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2 biggest areas of risk for ASX bank stocks that are being overlooked

ASX banks will be exiting financial year 2020 with their tails between their legs, but investors may not fully appreciate the key areas of risk to their earnings.

The worst performer over the past year is the Westpac Banking Corp (ASX: WBC) share price, which fell around 37%. The Australia and New Zealand Banking GrpLtd (ASX: ANZ) share price isn’t far behind with a 33% drop.

The National Australia Bank Ltd. (ASX: NAB) share price comes next with its 31% fall from grace while Commonwealth Bank of Australia (ASX: CBA) share price shed 17% over the period.

CBA shareholders shouldn’t feel too smug. That’s still a meaningful 7% behind the S&P/ASX 200 Index (Index:^AXJO).

Business loans are the bigger risk

The impact from the COVID-19 pandemic on the sector is well flagged. Mortgagees who’ve lost their jobs due to the shutdown can’t repay their loans and that will fuel the rise in bad debt.

However, the spotlight should be on loans to small to medium enterprises (SMEs), according to Citigroup.

“Indeed, anecdotally several banks have noted to us in recent weeks that investors remain fixated on discussing mortgages, while the pain likely resides in the SME book,” said the broker.

Industries most at default risk

The latest data from the Australian Bureau of Statistics showed that around 30% of businesses don’t have cash or access to debt that will allow them to survive for three months.

The types of businesses that are overrepresented in this distressed group include the usual suspects in retail and accommodation and food businesses.

Others in the firing line are “professional, scientific and technical services” and “transport, postal and warehousing”.

Can’t last for 3 months

The other sobering finding from the ABS was that around 70% of businesses impacted by the coronavirus lockdown have suffered a revenue drop of more than 25%. For industries operating on low margins, the decline is enough to push them over – and that may happen when JobKeeper ends in on September 24.

This is a bigger risk to the banks because they are likely to show leniency to mortgage customers in respect to extending loan holidays. But the lenders will only continue to support SMEs that they think can survive the next few months.

The focus is on what new support the government can provide after the wage subsidy ends. The Morrison government ruled out extending JobKeeper but left the door open to supporting specific industries that are hard hit by the virus.

However, Citigroup warned that 57% of SME loans are to industries that are difficult to target in isolation.

First home buyers in the hotseat

Having said all that, mortgage defaults still represent a significant risk to ASX bank investors. But the risk in this area is concentrated on younger first home buyers, according to ANZ’s analysis reported in the Australian Financial Review.

The bank is more worried about this group as they are likely to have entered the market near or at its peak. This means they have taken on more debt and are coming into the crisis with more leverage than others.

The risk of rising unemployment and fact that banks have reached the interest rate floor will make the next two years a challenge.

Let’s also not forget that a big amount of new recent mortgages have gone to this group of homebuyers and that the government’s $25,000 grant could entice even more to jump into the market with their eyes closed.

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Motley Fool contributor Brendon Lau owns shares of Australia & New Zealand Banking Group Limited, Commonwealth Bank of Australia, National Australia Bank Limited, and Westpac Banking. Connect with me risk-free on Twitter @brenlau.

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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