Market wise to softening tones of bank debt and funding: UBS

Pressure is mounting to prevent a wave of foreclosures on business loans and mortgages in the lead-up to Christmas.

As major bank share prices retreated on Thursday, Mr Mott also flagged a “W-shaped” provisioning and earnings outlook. Picture: AAP

Investors will “look through” any capital relief granted to banks if the industry extends loan deferrals beyond their scheduled expiry in October, with the sector also likely to report lower bad debts and funding costs in the second half, according to an analyst.

UBS said in a report on Thursday that talk of the Australian Prudential Regulation Authority allowing capital relief was “academic”.

“Experience overseas has shown that where regulators grant relief from non-performing loan recognition - for example, ‘extend and pretend’ or forming new categories - the market looks through this,” analyst Jon Mott said.

“We would expect a similar response in Australia, with focus on ‘real NPLs’ and ‘real common equity tier one’ ratios.

“Transparency and conservatism has been a hallmark of the Australian banks’ disclosure for many years.

“Moving away from that now is unlikely to be well received, in our view.”

Pressure is mounting on regulators and the banks to prevent a wave of foreclosures on business loans and mortgages in the lead-up to Christmas.

Last March, APRA announced that deferrals would not count as a period of arrears, avoiding the need for banks to hold extra capital against the loans.

APRA is expected to give more guidance on the issue of capital relief in return for longer repayment holidays by the end of next month.

Mr Mott said regulators in many other regions had created other categories for loans which had suffered a deterioration in quality.

Often, there was a failure to recognise the loans as non-performing, and additional risk-weights were not applied.

It was in these situations that the market made its own NPL and CET1 calculations.

The banks, he said, also provided detailed disclosure of their asset quality and risk-weighted assets in their Pillar 3 reports.

“Adjusting any company-reported ratios to calculate a ‘real NPL’ or ‘real CET1’ calculation is not difficult and would, we believe, become common practice in the market,” Mr Mott said.

“Further, the Australian banks have built a reputation for both transparency and conservatism in disclosure over the decade since the global financial crisis.

“We believe the market will continue to reward the banks which are seen to have the strongest capital, asset quality and most conservative accounting given the uncertainty remaining in the economy.

“These banks are also likely to be in the best position to return to higher levels of profitability as the economy recovers.”

Earnings outlook

As major bank share prices retreated on Thursday, Mr Mott also flagged a “W-shaped” provisioning and earnings outlook.

He upgraded forecast 2020 earnings per share by 12 per cent, as well as 9 per cent in 2021, with the possibility of a sharp fall in provision charges due to economic overlays already booked.

“How the (mortgage and SME books) perform at this time is a topic of much contention, but in reality we are in an information void,” Mr Mott said.

“Customer ‘check-ins’, transaction account analysis and other reviews are important, but responses are susceptible to positive selection bias.

“As a result, with limited, if any, NPL formation during this deferral period, it is possible the banks credit impairment charges may fall sharply during (the second half), given the economic overlays recently taken.”

Provision charges, however, could rise again in the first half of the 2021 financial year due to the economic scarring felt by households and SMEs.

This would lead to the ‘W-shaped’ provisioning and earnings outlook.

While the economy had performed more strongly through the reopening phase, particularly in retail sales, there was concern about the outlook for the December quarter.

This was when $100bn of policy stimulus, worth more than 20 per cent of quarterly GDP, was due to be removed.

Loan deferrals accounting for about 10 per cent of the banks’ mortgage books and 15 per cent of their SME loans would also expire.