Market headwinds trigger call for hedge against big 4

The big four’s stronger underlying position has been partially attributed to operational cost savings and the post-COVID-19 economic recovery, which spurred a spike in demand for housing credit off the back of record low interest rates.

However, global economic instability, characterised by high inflation and a reversal in property market sentiment threatens to weaken the balance sheets of the major banks.

According to the latest Lending Indicators data from the Australian Bureau of Statistics (ABS), the value of new borrow-approved loan commitments fell 8.2 per cent in September to $25.1 billion — a negative trend commencing in April in response to changes in monetary policy settings.

Doug Nixon, EY Oceania banking and capital markets leader, said higher interest rates would help sustain bank earnings in the short term before a “challenging medium-term outlook” weighs on profitability.

“Significant and interconnected global threats and tightening of global financial conditions could result in a slowdown in economic activity relatively quickly, fueling a growing likelihood of global recession that would have spill-over effects in Australia,” Mr Nixon observed.

Steve Jackson, KPMG Australia’s head of banking, added that while beneficial for bank margins in the short term, monetary policy tightening is also introducing inflationary pressures curbing efforts to reduce the big four banks’ cost bases.

Rate hikes could also contribute to an “economic slowdown and a rise in bad debts”.

“Banks are signalling challenging times ahead for the economy and the big question is whether a ‘soft landing’ will be achieved that avoids the harsher potential outcomes,” he said.

Given this outlook, Russel Chesler, head of investments and capital markets at VanEck, has urged investors to be “cautious” about being “overexposed to the big banks”.

“Most Australian equity portfolios have significant exposure to the big four banks which represent nearly 20 per cent of the S&P/ASX 200 Accumulation Index,” he observed.

“In other words, if you hold a blue-chip portfolio or are invested in an Australian equity fund that tracks or benchmarks to the S&P/ASX 200, one out of every five of your dollars is likely to be invested in banks.

“That represents a big risk with the slowing property market which is spreading from Sydney and Melbourne into the smaller capital cities.”

According to Mr Chesler, high levels of household savings would not be enough to cushion the blow for a segment of borrowers hit by higher interest rates and subdued property prices.

As such, banks could be faced with a deterioration in credit quality.  

“Those households that are not so strong are going to be the ones that come under pressure with such a rapid increase in interest rates and inflation; ultimately this will have an effect on mortgage loan serviceability and loan default rates,” he added.

“We do not believe these risks are fully factored into the major bank’s share prices.”

But EY’s Mr Nixon is less bearish, claiming that the big four banks’ collective FY22 performance suggests they are well placed to withstand headwinds. 

“Those that can successfully manage the margin opportunities from rising interest rates have an opportunity to capture the upside in a highly competitive domestic market,” Mr Nixon said.