The ASX banking sector has been fighting off a slumping property market, grumpy regulators, nervous borrowers and the fallout from the Banking Royal Commission.
But there's a new battlefront opening up and it comes in the form of the bond market!
Shares in our big banks have fallen with the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index this afternoon with the National Australia Bank Ltd. (ASX: NAB) share price leading the sector lower with a 1% fall to $25.09.
The Australia and New Zealand Banking Group (ASX: ANZ) share price isn't far behind with a 0.8% tumble to $26.24, while the Commonwealth Bank of Australia (ASX: CBA) share price and Westpac Banking Corp (ASX: WBC) share price gave up 0.6% each to $76.99 and $26.18, respectively.
Banks don't need to fear yield inversion
There are further downside risks to the bank's earnings forecasts from falling bond yields, warned Credit Suisse.
But the threat isn't coming from the inverted yield curve where shorter term bond yields are higher than those on longer maturity bonds even though banks are said to borrow short and lend long.
That business strategy works during normal times when banks can borrow cash at a lower rate from the market and price their longer-dated mortgages higher to profit from the difference.
"It would be reasonable to think that banks' net interest margins would be correlated to the steepness of the yield curve. That is, a steeper yield curve leads to higher margins," said Credit Suisse.
"We find that for Australian banks there is only a weak correlation of bank NIMs [net interest margins] to the steepness of the yield curve (r2 =0.17) and put this down to banks terming out funding post the Global Financial Crisis, with the weighted average maturity of wholesale funding currently 5.6 years, up from 3.8 years in 2008."
The real risk to bank margins
It appears the real risk to bank margins comes from the 10-year Australian government bond yield, which had collapsed to a record low of around 1.7% last month and is currently sitting at just under 1.9%.
The broker found a strong correlation between NIMs of the big banks and the 10-year bond yield.
"Over 1990-2018, we find that the correlation of bank net interest margins to the ten-year bond yield to be significantly stronger (r2 = 0.75)," said Credit Suisse.
"There is also a moderate correlation with the cash rate (r2 = 0.53)."
Many economists expect the Reserve Bank of Australia to cut the cash rate to fresh record lows, and if history is any guide, that means ASX banks could be entering into an extended period of margin pressure.
Just what bank shareholders don't need – another hoop to jump through before the highly anticipated earnings recovery for the sector!
