I did ask that question: Are we going to get a recession (in the...

I did ask that question: Are we going to get a recession (in the US)? It doesn't matter if RBA says Australia is not. If the US is in recession, it can't be good for the world economy. Everywhere would be impacted, in bigger or smaller ways.

Now given that backdrop, will banks earnings grow or grow enough to justify existing PE multiples? Ask that question yourself if you think banks are good buys now. I have already highlighted that CBA's Klarna problem too in an earlier post.

The Commonwealth Bank (CBA) is facing the prospect of a billion dollar plus impairment of the book value of its 5.5% stake in the Buy Now Pay Later (BNPL) giant Klarna following news the Swedish-based group is finding it harder to raise new capital at prices sharply lower than a year ago.
How investors are playing the big bank sell-off
Alex GluyasMarkets reporter
Jun 22, 2022 – 5.00am


Investors are divided about whether bank stocks should still have a position in their portfolios following a vicious sell-off sparked by concerns about the economic impact of aggressive rate increases by the Reserve Bank.

Some see the rout as an opportunity to buy or top up their holdings in the big four. Others have been deterred by the RBA’s larger-than-expected half-percentage-point interest rate rise this month and the potential for similar-sized moves in the months to come.

The big four banks have been battered after interest rates went up.  Simon Letch
As the RBA has raised rates, the major retail banks’ share prices have suffered. Commonwealth Bank, ANZ, Westpac and National Australia Bank are all down between 10 and 16 per cent over the past month. The decline was more sharp after the RBA rates announcement of June 7.

Analysts have attributed the sell-off to fears that sharp interest rate increases will cause an economic slowdown that flows through to the property market and hurts the banks’ customers.

This would potentially bring an end to years of bumper growth in lenders’ mortgage portfolios, fuelled by record low interest rates and a booming housing market.


Fund manager T. Rowe Price remains significantly underweight the Australian banks, and believes their earnings could weaken sharply in the next six to 12 months as slowing growth sparks an increase in non-performing loans.

Baltimore-based T. Rowe, which manages $US1.5 trillion ($2.1 trillion) in assets, is concerned this will offset the benefit that higher interest rates will have on the banks’ net interest margins (NIMs) – the critical gap between the cost of borrowing and lending, a key driver of profits.

“When rate increases go beyond a certain point, the market becomes concerned that there is no benefit to banks from higher NIMs as they get absorbed by worse operating conditions and impairments. And I think we are close to that point now,” said Nick Vidale, equity analyst at T. Rowe Price.

“Higher interest rates also mean funding costs will rise, and we are already seeing increased competition for term deposits, which is negative for NIMs.”

Morgan Stanley also recently cut its exposure to Australian banks in its model portfolio to “underweight”, from an “overweight” position.

The broker said that a quick and aggressive tightening cycle provides more support for margins, but it will also lead to a weaker housing and mortgage market and a higher probability of recession.

Morgan Stanley slashed its price targets on the major banks by an average of 15 per cent, and revised its order of preference to Westpac (overweight), ANZ (equal weight), NAB (equal weight) and Commonwealth Bank (underweight).
Dividend outlook

Another worry for investors is the prospect of flat or declining distributions from the banks, following years of bumper returns through dividends and buybacks.

T. Rowe said it would not be surprised if CBA and NAB suspended their most recent buybacks in light of developing macroeconomic conditions.

“We think there are limited prospects for additional buybacks in the near-term,” Mr Vidale said. “As for the outlook for dividends, we think a good outcome for the banks in the coming years would be if they were able to hold dividends flat.”

However, fund manager Plato Investment Management says financial stocks are still an important element of a diverse equity income portfolio, and bank dividends will remain good sources of income in the short term.

“We don’t expect dividend cuts in the near future,” said Plato’s managing director, Don Hamson. “However, we are less bullish on the potential for further bank buybacks given increased market uncertainty, and the fact that all the big four bought back capital either on or off-market in the past year.”

The firm says investors will receive solid returns from the banks in the next dividend season and, given their share prices have sold off recently, Plato believes their dividend yields look even more attractive.

As for the market’s worries that higher interest rates will increase loss provisions and that a recession is looming, Mr Hamson said those fears were exaggerated.

“Concerns about rising loss provisions are way overdone. Similarly, we think speculation about a potential recession is way too premature,” he said. “Australia has very high employment rates and people with a job usually pay their mortgage.”

UBS believes the major banks were well placed heading into this raising cycle because they carried a total of $15 billion in collective provisions.

“There would need to be a substantial blow-up in credit provisions to derail the Australian banks earnings story,” said John Storey, head of Australian bank research at UBS.

Buying the dip

Citi agreed that the major lenders were well positioned to overcome concerns about a potential deterioration in the quality of their mortgage assets caused by borrowers being hit by the higher cost of living and higher mortgage repayments.

“We find that the current underwriting standards explicitly build a significant level of financial buffer, even for the most leveraged borrowers,” said Brendan Sproules, head of Australian bank research at Citi.

“Also, we find that the banks possess material excess loan loss provisions to cushion any asset quality deterioration.”

Citi maintained its positive view of the banking sector and viewed the sell-off in the aftermath of the RBA’s rate increase as a buying opportunity.

Macquarie also labelled the recent weakness in bank share prices as a “tactical buying opportunity”, noting that the major lenders’ near-term margin outlook was favourable.


“Rising rates and an upward sloping yield curve provide an upside to banks’ margins from improved deposit profitability,” Macquarie analysts said.

While acknowledging that competition for term deposits was intensifying, Macquarie said the banks were benefiting from “lazy” customers, meaning those not chasing special rates offered by competitors.

The broker estimates “lazy term deposits” are one of the more profitable bank segments.

Morningstar also believes that concerns around bad debts for the banks which sparked the sell-off present a long-term buying opportunity.