Economic conditions put big banks at risk

Australia's major lenders face a potential 'blowout in bad debts' if funding costs are to significantly increase, according to Morningstar.

In an investor research update issued last week, Morningstar’s analysts said the strength of the domestic economy and the outlook for unemployment will affect CBA, NAB, ANZ and Westpac, particularly in terms of earnings risk.

“Despite our confidence in the near-term earnings outlook for Australia’s four major banks, we are concerned that economic, regulatory and market risks could adversely affect our medium- to long-term earnings forecasts,” the research house reported. “Higher funding costs and a potential blowout in bad debts cause most concern.”

Morningstar has justified its “medium” uncertainty rating for all four banks on the volatility of earnings from a diverse product portfolio.

Each institution also faces specific risks associated with distinctive strategic policies, the report said.

Growth opportunities for NAB’s wealth management division will require more favourable economic conditions, stronger equity markets and increased consumer and business confidence, the report said.

Meanwhile, NAB’s strategic priority – expanding its Australian and New Zealand businesses while extracting value from overseas ventures – will only be successful if such economic conditions improve, it said.

This is similar for Commonwealth Bank, as “wealth management earnings depend on the levels and direction of equity markets”.

Further, the report stated that “only a catastrophic bank funding crisis and severe downturn in Australia could force sharp falls in earnings and dividend [for CBA]”.

Westpac investor confidence will be impaired if the bank experiences “weak credit growth, a loss of market share and a contraction in net interest margins, which represents about 70 per cent of total operating income”, it said.

Meanwhile, ANZ faces more regional risks associated with the bank’s heavy investment in the Asian market.

“Returns will rise strongly if ANZ executes successfully, though the upside comes with higher risks,” Morningstar said.

The research house also pointed out that “all four banks benefit from substantial competitive advantages because of their dominant oligopoly, extensive pricing power, high barriers to entry, low-cost operations, high-profile brands and very profitable operations”.

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