By Robert Guy
Wilson Asset Management’s Matthew Haupt says his view on bank stocks is on a “knife edge”.
It’s an apt descriptor given Victoria’s grim accounting of the runaway virus stalking Australia’s second largest state, a crisis that threatens – if not contained quickly – to deliver another body blow to an economy and jobs market already on the back foot after months of lockdown restrictions.
Haupt, who spoke to investors in WAM’s Leaders Fund on Friday, says bank stocks look “interesting” but warns rising new virus cases could weigh on lenders who have already shouldered a heavy burden in keeping the economy afloat through mortgage and business loan deferrals.
“Looking on a short-term basis I think there is some weakness in the Australian banks, and I’m talking real short – like one to two weeks – as the Victorian situation puts a lot of fear into how the economy is going to bounce back.
“If we get further spread within other states, obviously banks are not a buy.”
But Haupt reckons if the Victorian situation can be contained, the US can control its outbreak, bond yields edge higher, and the yield curve steepens, then banks could be a buy.
“[It’s] very much on a knife edge at the moment but a trade we’re looking at. They do look like good value if containment can happen.”
That “if” speaks to the high stakes at risk in Victoria’s attempts to contain a resurgence in new cases that has spotlighted manifold governance failures.
Given the big four banks account for a near 20 per cent weighting in the S&P/ASX200 Index, concern about a renewed strain on their balance sheets from delayed prospects for recovery is a wake-up call for a sector that had enjoyed a solid rebound in share prices.
The S&P/ASX200 Banks Index rallied 30 per cent from May 22 to June 9 as recovery hopes, higher yields and a discount to book values attracted investors. Lower funding costs have also been a tailwind and should provide some support to net interest margins.
However, net interest margins will continue to be pressured by intense competition in the mortgage market among the sector heavyweights, which appears to not have dulled amid the crisis.
AFG’s fourth-quarter mortgage index report showed the big banks used their balance sheet to steal share from non-bank lenders, with 70 per cent of the mortgage broker’s business going to the big banks in May before pulling back to 60 per cent by the end of June.
The rapidity of Victoria’s outbreak has surprised investors emboldened by massive government support programs – headlined by JobKeeper – and a move to record low rates and the embrace of yield curve control by the Reserve Bank of Australia.
The mortgage repayment deferrals reflect the fragile state of household finances, where the combination of low income growth and too much debt has come home to roost as the virus has smashed the jobs market and the ability to service loans.
But it was only last week that the banks started prodding customers who could afford to start repaying deferred loans to do so as states ease restrictions and more businesses reopen their doors.
No doubt the latest data from the Australian Prudential Regulation Authority has helped focus the minds of the big four bank chiefs when it comes to encouraging customers to stump up.
The banking watchdog says there are $266 billion in deferred loan repayments, or 10 per cent of total loans. Around $192 billion is deferred home loan payments.
These are undeniably large numbers.
That’s a lot of capital – and interest income – dependent on the virus being contained, the economy bouncing back, and the jobs market kicking back to life ahead of the March expiry of APRA’s temporary rules around the capital treatment of deferred loan payments.
APRA reminded lenders that accounting standard AASB 9 – which relates to the accounting of financial instruments – continues to apply, and banks should re-rate and grade borrowers.
Morgan Stanley says this means investors should be looking for more information during the reporting season on the migration from stage one to stage two under AASB9, changes in probability of default, and potential increases in regulatory expected loss.
It’s little wonder the prospect of Australia’s second most economically important state taking another hit, thereby impairing the national economic recovery, steered bank stocks lower over the course of the week.
With Melbourne in lockdown and many businesses having to shut or re-embrace past virus practices – such as takeaway for cafes and restaurants – epidemiology threatens to trump the economy again.
With two weeks to go until the start of the earnings season, fund managers and analysts had assumed the worst of the virus crisis had passed for corporate Australia.
Full year 2020 financial year results, especially in the second half, are going to be a shocker thanks to the fallout from COVID-19 on revenues and the bottom line.
Chief executives will use the virus crisis as an opportunistically timed excuse to “kitchen sink” all their accounting nasties.
The memes of coffee mugs emblazoned with EBITDAC – earnings before interest, tax, depreciation, amortisation and COVID-19 – offer a comedic take on what will be a red ink stained reporting season.
But investors have been looking forward. The sharemarket rally has been driven by hopes 2021 financial year earnings will rebound, thanks to the tailwinds from monetary and policy stimulus.
That’s driven the market’s prospective price-to-earnings multiple to around 20 times, a ritzy valuation where hopes for an economic and earnings recovery are yet to be translated into reality or confirmed by management outlook statements.
While there has been a healthy debate about whether the trajectory of economic recovery will be V, U, or W-shaped, the projected rebound in earnings have been V-shaped.
Macquarie notes that four-week rolling net earnings revisions are positive after two years.
The positive net revisions have been boosted positive revisions for companies like retailers JB Hi-Fi, Wesfarmers and Harvey Norman, as well as ventilator manufacturer Fisher & Paykel Healthcare and building materials supplier James Hardie Industries.
While the one-two hit of fiscal and monetary stimulus has bolstered markets, there has been a growing wariness about the looming fiscal cliff as given the impending legislative expiry of key support programs.
The crisis in Victoria will only exacerbate those anxieties and has sharpened focus on the government’s July 23 economic update.
UBS says that while GDP forecasts are in an upgrade cycle and earnings per share forecasts could be lifted for the top 100 stocks, it is concerned government plans for tax cuts and other support may be “insufficient” to stop a fiscal cliff in the fourth quarter. It estimates the fiscal cliff at around $100 billion.
The broker argues that low interest rates are supporting equities, but it’s concerned that if consumers save more in the fourth quarter and further stimulus does not meet market expectations, equities may fall.
It says sectors potentially affected by the fiscal cliff account for about half the market’s market cap.
UBS says without ongoing stimulus measures earnings per share growth in the 2021 financial year could be negative compared to consensus expectations for around 8 per cent growth.
Sustaining a rally will be difficult if 2021 earnings expectations start to deflate.
The pressure is on Daniel Andrews to get the virus under control so Victoria can assist in the collective push to restart growth rather than hinder it.