The Debt Reset That Could Cripple Aussie Banks
Is this the sign that Aussie bank stocks are having one final share price spurt before they’re cut down to size?
Commonwealth Bank of Australia [ASX:CBA] shares have managed to eke out a small gain in the past week.
With the banking Royal Commission now a distant memory, punters have pushed CBA back up to $76 per share.
It’s a similar tale with ANZ, NAB and Westpac. All the major bank stocks are up in the last few weeks.
But I’m not confident the rally will last.
In my view, despite the marginal recent gains, Aussie bank share price falls are only half-way done.
And it’s all because of owner-occupiers.
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All the Big Four banks are down from their April 2017 highs.
All are down on average 14% in that time.
As far as I’m concerned, the final nail in the coffin for bank share price rises came in April this year.
The Big Four had become victim to what’s called the ‘Death Cross’.
That’s a phrase technical analysts use to describe when one long-term moving average falls below another one. A moving average is simply an indicator that ‘smooths’ out price movements by removing the noise from random price fluctuations.
I’ll show you what the Death Cross looks like…
CBA daily chart
Source: Yahoo Finance
The purple line in the chart above represents the CBA 50-day simple moving average (SMA) and the red line is the 200-day SMA.
When the 50-day SMA falls below the 200-day SMA — the ‘Death Cross’ — it’s typically bad news for the stock in question. And that’s certainly the case for CBA.
That’s because the shorter 50-day SMA is a gauge of medium-term direction, whereas the longer 200-day SMA is the long-term trend.
In short, when the Death Cross occurs, it means that a bearish trend has set in and that bigger falls in the share price are likely to come.
From here, the 200-day SMA acts as point of resistance — a psychological point which the share price struggles to push above.
The 50-day SMA drop beneath the 200-day SMA is most obvious with Commonwealth Bank. But the story is the same with the other three big banks.
All are in a downtrend, all show the Death Cross in their chart, and all are struggling to get back above that 200-day SMA.
Right now, there are very few catalysts in the market that could lift bank stocks from their funk. And I say that knowing the big banks are just weeks away from likely reporting billions in profits…
When billions in profit is not enough
For the 2017 financial year, the Big Four banked $31.5 billion in profits between them.
Yet that sort of coin may be a thing of the past.
CBA’s cash profits fell to $4.73 billion (down 1.9%) for the first half of the year. If CBA reports bigger falls in the full-year data, the share price will likely drop again.
The fall in major bank shares this year has largely been put down to reining in investor loans, in addition to the banking Royal Commission.
With Australian Prudential Regulation Authority (APRA) tightening the screws on the growth of investor loans to owner-occupier loans — in addition to restricting interest-only loans — the profit dip was expected.
Slowing investor loan growth dragged the stocks down. But the bad press from the banking Royal Commission kept them down.
One thing the market is yet to factor in is how owner-occupiers will affect bank shares going forward.
The newest problem for the banks isn’t investor loans but falling valuations.
Given that CBA is the most exposed bank to the mortgage sector, it can expect its stock to be hit the hardest in all likelihood. The chart below shows the size of home loan books for each of the Big Four banks.
Source: Bloomberg; APRA; ABS
A month ago, the Australian Financial Review reported that Aussie banks were in a precarious position with their home loan books. Turns out, if only 5% of CBA’s total credit exposure was written off, the $45 billion put aside to protect customer deposits would be wiped out.
In other words, the cash safety cushion isn’t nearly as big as we’re led to believe.
Tighter lending standards mean smaller loans
Now, let me be clear: I don’t think Aussie banks are in any danger of busting in a Lehman Brothers-style collapse.
But there are a whole bunch of problems unravelling in the home loan market that aren’t being factored into bank share prices.
Yesterday’s data dump from research firm UBS indicated Aussie banks aren’t likely to lend as much going forward. This has the potential to cause massive problems for their stock prices.
Using the firm’s own archived lending calculators, Jonathan Mott, a research analyst at UBS, said that there has been a significant reduction in what banks would lend:
‘We have assumed a family of four, with combined income of $100,000, along with $20,000 bonus and $30,000 rental income. This scenario also includes a $400,000 existing home loan balance. We have also assumed the customer has a $9,000 car loan and $4,000 in credit card limits.
‘In 2015 this customer was estimated to have around $36,000 in living expenses and therefore would have been able to borrow an additional $426,000 for a maximum borrowing capacity of around $838,000 and debt-to-income ratio of 5.6 times.’
Three years later, this same customer’s debt profile has changed:
‘In 2018 this customer was estimated to have around $44,000 in living expenses and therefore would be able to borrow an additional $260,000. This reflects a maximum borrowing capacity of around $673,000 and a debt-to-income of 4.5 times.’
In other words, what a customer can borrow has dropped 20% in just three years.
Obviously, this is a generalised example of a potential customer. But broad data like this can’t be ignored.
In addition to this, the group hardest hit are newest entrants to the market.
It turns out one-third of 18–34 year-olds are struggling to refinance their home as valuations are falling.
That’s going to be a problem. There’s some $400 billion in interest-only loans due to reset to principal and interest loans in the next couple of years. Meaning that most of these repayments are going to jump by 50% suddenly.
UBS says that will force these borrowers to find another 15% of their income to set aside for higher repayments. Which could see up to 60% of their total income devoted to paying off the mortgage.
For that reason, UBS says that we are only one-third of the way through the ‘credit tightening’ process for owner-occupiers.
It’s this shocking insight the market hasn’t factored into bank stocks.
For a decade, banks have been the cash-cow for many investors.
Regular and increasing bank dividends have matched impressive share price growth.
They’ve been the highly sought-after ‘set and forget’ stocks that passive investors love.
Even international pension funds have invested in Aussie bank stocks for this very reason.
But the glory days of big stock gains are behind the banks for now it seems. Astute investors may have already assessed the effect of investor lending on bank shares and ditched them.
What the market is yet to realise is how falling property values and decreasing lending to owner-occupiers wanting to refinance will impact bank stocks.
Judging by the data we have at hand, bank stocks appear primed to fall further this year.