Dividends will dip but banks will survive the stress test

Federal Treasurer Josh Frydenberg met with Australian bank chief executives in March to discuss responses to the pandemic crisis. Picture: AAP

Across Australia the quest for yield is getting tougher and tougher. Nothing illustrated that better than this week’s bond tender by the finance arm of the Port of Brisbane via the FIIG broking network.

The expectation was that the 10 year term bonds would yield a little over 3.1 per cent. Instead the tender came in at 2.78 per cent. The issue was dramatically oversubscribed, even at that low return level. But of course, 10 year bonds and most bank term deposits are yielding below 1 per cent, so there is almost a sense of desperation given the vast amounts of cash sloshing around the system. It seems that the only way to get yield is to take greater risks. With the share market at high levels, on the surface that’s looking reasonable.

But there is a hidden risk which certainly applies to those seeking yield via bank shares. In 2017 APRA did a stress test of 13 banks and deposit taking institutions, using what then seemed to be ridiculous assumptions. For the test, APRA assumed that there would be a 4 per cent decline in GDP; a rise in unemployment to 10 per cent and a decline in national house prices over three years of around 35 per cent.

Most of these assumptions now look realistic. The house price test assumption at this stage looks too harsh because they have performed well in most areas outside Melbourne, but it’s not unrealistic.

That stress test showed losses for the 13 institutions surveyed of around $144 billion, which is not good news for bank shareholders. But the banks’ corporate structures were able to stand that level of loss, given our strong bank capital ratios and the fact that the assumed 35 per cent fall in house prices was not as catastrophic for the banks as the fall in GDP was for business loans.

Currently we are seeing the Reserve Bank stand behind the banks with large amounts of token interest rate credit. And of course banks are now doing their own stress tests, which is why NAB made a share issue and others will consider following. Those current stress tests, if they produce anything like the APRA tests, will constrain bank dividends. Nevertheless, the APRA stress tests are giving investors in bank hybrids some confidence, especially as the Reserve Bank is ruling out negative interest-rates, which indicates we are probably close to the interest rate bottom.

As I described on Thursday in The Australian, the last Australian treasurers to encounter debt of the level now facing Australia were the immediate post-war treasurers Ben Chifley (ALP) and Arthur Fadden (Coalition). They had a detailed plan which included regulating economic activity, not by higher interest-rates, but by credit control. When debt is high lifting interest rates cripples governments so there is no Australian interest rate increase likely for some years unless we are forced into higher rates by international pressures. The Australian governments of the future may have to follow Chifley and Fadden and adopt some of their strategies.

Meanwhile Australians looking for yield are flocking to extended currency terms or taking bigger risks. The bank hybrids gain their security via bank dividends and if there is a crash the hybrid securities become bank shares. With yields under 4 per cent the market is not anticipating bank crashes. AMP and similar hybrids are yielding around 5 per cent, That’s not a rate that is forecasting a disaster but a recognition that the AMP is not as safe as the big four banks in the sort of environment we are facing.