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Banks won't pass on RBA rates cut: analyst

Updated April 25, 2012 01:16:23

Banking analyst from CLSA Asia-Pacific Markets, Brian Johnson, discusses how the banks will react to a rates cut from the Reserve Bank.

Source: The Business | Duration: 6min 33sec

Topics: banking, economic-trends, housing-industry, money-and-monetary-policy, australia


TICKY FULLERTON, PRESENTER:  As our top story indicated, a rate cut is on the way moving the spotlight on to Australian banks for their reaction. We're now in the lead-up to bank half-year results, which are expected to reveal strong overall bank earnings but falling profits on bank loans - their net interest margins - which as we know makes them very upset.

Well, I'm joined in the studio now by leading banking analyst from CLSA Asia-Pacific Markets, Brian Johnson.

Brian, welcome to the program.


TICKY FULLERTON:  Rate cuts on the cards, obviously - how do you expect the big banks to respond next week?

BRIAN JOHNSON:  Well, there's no way they're going to pass on the full rate cut to borrowers.

TICKY FULLERTON:  None of them? 

BRIAN JOHNSON:  None of them. The reason is that, increasingly their cost of funds is moving at a different rate to the official cash rate, and so what it means is I think increasingly the Reserve Bank will be targeting the housing rate the banks actually offer, which means you're probably going to see rate cuts on the agenda for quite a while to come. 

TICKY FULLERTON:  You're actually overweight in the banking sector, aren't you - is this one of the reason banks indeed will be passing on rising costs to the consumers?

BRIAN JOHNSON:  That's correct. Ticky, if you really look dispassionately over the long term we haven't had much competition since the very early 1990s in Australian banking. And basically what happened was that you had Aussie Home Loans came in, the banks responded by cutting margins. Once we reached the equilibrium point, there's been no such thing as competition. But what has really happened is that in 2008, when the non-banks couldn't compete because the funding environment was even worse for them, the banks don't face a lot of competition so they're really determining where their pricing goes. And that's why I'm positive.

TICKY FULLERTON:  We thought the wholesale funding costs for a moment were going to get better. In February we had the ECB and Europe doing their refinancing - the LTRO - but everything seems to have gone pear-shaped again?

BRIAN JOHNSON:  Ticky, there's a lot of ways you can explain it, but I think the best way is to think of a drug addict that needs a drug every four hours, and all the ECB do is they're giving you a drug for about an hour.

Sovereigns in Europe need to borrow money for 10 years; giving them money for three years helps out in the short term but it doesn't resolve the fundamental problem that there's just way too much debt in these economies, and there's no prospect of them paying it back in the very short term.

TICKY FULLERTON:  We've had the ANZ of course take a rather different road with their out-of-cycle moves and their different deliberation and setting times, what do you make of that strategy - because even some this week on our program in small business have thought it was a very, very bad PR strategy?

BRIAN JOHNSON:  I think it was predicated on the fact they thought the other banks would actually follow very quickly. In the new world you can't signal what you're going to do on pricing, and increasingly the Reserve Bank cash rate is not what drives your cost of funds.

So what ANZ have committed to do, is every month they will update ... on the second calendar Friday of every month, they will update us on what's happening with the cost of funds and tell us what they will tell us what they will do with their rate on the next Friday.

TICKY FULLERTON:  Glad you've got the date right, by the way! (laughs)

BRIAN JOHNSON:  Yeah, well, it's a skill.

TICKY FULLERTON:  All right. What about this whole property bubble that we occasionally hear about. Bad news recently the Bank of Queensland first-half results, and then mortgage insurer Genworth delaying its IPO and now looking at a possible downgrade, is this a likely problem for the big banks?

BRIAN JOHNSON:  Massive problem. But you can have one of two scenarios. I mean, the first question is, is there a bubble, and you've only got to look at levels of leverage in households to see clearly house prices are pretty hard to justify - but we can have one of two scenarios. We can have the dramatic collapse you've seen in the United States, or the slow, gradual grind-down we've seen Japan. And the way Australian home loans are structured, they're probably safer than the ones in the US, so...

TICKY FULLERTON:  But you're actually more worried about asset quality than you are bank funding, aren't you?

BRIAN JOHNSON:  Yes. You know, margins get all the commentary but, you know, at the end of the day, if a bank chops 2,000 staff it increases their earnings by about 1.8 per cent. If the margin moves five basis points, which is not much, the earnings move 3 per cent - but if their loan loss charge moves by 1.3 basis points - which is nothing - their earnings move by 1 per cent. That is the really big sensitive issue for bank earnings.

TICKY FULLERTON:  Banks also facing regulations, the new BASEL III regulations. When I spoke to you last, I think you were quite worried about them, has anything changed?

BRIAN JOHNSON:  I was 100 per cent wrong. When you have a look at the way the BASEL is working for the Australian banks, I would observe that I think it's very bank friendly.

TICKY FULLERTON:  Bank friendly?

BRIAN JOHNSON:  Bank friendly.

TICKY FULLERTON:  In what way?

BRIAN JOHNSON:  The way they're allowed to treat dividends. The dividends they pay out means it really doesn't come out of their capital base straight away, and also they're delaying some of the more onerous capital aspects of it until 2016, by which time the banks will be quite well capitalised.

But the really important thing, Ticky, is banks don't go bust because they run out of capital, they go bust because they run out of cash - and when you look at the way the Reserve Bank is ... the kind of liquidity facility they will operate for the banks, they're not going to run out of cash any time soon. So when I look at it, I just think it's very bank friendly.

TICKY FULLERTON:  So what does this actually mean for the all-important bank dividends? Are they sustainable now in your view?

BRIAN JOHNSON:  Yes, there's no doubt about it that we're in a low asset growth world where banks have to retain less capital. I think their earnings - because they've got the pricing power to pass on the pressure - are probably relatively safe. When I have a look at it, the high-powered ratios, yes I think they are sustainable. And the most important thing is if you look at big global fund flows ... you know, tonight we're hearing about Europe once again blowing up, next week you'll hear it roaring back, week later you'll hear about it falling over. The one safe thing that investors are looking for globally is dividends, and the Australian banks look very good in a global context on that basis.

TICKY FULLERTON:  So finally, taking the "big four", which do you see best value and less value, from an investors point of view at the moment, because they've got very different strategies about moving offshore and all this sort of stuff?

BRIAN JOHNSON:  You know, it's hard to kind of call them from time to time, but for me it's pretty black and white at the moment. When I have a look at it, National Australia Bank has managed to deliver a very round number of EPS growth basically in the 10 years up until 2010, and that EPS growth figure was zero. The end fact is that the market treats NAB as though it will fail in perpetuity. I think that actually makes it really, really cheap. NAB is a risky bank, but I think it's way too cheap, so that's why we've got it as our number one pick.

Our number two pick at the moment is Commonwealth Bank, which everyone always tells me is expensive, but if you sold Commonwealth Bank every time over the last 15 years when it was expensive, you would have lost a lot of money. ANZ has had a big run, I still like it and I think Westpac have got a lot of structural earnings growth issues at the moment, so I've got a negative view on them.

TICKY FULLERTON:  Brian Johnson, you got it all in, thanks so much for joining us.

BRIAN JOHNSON:  Thank you.