Regional banks to see increase in bad debts

In a research note this week, Morningstar said that while in the medium term the regional banks will benefit from tougher regulatory requirements forced on the majors, riskier lending remains a concern.

“The risk for the regional banks is an increased proportion of higher-risk loans and, eventually, higher bad debts,” according to the Morningstar report.

“We expect net interest margins for the regional banks to decline, but this could change if the major banks (the price setters) increase loan rates providing the regionals with more opportunity to improve lending margins.

“While this may help in the short term, in the long term, we still think a lack of cost advantages in commoditised lending markets will see the regional banks deliver below-system loan growth.”

The regional banks have the upper hand when it comes to customer satisfaction, however Morningstar said this does not translate into superior returns, with regional bank returns on equity expected to remain well below those of the major banks.

The report highlighted that key risks for the banking sector are higher-than-expected loan losses and tougher regulatory capital requirements.

Morningstar predicts demand for mortgage credit will increase broadly in line with current owner-occupier levels of five to six per cent as lending to property investors slows from current levels of more than 10 per cent to "somewhat less than 10 per cent".

“Long-term demand for mortgages is closely linked to the pace of employment growth, wages growth, interest rates, population growth, household formation and housing affordability,” it said. “More importantly, we are looking for the long-awaited recovery in business lending for the medium term.”

Morningstar’s business loan growth assumptions have eased from an average of 6.0 per cent per annum to near 5.5 per cent per annum. Average loan loss rates are forecast to rise to 0.23 per cent in the next five years, compared with 0.19 per cent for the past three years.

The report noted that while loan losses remain low, in the third-quarter of this year ANZ reported higher losses than expected.

“Pressure is coming from mining and agriculture sectors. Banks are not benefitting from write-backs to the extent they were in the past.”

The same report also raised concerns about the Australian residential property market.

“We have concerns about Australian residential development as we think speculation has driven the rate of supply above underlying demand, and we anticipate prices will soften to absorb excess supply,” it said.

“We also have a cautious outlook for the Australian office sector given that Brisbane, Perth and Canberra are all oversupplied, while Sydney is anticipated to be oversupplied from 2016. Rents will likely fall on most expiring leases and vacancies could trend higher, a major headwind for growth in rental income.”