Banks, it seems, are finding it increasingly difficult to live up to lofty investor expectations.
After dazzling investors with their ability to largely withstand the economic upheaval caused by the pandemic, and after benefiting from writing back billions in provisions they squirrelled away to cover soured loans, banks are struggling to convince investors that they’ll be able to continue to grow their earnings.
And that’s left investors anxious that the banks’ share prices are vulnerable to even the slightest disappointment, given that so much optimism – both about the economic outlook and on bank earnings – is already priced in.
For instance, the share price of the country’s largest lender, the Commonwealth Bank, has climbed from a low of 57.66 last march, to close at $98.78 in trading yesterday – a rise of 71.3 per cent.
But investors are reining back some of their previous enthusiasm which pushed the Commonwealth Bank’s share price as high as $103.69 last month.
Part of the investor malaise reflects a growing unease over the outlook for the home loan market.
After all the strong rebound in earnings of the big four banks largely reflects the astonishing surge in demand for home loans. As a rough rule of thumb, every 1 per cent increase in mortgage lending boosts the banking sector’s earnings by 1 per cent.
But there are growing doubts as to whether activity in the property market can continue at such a frenzied clip.
Especially since there are signs that the prudential regulator could be looking at ways to take some heat out of the market, either by raising the interest rate buffer on new loans, or by imposing limits on loan to valuation ratios, or how much debt people can take on relative to their income.
Meanwhile, the latest lockdown of greater Sydney will weigh on bank earnings, because a number of home loan and business customers will decide to defer their loan repayments.
What’s more, the Sydney lockdown will also make the big banks much more cautious both with respect to releasing some of the provisions they set aside during the pandemic to cover the expected surge in bad debts, and to calculating their dividend payments.
More importantly, however, the lockdown will likely undermine consumer and business confidence.
The Westpac-Melbourne Institute Index of Consumer Sentiment shows that consumer confidence has already been shaken, with a 13.6 per cent drop in Sydney, and a 10.2 per cent decline in NSW.
As Westpac chief economist Bill Evans pointed out, it’s likely that when the survey was taken, many respondents were anticipating a shorter lockdown period.” Ominously, that suggests confidence in Sydney and NSW could fall significantly further, if lockdown measures are unsuccessful or slow to act in containing the outbreak,’’ he noted.
And although there has been a slight pickup in business investment, partly in response to tax incentives contained in the budget, bank lending to companies dropped 2 per cent in the year to May 2021.
Bankers point out that the closure of international borders means that there are whole sectors of the economy – such as tourism, aviation and education – where businesses are trying to whittle down their debts.
More broadly, the Sydney lockdown is causing investors to worry that the country’s vaunted economic rebound may not be as robust as it appeared.
And this makes it more likely that the Reserve Bank will be correct in its forecast that official interest rates will remain close to zero until 2024.
For the country’s banks, this means that the squeeze on their interest rate margins – what they pay on deposits and what they earn on loans – will persist for years.
Indeed, it’s likely to worsen. The banks benefited from around $200 billion in ultra-cheap three-year loans from the Reserve Bank, but this program has now ended.
Similarly, they were able to protect their interest rate margins by nudging down the rates they pay on term deposits, but this repricing is now largely completed.
At the same time, banks are increasingly competing on price, particularly in the coveted home loan market. As a result, local bankers are bracing for further erosion in their net interest margins.
But big four locals at least have some consolation. Investors were equally underwhelmed by the blockbuster second quarter results that both Goldman Sachs and JPMorgan unveiled this week.
The two giant Wall Street banks both benefited from a surge in merger and acquisition activity, which has been fuelled by ultra-low borrowing costs.
Corporate chiefs, private equity firms and blank-cheque companies have spent hundreds of billions on corporate takeovers.
Meanwhile, investors have been lining up to buy the hundreds of billions of shares issued by corporates making their share market debut.
Fees in Goldman’s investment banking were up 36 per cent compared with the same period a year earlier, to $US3.6 billion ($4.8 billion). And at JP Morgan, investment banking fees rose 25 per cent to an all-time high of $US3.6 billion.
This buoyant investment banking activity helped Goldman report quarterly profit of $US5.5 billion, on revenue of $US15.4 billion.
Meanwhile, JP Morgan posted profit of $US11.9 billion, on revenue of $US30.4 billion.
Still, although the results of both banking giants exceeded expectations, investors were underwhelmed.
Goldman’s share price – which has climbed 80 per cent in the past year – finished 1.2 per cent lower. And JPMorgan, whose share price has climbed close to 60 per cent in the past year, finished 1.5 per cent lower.
Although they celebrated the sharp rebound in traditional investment banking activity, investors were somewhat disheartened by the steep slide in trading revenue.
What’s more, there are worries that the new coronavirus variants could still weigh on the global economic recovery. Investors are conscious that the US bond market continues to point to more muted pickup in activity.
And this was reinforced by the anaemic loan growth. JPMorgan, the largest US bank, reported that loans outstanding were flat relative to a year earlier at around $US1 trillion.
There are also concerns that moves by the Biden administration to stamp out anti-competitive practices could weigh on investment banking earnings. Proposed mergers and acquisitions could come under far greater regulatory scrutiny if there is pressure to more vigorously enforce antitrust laws.
Increasingly, investors are questioning whether the spectacular recovery in bank share prices since the dark days of the pandemic can continue.
The author owns shares in the major banks.
