacts of COVID-19 in 2020.
  • A general move to divest non-core assets.
  • Additionally, the banking regulator, APRA, has required the banks to accelerate the issuance of securities to meet APRA’s new loss-absorbing capacity framework (LAC), which comes into effect under two stages in 20224 and 2026. APRA has noted the big four banks have already met the 2004 requirements.

 

What Should Investors Do?

We’ve focused on two of the big four banks we consider worth considering.

Westpac Banking Corp (WBC)

Westpac is the second largest bank in Australia by number of customers and profit and is also the largest bank in NSW. Westpac recently bucked market expectations of deteriorating profit drivers, which strongly pushed its share price up in February. We believe Westpac is a strong proposition based on:

  • Its improving mortgage credit growth.
  • Sector wide asset quality growth.
  • Opportunity to materially extract cost savings and potential for capital release via divestment.
  • Increasing cash rates will benefit Westpac significantly

 

Recently, Westpac’s earnings beat market expectations by 7-13%. Costs were also 3% ahead of expectations with good signs of progress on headcount cost reductions (1,100 through the first quarter), according to Bloomberg.

Australia and New Zealand Banking Group Ltd (ANZ)

ANZ is one of the largest Australian-based banks operating in retail and business banking in Australia, New Zealand and the Asia Pacific. Australian operations make up the largest part of ANZ's business with commercial & retail banking & funds management.

ANZ is set to benefit from:

  • A steepening yield curve.
  • Improving volumes in institutional and housing momentum.
  • Higher NZ rates and deposit repricing.
  • Our research indicates ANZ Asset quality is expected to remain strong with just a 0.2% bad and doubtful debt charge in the first quarter (consensus 0.8%).

 

Wealth Solutions  >

Any advice is general advice only. It was prepared without taking into account your objectives, financial situation, or needs. You should also obtain and consider the relevant Product Disclosure Statement and terms and conditions before you make a decision about any financial product. Investors are advised to obtain independent legal, financial, and taxation advice prior to investing. Past performance is not an indicator of future performance.

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