Credit risks ‘real and rising’, says UBS

Predicting likely recommendations of the Hayne royal commission, UBS analysts say the risk of a credit crunch is growing.

Samantha Bailey

*Fairfax Pool Images* The Royal Commission into the Financial Services Industry. 12 February 2018. The Age News. Photo: Eddie Jim. ( The Commissioner Kenneth Hayne )

2 min read

1:02PMDecember 06, 2018.

Updated 1:28PMDecember 06, 2018

The current credit squeeze could deteriorate into a full credit crunch if banking royal commission recommendations result in reduced borrowing capacity, further restricting the flow of lending and credit growth, UBS analysts say.

In a note to clients predicting the impact of possible Hayne royal commission recommendations, UBS analysts led by Jonathan Mott said they remained very cautious on the banks, as fundamentals on the sector continue to deteriorate.

“The banking sector is facing a period of substantial and sustained earnings pressure which is likely to last several years,” UBS analysts said.

“The risk of the current credit squeeze turning into a credit crunch is real and rising, with the housing market now falling sharply.”

Their recommendations come ahead of the release of commissioner Kenneth Hayne’s final report, which is due out by February 1.

The analysts expect that one of the most significant recommendations will be a further tightening of the loan verification process, and in particular, the capping or removal of the usage of the household expenditure measure (“HEM”) benchmark to estimate a customer’s living expenses.

“If the use of the household expenditure measure benchmark is deemed to not meet the requirements of responsible lending this further increases the risk that the banks face mortgage mis-selling actions,” the analysts said.

“We see this as a large and significant tail-risk which appears to becoming increasingly likely as house prices fall.”

Regulatory implications from the recommendations are likely to hit Westpac the hardest, given announcements by the other major banks to sell, divest or IPO their wealth businesses.

“We believe a mandated structural separation of banking and wealth management operations appears more likely following the final round of hearings at the royal commission,” the analysts said.

UBS also predicted increased legal and compliance costs as banking regulators ASIC and APRA become more litigious.

That could lead to ongoing staff and technology cost pressures, while fines and legal costs are also likely to step up significantly, they said.

The major banks are all likely to announce further customer remediation provisions during the 2019 fiscal year, mainly related to aligned dealer groups and banking operations.

Further near-term remediation charges are likely be most significant for Commonwealth Bank, NAB and Westpac, they said.

“While most of the banks have made inroads into customers payments for fee-for-no-service and inappropriate advice for their salaried advisers, compensation for customers who have used aligned dealer groups has been less forthcoming,” the analysts said.

“Despite a process that has already lasted several years, delays in customer remediation remain a major concern and were a feature of the royal commission.”

UBS also said banks are likely to have further investment spend on systems to ensure full documentation of work undertaken and compliance with regulations going forward.

Royal commission remuneration recommendations are likely to mean a move away from a focus on short term profit, return on equity or total shareholder return measures, they said.

“We believe management is likely to be less focused on these financial measures,” UBS said.

“This may lead to some discontent amongst elements of the market as investors’ and executives’ short term interest are likely to diverge.”

UBS’ predicted royal commission outcomes

Remuneration