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Aussie banking sector not immune from the mood of the market

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Aussie banking sector not immune from the mood of the market .

Larry Williams:
The Australian banks updated the markets last week — I see the share prices were down generally, did investors not like the banks results?

Manuel Greenland:
Global markets were weak last week as bonds sold off dramatically and most other asset classes followed suit. Also, last week the Reserve Bank of Australia issued some statements which pointed to a shift in interest rate strategy and that added to market unease in Australia generally and to the bank stocks specifically.

So a number of things were happening while the banks were reporting which may be clouding the investor response to the banks themselves, but in summary I think your observation is fair — overall investors were probably not impressed with the banks results.

Larry Williams:
So what happened — given the strong Australian property market, wouldn't loan growth have been strong?

Manuel Greenland:
Yes, again a fair observation. The mortgage market remains very strong, in fact possibly too strong as Australian regulators are now encouraging the banks to slow down their rate of mortgage lending in an effort to contain house price appreciation. If we look at other forms of consumer lending — credit cards, over-drafts, vehicle finance and the like — these saw continued weak-ish trends. If we turn to companies, corporate borrowing was relatively strong among big companies, but still weak among small and medium enterprises.

So, the broad conclusions would be that general consumer demand is not great but house prices continue to accelerate, and business investment is still weak but large companies are borrowing either to return cash to shareholders or make acquisitions. So yes, reasonable loan growth, but probably not of the quality we want to see.

Larry Williams:
Given that they'd like different loan growth composition, presumably the banks would remain profitable — right?

Manuel Greenland:
Absolutely, the Australian banks are very profitable businesses. The share market however looks to the direction of profitability, rather than its absolute level — and on that basis the picture is maybe a little less rosy.

The banks are offering borrowers lower rates as they compete for loans, so that's negatively impacting interest income. In some areas affected by the mining slow down, they are beginning to see loan delinquencies rising, so their bad debt expense probably won't decline further.

They did a good job of containing costs, the weight of additional regulation and the demands of some technological innovation in which they have to invest, will probably pressure costs going forward. So again, yes they are very profitable, but maybe a little less profitable than investors had hoped.

Larry Williams:
They have to raise additional capital, is this an issue for investors?

Manuel Greenland:
Look, they do have to raise additional capital and in this result we saw that start with three of the big four banks announcing some sort of capital raise. We estimate that they need to raise around A$25b of additional capital and we think it is a good thing, as it makes them more stable businesses over time.

In the main, this can probably be achieved by persuading investors to reinvest their dividends in the banks and frankly investors have shown a willingness to do this. I think this issue is well understood and probably isn't a big issue for investors going forward.

Larry Williams:
What will be the key issues going forward?

Manuel Greenland:
I think the key issue for the Aussie banks is the sustainability and attractiveness of their dividends. A lot of investors like the Aussie bank shares because they've paid out healthy and growing dividends, which have become particularly attractive as the interest rates investors can earn on deposit accounts have fallen.

Clearly the sustainability of the dividend payment depends on these businesses maintaining and growing their profits. While the attractiveness of the dividends is probably determined by interest rates, if interest rates remain low or go lower yet, then investors will likely continue to prize the dividends they can earn from investing in these bank shares.

 

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