You can still bank on it
With the Liberal National Coalition being elected at the recent Australian federal election, returning with a majority that many did not see coming, it appears the animal spirits may be back. To be fair, there are several recent developments stoking this renewed confidence in Australian shares and the economy
(1) no changes to franking credits and negative gearing / capital gains tax;
(2) the RBA to cut interest rates one or two times in 2019;
(3) APRA looking to remove the 7% mortgage serviceability provision and Coalition’s first home buyer policy.
Within a week of these developments, the Australian stock market experienced a re-rating and latest property auction clearance rates also point to increased confidence. This is clearly a positive for Australian banks and in this note we talk through how some of the headwinds for the sector are now Neutral.
Positive #1 Coalition majority and less hostile Senate
With the Coalition back with a majority, the status quo has provided greater certainty (i.e. removed policy headwinds) to consumers, businesses and investors. Put another way, in our view this is likely to stoke the animal spirits on key fronts – increased hiring, credit growth and housing market.
Positive #2 RBA interest rate cuts
In a recent speech by RBA Governor Philip Lowe, he provided a fairly clear indication of a potential rate cut at the Jun-19 meeting –
“At that meeting [May-19 Board meeting], we discussed a scenario in which there was no further improvement in the labour market and the unemployment rate remained around the 5 per cent mark. In this scenario, we judged that inflation was likely to remain low relative to the target and that a decrease in the cash rate would likely be appropriate. A lower cash rate would support employment growth and bring forward the time when inflation is consistent with the target. Given this assessment, at our meeting in two weeks’ time, we will consider the case for lower interest rates.”
The market, as indicated by the Australian long-term bond yields and Australian dollar, is now expecting at least two interest rate cuts by the RBA in 2019. The more aggressive economists are expecting even up to three rate cuts this year.
Positive #3 APRA looking to remove serviceability assessment
The Australian Prudential Regulation Authority (APRA) is looking to remove its serviceability assessment on mortgages, which it introduced in December 2014. In the assessment, borrowers were assessed on whether they could afford their mortgage repayments using a minimum interest rate of at least 7%. Given the historically low interest rates are likely to stay for longer (and the RBA likely to cut interest rates further) APRA has probably assessed that this assessment is in fact not realistic. Specifically, APRA noted –
“With interest rates at record lows, and likely to remain at historically low levels for some time, the gap between the 7 per cent floor and actual rates paid has become quite wide in some cases – possibly unnecessarily so.”
APRA will instead allow banks to review and set their own minimum interest rate floor when determining serviceability assessment. The removal of this could see the banks credit growth improve as it is likely to increase the approval rate of mortgages.
Coalition’s first home buyer LVR subsidy
The Liberal National Coalition has also announced a policy to help first home buyers to purchase their home with its First Home Loan Deposit Scheme. Under the scheme, the selected applications will be allowed to purchase their first home with a deposit of 5%, with the government guaranteeing the other 15%. This will allow the first home-owner to save of significant amount of lenders mortgage insurance which typically goes with such high LVR loans. From our understanding, the scheme only has limited places and isn’t likely to cover more than 10-15% of total demand from first home buyers looking to get into the property market. In any case, it is a positive and should assist with credit growth.
Positive developments for Australian major banks
The developments above are broadly positive for the major Australian banks – Australia and New Zealand Banking Group (ANZ), Commonwealth Bank of Australia (CBA), National Australia Bank (NAB) and Westpac Banking Corp (WBC). We say broadly because if the RBA cuts interest rates by two or three times (at 25bps at each interest rate cut), this will be negative for their respective Net Interest Margin (NIM), which are already in pressure.
Buy the big four on any dips for income.