Rates are about to hit rock bottom and big banks have announced record losses because of the virus crisis. In this fortnights update we talk about bank losses and profits, what it could signal for the economy but why it does not matter that much.
Big banks feeling the pain
The big banks have started to show the extent of losses from the virus crisis.
In the recent full year results ANZ announced a colossal downgrade of profit by 42% compared to the prior year and this was largely from real and expected losses. With Westpac eclipsing their poor performance to announce a staggering 62% decline in profit.
Big banks are a kind of canary in the proverbial economic coal mine so when they show pain it is a signal and reflection of the economy.
We talked back in April about the provisions big banks were making and how pessimistic they were about the economic recovery and now the full extent of that pessimism is coming through.
In the case of ANZ, they have made a $2.47 Billion dollar provision which is equal to 65% of the $3.76 Billion profit they made this year. That means they are saying they could expect to lose more than one half’s full year profits from virus related losses and others.
That is not too bad if you really think about it. Less than a year’s work to cover the (potential) losses.
In the case for ANZ, essentially this means they could cover all the losses from the virus in just a year, at least from a dollar perspective.
Another big bank that is feeling the pain is Westpac. I mentioned in a recent update that Westpac might be in a bit of trouble and their full year results they announced this week show a decline in profit of 62% reinforces this view.
Westpac has put away a whopping $6.2 Billion in impairment charges from real and expected potential losses. In their case, based on the most recent years subpar profit performance, it would take them three years to cover those losses. Compared to ANZ who could do it in less than a year.
Looking at one year’s profits to cover expected losses is a drastically oversimplified calculation of the complicated situation every bank finds themselves, but there is truth in it. They could wipe the loans and losses off their books and recover that amount in profit.
It also does not seem that bad when you consider in a ‘normal’ year the combined profits of the big four banks (CBA, ANZ, Westpac and NAB) is close to $30 Billion.
Considering that there was about ~$250 Billion in loans that people froze their repayments on it shows that the economy is bouncing back quite strongly. People are starting to make repayments again and the pessimism from the banks is persistent but fading. They know that the full economic recovery will take years, 5 to 10 in some ways, but it is not as bad as many thought it would be.
For perspective, the total value of all residential property in Australia is around $6 Trillion, so the $250 Billion that was most at risk during the pandemic was roughly 4% of the total market.
It also appears that the recession is not as bad or as deep as we thought it might be. It might have been even less severe if Victoria did not need to go into the harshest lockdowns of any Western democracy as well.
In an update in September I argued the case that while we had entered a technical recession a sharp recovery in property prices would lead a broader recovery of the economy.
This was on the back of a counterintuitive prediction that I made back in June that “property prices will recover all lost ground in 2020 and be setup for a boom in 2021 that will reach or exceed previous record highs”.
This was a view that was not commonly held but is proving accurate. CoreLogic, the most recognised property data provider has said that property prices increased in the month of October on a national basis by 0.4% which is the first official price increase in five months.
It seems property prices are recovering strongly and heading towards a boom in 2021.
Rates are about to hit rock bottom
Last year in October I said “After all of this [rate cuts], the RBA will put the knife away for a till the middle of 2020, or until the inevitable recession hits - when the cash rate goes to zero or potentially negative”.
In March, this year when the RBA cut the cash rate to 0.50% all of the big 4 banks and many others immediately passed along that full cut to their customers. This was quite a team Australia moment and one for the history books as it is unlikely all of the banks will move in such unison again.
In May we talked about why fixed rates are so low (hint: it is good for the banks, which I think is verified by the big banks lowering their fix rates but not their variables after the RBA rate cut) and whether to fix your rate or not. It all depends on your circumstances but even now banks are still offering thousands of dollars in refinance cash back offers to buy your business. A practice that could be considered irresponsible by some.
In July we talked about how for the first time ever a home loan rate of 2% was available and I said this was just the start of rates so low.Now, most of the big banks are now offering a 1.99% fixed rate or pretty close to it. Another prediction for me to check off.
This week the RBA cut the cash rate to 0.10% and while not quite 0% is as close as we will probably get.
Any lowering of rates will be due to competition.
Banks are fiercely competing for (quality) home loan and business borrowers. Even offering cash back for refinances and trying to lock people into long fixed term contracts.
Behind the scenes right now in the bank lending and borrowing work the day to day (money market) cost of funds is around 0.8% - 0.10% so with the official cash rate lower to this point as well it does not actually make a huge difference in the cost of funds for banks.
You might recall in an update a year ago we talked about the all-important NIM. The ‘net interest margin’ is basically the profit banks make from borrowing at one (lower) rate and lending at another (higher) rate. This is a tad over simplified and there are all sorts of different sources of capital banks have at different costs, but the important thing to remember is that banks need to borrow money to lend money, and they make more money the more they lend and the cheaper it is for them to borrow.
To keep money cheap for banks and to keep them lending and pumping along the economy the government has established various sources of cheap capital for banks including a $243 billion dollar liquidity fund, government guaranteed the deposits and currently lends to them at 0.25% for three years. The RBA governor also said rates will not increase for three years so the banks can be pretty certain rates are staying low.
This all means the borrowing costs for banks are staying low so rates are staying low.
Rates are about to hit rock bottom and big banks have announced record losses because of the virus crisis. In this fortnights update we talk about bank losses and profits, what it could signal for the economy but why it does not matter that much.