Australian banks could withstand losses but longer disruption a risk

Credit losses will nearly double this year, with business loans leading the surge.

Australia’s banks can take the surge in credit losses and disruption to funding markets with no threat to creditworthiness, but a persistent impact may deal significant blows to the sector, according to a S&P Global Ratings report.

The coronavirus pandemic will lead to credit losses nearly doubling this year to about 30bp of gross loans and advances from record loans in 2019, said analysts Sharad Jain, Nico DeLange and Lisa Barrett. However, it should remain low compared to expected long-term averages.

Business loans will mostly comprise the initial surge in credit losses for the industry, with the travel, hospitality, retail-services, and transport sectors likely being the most hit. COVID-19 came after several major natural disasters in Australia, the combined effect of which will further undermine already lukewarm consumer sentiment and business confidence, the report said.

“Nevertheless, we expect the impact on the Australian banking system to be relatively small in the short term on the back of sound long-term economic prospects and our forecast rebound in economic growth as this event passes. We also expect that fiscal stimulus from the Australian government should somewhat support short-term economic outcomes,” analysts said.

Major Australian banks are adequately placed to withstand a temporary disruption in their access to offshore wholesale funding. A large part of the banks' offshore borrowings remains short term in nature, the refinancing of which is more sensitive to financial market sentiment and increase in spreads.

Nevertheless, analysts believe that these banks have significantly completed their wholesale term funding for the financial year.

They also have the headroom and capacity to issue covered bonds to supplement their funding if needed, alongside holding a good level of liquid assets on their balance sheets. The banks have access to the Reserve Bank of Australia's (RBA) Committed Liquidity Facility, which was set up following the global financial crisis to help them meet unforeseen liquidity needs.

The RBA has displayed its preparedness to support the liquidity of the secondary bond markets as well as its plan to conduct longer-term repurchase operations of six-months maturity or longer at least weekly, as long as market conditions warrant.

“Furthermore, we expect that many Australia-based fund managers are likely to choose debt issued by Australian banks in preference to offshore investments because of geographic proximity and likely better understanding of local operating conditions. We also expect that a larger proportion of new savings will accrue to the Australian banks in the form of customer deposits as the impact of the outbreak continues, with retail customers likely to become more risk averse,” the analysts said.

All four major banks have passed the recent interest rate cut by the RBA in full through to their borrowers, despite persistent pressures on their interest margins and earnings headwinds.

A persistent COVID impact could bring about major problems for Australian banks, as the sector would be challenged in accessing offshore wholesale funding if the global financial markets remain dislocated or if the Australian economy significantly deteriorates. A prolonged disruption in that access is also likely to weaken the banks' ability to meet credit demand.

A significant drop in economic activity alongside fragile business and consumer confidence could spur a rapid rise in unemployment and a drop in property prices. Consequently, such a scenario would likely result in a sharp rise in the banks' credit losses, well above those that we currently forecast, and significantly weaker earnings, analysts said.