In a research paper released this week, UBS analyst Jonathan Mott explains that with interest rates entering ultra low territory, the ability of the banks to generate a lending spread and return on equity (ROE) has become significantly challenged.
“If the housing market does not bounce back quickly this could put material pressure on the banks earning prospects over the medium term, implying that the dividend yields investors are relying upon come into question once again,” he said.
UBS now believes the majors will be forced to cut dividends in the next two years.
“We believe the significant revenue pressure the banks are facing as interest rates fall and NIMs decline will force the banks to review their dividend policies,” Mr Mott said.
“We expect each of the remaining banks CBA, Westpac and Bendigo and Adelaide Bank to cut their dividends over the next two years if the RBA cuts the cash rate to 0.5 per cent or undertakes any alternative monetary policies like QE.”
One of the key positive factors investors point to for the major banks is their industry power and ability to use mortgage repricing to stabilise NIM.
This has been evident since the financial crisis, Mr Mott said. However, this pricing power has now been challenged by the prospect of further rate cuts. UBS expects the RBA to cut the cash rate to 0.5 per cent via one 25 bp cut in October and another in February.
“With the BBSW-OIS spread coming in sharply in recent months, this provides a near term NIM tailwind to the banks into the 2H19 results,” Mr Mott said.
Given the current climate, UBS expects this will lead to political pressure on the banks to pass through the vast majority of any future RBA cuts to customers.
“Should the banks not pass the majority of the RBA’s rate cuts through to customers to help protect net interest margins and ROE, we believe this benefit will be quickly eroded as customers’ churn into lower rate loans is subsequent halves,” Mr Mott said.
This front-book/back-book discounting and customer churn cost the banks several basis points to their NIM each half. With the major banks losing market share of approvals we expect this trend to accelerate, especially if the banks attempt to protect their NIMs in the face of ultra low rates.
The UBS analyst noted that the growth of foreign banks and non-banks with alternative funding and the ability to undercut the banks’ mortgage prices adds to this pressure.