Business lending to support bank stocks

LAST year was a mixed one for Australia’s major banks. There was a lot of pressure to sell from various quarters.

The Commonwealth Bank shares had a good year in 2014.

LAST year was a mixed one for Australia’s major banks. There was a lot of pressure to sell from various quarters, on the view that banks were expensive.

The Commonwealth Bank in particular looks to have had a good year in 2014, up about 10 per cent, a performance not matched by the other large banks.

Admittedly there have been some serious headwinds facing the sector. Incredibly, regulators thought that the slump in commodity prices and the associated pressure that put on the large miners signalled a good time to scare investors witless about the banking sector.

The banks alone account for about 30 per cent of the local stockmarket. Needless to say, the Aussie market hasn’t completely shared in the bounty wrought by the global equity bull run.

The year ahead could be a better one for our banks. That is, if regulators can remember that Australia is not the US or Britain — that our banks are already well capitalised, are not globally systemic and didn’t take part in the pre-global financial crisis excess. If they can do that, and stop scaring off global investors, then it could be a good year.

Underpinning that fact is the rebound in credit growth. We know the story for housing credit — credit growth for investors and owner-occupiers is picking up. This is a good thing and has helped drive bank earnings through 2014.

Even so, it’s important to note that the marked recovery in credit growth — growth in lending to both owner-occupiers and investors — remains well below what is regarded “normal” rates. So there is scope for further upside in 2015. Recall that cash deposits of households are quite elevated relative to recent history. If these cash holdings are run down, or even leveraged upon, that could produce a sizeable lift in credit growth.

But the key for our banks isn’t so much the housing credit story. It’s what we’re seeing in the business space. Indeed recent data shows that businesses are becoming much more confident: Lending certainly started to grow through 2014, with non-financial public corporations taking on an additional $729 billion in debt over the last year, the largest gain on record.

Normally, when people see the word debt and record, they panic. It never used to be the case, but the GFC has changed people’s perceptions. Leverage isn’t to be taken lightly. Yet it isn’t the case that it’s always bad. It’s often forgotten in the broader commentariat that debt does have a place in society — if used properly and not to excess. In the Australian context, and when we are taking about our non-financial companies, it could hardly be said the debt burden is excessive.

To see this, consider that cash held (by corporates) as a percentage of total debt has averaged 60 per cent these last few years (currently at 55 per cent). This is a full 12 percentage points above what we saw pre-GFC. Cash holdings are very high, and as a per cent of GDP non-financial debt is extremely low — 1.8 per cent. In any case, total debt is always going to increase over time as a nominal economy expands. It’s what a reasonable person would expect. There is an added incentive now — it makes sense to take advantage of the lowest interest rates in a generation, as long as it is used productively.

That business is borrowing more after a post-GFC hiatus, shows that they are becoming more confident, more willing to spend and invest. They may not be reporting that they feel confident — as shown by some business surveys. Yet their actions suggest there is a tentative turnaround — something that is supported with reference to other statistics as well — in particular, the jobs figures. Roughly 170,000 jobs have been created over the past year, with the November jobs gain the strongest in more than a decade.

The unemployment rate — on the original figures — has been stable at 6 per cent or so for six months. This all supports the idea that non-mining investment is on the uptick. Sentiment to invest, further supported by very strong growth in the US.

The wheels are in motion, and at this stage the headwinds appear to be few. All of this suggests that banks will see business lending as a source of solid revenue growth into 2015.