Major banks have headroom for a severe downturn: S&P

  • By Christine St Anne

Major banks will be able to withstand credit losses rising six times compared with 2019 as well as a 20 per cent decline in their interest and operating income.

In a report released on Wednesday, S&P estimates that credit losses in 2020 will increase to above 0.5 per cent of gross loans and advances compared with 0.14 per cent in 2019 following a contracting economy underpinned by, rising unemployment, and depressed consumer and business sentiment in the wake of the coronavirus outbreak.

This, says S&P is also in addition to the recent natural disasters which will only heighten risks with expected likely “second order effects” on the economy and banking such a reduced income and unemployment.”

The report notes that government and regulatory support to date together with the support packages announced by banks will “cushion the blow from the outbreak to the households and businesses, and consequently the banking sector”.

Further, the government’s SME loan guarantee scheme – which covers up to $20 billion in credit losses is another support measure.

Nevertheless, S&P expects that business loans will contribute to most of the increase in credit losses for the Australian banks, and the tourism, transportation, and retail sectors are likely to be among the more severely impacted.

It was a view already highlighted by S&P in an earlier report.

Not surprisingly, S&P also expects defaults from the household sector will also rise due to the loss or reduction in income.

Banks would face community pressure against pricing up the loans to businesses and households as well as in cutting interest rates on deposits from households.

“Despite such a significant increase, the Australian banks' credit losses should remain broadly in line with our expected long-term average, partly reflecting our expectation that the Australian economy will strongly rebound toward the end of the current calendar year following a significant downturn.,” S&P analyst Sharad Jain said.

Jain, the author of the report added that he expects that a longer lasting and more severe impact than our forecasts would trigger a greater level of credit losses.

The report also assesses the impact on bank margins and the way the banks will have to manage those margins going forward.

Jain said it is particularly difficult to predict the net interest income with the likely changes in funding composition and uncertainty underlying pricing of loans, deposits, and wholesale borrowings, his base case is an assumption of a 3 per cent cut in net interest income.

In conjunction with a 2 per cent growth in loans and advances (factoring in growth in year to date), this corresponds to 8-10 basis point cut in net interest margin, which Jain considers to be a plausible scenario.

Notwithstanding access to cheap funding from the Reserve Bank he expects net interest income would likely decline.

“We expect lower returns from the banks' security portfolios would also suppress interest income,” Jain said.

In addition the banks retain limited ability to further reduce interest rates on their low cost or zero-interest deposits.

Jain believes that banks would face community pressure against pricing up the loans to businesses and households as well as in cutting interest rates on deposits from households.

The S&P analyst and author of the report also expects that banks would like to maintain some issuance to the wholesale markets although it would be significantly costlier - due to substantial increase in spreads- than funding from the RBA.