2017 has been a fantastic year for Asian Banks with the Index rallying 24 per cent year-to-date, outperforming US Banks and in-line with Euro peers.
On the other hand, Japan and Australia have been big losers. The Japanese banks have been a laggard this year, failing to follow on from their post Trump bump.
Yet, after a horrible second quarter – where share prices fell 10 per cent- the Aussie banks have seen a solid recovery in recent weeks and there are signs the rally could continue near term.
A quick cross-check of the region reveals that banks have run hard in Asia. Moreover, noted UBS analyst Jon Mott, the rally has been broad-based.
“All markets, except Japan, have delivered double digit returns as the economic outlook have improved and the prospect of higher interest rates supports revenue.”
In a client note, Mott points out that in US dollar terms, Korea has been a standout performer, up 45 per cent year-to-date while India, Singapore, Hong Kong and Indonesia have also outperformed.
“Korean banks have been the surprise packet of 2017. “Last week's second quarter profit results came in 24 per cent above consensus with all line items surprising,” he said.
It’s not just Korea. Bank sector earnings forecasts in the region have been consistently revised upwards in the last 5 to 6 months although to a less extent in India, the Philippines and Taiwan.
Equally, Mott added, earnings fundamentals are improving in Indonesia, with strong growth and recovering credit conditions driving outperformance.
Back in Australia, things are a little more hazardous.
Aussie banks had a big win on capital from APRA last week which led to a clear turn in sentiment towards them.
“This leads to the question- are we past the worst for the banks or is there another hit around the corner?”
There are other positive signs.
Neatly ticking off the ‘bull points" for the banks, he pointed to mortgage repricing which demonstrates the banks’ pricing power with margin expansion likely to offset slowing credit growth.
Importantly, he said, substantial cuts to mortgage broker commissions look inevitable.
Moreover, he argued, positive jaws should ensure reasonable pre-provision operating profit growth while falling unemployment and high business confidence should ensure asset quality strength remains.
Still some warnings lights are starting to flash. To Mott the medium term remains challenging - potentially capping share price growth.
Crucially, he noted, Australian consumers are the most over-leveraged in the world.
"If the housing market does not slow APRA is expected to keep turning-up-the-dial on Macro Prudential until it does,’ he argued.
Also, he added borrowers will need to migrate from interest-only loans to principal-and-interest loans putting pressure on cash flows.
“The recent caps on interest-only lending to 30 per cent of mortgage flows implies that a large number of borrowers will either not be able to access such loans, refinancing will become more challenging, while APRA will be paying close attention to these loans being extended.
“As a customer migrates from the interest-only phase to the principal-and-interest phase of their loan, mortgage repayments step-up by between 30 per cent and 60 per cent (potentially more if the interest-only phase has been rolled several times).
Increased bank levy?
“This is likely to put significant pressure on customers' cash flows and increase mortgage stress."
This would inevitably lead to higher bad debt charges.”
The UBS analysts noted further that investor rates are already being increased to 6.3 per cent limiting the scope of further repricing without creating mortgage stress, while rotation to principal-and-interest loans should largely offset product repricing.
But the big-ticket issue for investors looking to increase their investment in the banks is the extremely challenging political environment.
“The Federal Election is now 12-18 months away with Labor well ahead in the polls.
“Labor's stated policies include: reducing negative gearing; capital gains tax relief and trust tax shelters; higher tax rates for high income earners; and a Royal Commission into the banks. Potentially we could see a higher a higher Bank Levy.”