One of the biggest questions on the share market for SMSF and other income-oriented investors is which way next for big bank shares?
After all the Commonwealth Bank of Australia (ASX: CBA), National Australia Bank Ltd (ASX: NAB), Westpac Banking Corp (ASX: WBC) and Australia & New Zealand Banking Group (ASX: ANZ) make up around 25% of the S&P/ ASX200 alone.
Early last month I wrote this article explaining how the RBA's reported plan to deliver Australia ultra-low-interest rates at 1% or lower over 2019 and beyond could hurt big bank profits.
In Europe ever since the GFC of 2009 the central banks have been forced to maintain lending rates at or below 0.5% as a symptom of feeble GDP growth, wages growth, and inflation.
While the banks listed below are different to Australia's residential property market and vanilla retail banking operations, it's still worth taking a look at how some of Europe's leading blue-chip banks have performed since the GFC.
The stats cover the period from April 2007 to April 2019 and are taken from analyst David Buik's blog.
- Barclays Bank from 731p to 163p, down 77%
- Deutsche Bank $EUR107 to EUR9.71, down 91%
- Credit Suisse CHF 88.94 to CHF13.62, down 86%
- UBS in 2011 to today CHF70.12 to CHF 13.55, down 81%
- Royal Bank of Scotland (equivalent before split) 6,056p to 251p, down 96%
- HSBC 880p to 662p, down 25%
Ouch, and as Mr Buik points out these atrocious returns are despite years of liquidity-flooding quantitative easing in Europe in an attempt to stimulate economies.
Admittedly, it is slightly alarmist to compare these banks that operate in different spaces to Australia's vanilla big four, but a few points are relevant about the problems for banks in an environment where rates are falling to 'emergency levels' around 0.5%.
On a basic level the business of banking is about lending money on a risk-adjusted basis at the highest rates possible.
Therefore ultra-low-rates make it tougher for banks to lend at higher rates.
Of course they can borrow cheaper to protect their net interest margins as the spread between what they lend and borrow at, but protecting NIMs gets harder as banks have less room for manoeuvre when rates fall.
When I say room for manoeuvre, I mean room to gouge customers with lending rates on margins way above rates at which they can borrow from one another, depositors, or on wholesale funding markets.
Another problem for banks is that as lending rates fall competition becomes tougher, as every basis point starts to count and borrowers expect better terms.
While liability management wriggle room also disappears. For example the room to cut savers rates lower tightens as people look around more keenly for better deals.
In other words eventually banks are going to run out of room to keep cutting rates on liabilities if the RBA keeps cutting.
In the UK where the central bank rate is 0.75% net interest margins for non-investment banks are commonly 20 to 30 basis points lower than those sported by the Big 4 in Australia today.
A home loan lending and retail banking focused bank in the UK listed on the S&P/ ASX200 in Clydesdale & Yorkshire Bank (ASX: CYB) is forecasting a net interest margin between 1.6% to 1.7% in its financial year ending September 30 2019.
This compares to CBA's 2.1% NIM when it posted its interim profit report in February 2019.
If we remember that NIMs are a key measure of profitability for banks we can see that if ultra-low-rates shaved 40 basis points off their NIMs in the years ahead profits would get whacked.
One advantage the Australian banks have over UK banks is their oligopolistic market position, but this is unlikely to sufficiently offset the problems associated with lower benchmark rates.
Already NAB's new CEO has complained rate cuts won't help his bank or the economy, with Westpac's CEO also telling the media "interest rates are not the problem" for the local economy.
Outlook
Many of the bank CEOs were complaining of "challenging conditions" when house prices were soaring back in February 2016 and rates sat at 2%, so if we do see local rates go lower and a subsequent contraction in NIMs you can bet the house on central bankers taking the blame for falling profits.
I don't own bank shares myself and expect that the less competitive nature of the domestic market will help insulate what is pretty much a Big 4 cartel from the worst of the fallout from lower rates.
However, be warned that we could see moderately falling bank share prices over the couple of years ahead.
