SMSFs cautioned on bank stocks as interest rates continue to fall
While the risk of a hard landing in the housing market is now less likely, the cuts to the official cash rate may start to put pressure on the earning potential of the banks in the medium term, warns an asset manager.
In its Australian Banking Sector Update, UBS said the banking sector has come under considerable pressure over the last five years given higher levels of regulation, compliance, increased political scrutiny, levels of capital and liquidity and ultra-low interest rates.
“Despite this, the majors have continued to target high levels of profitability,” it said.
“The rapid contraction in the BBSW-OIS spread over the last four months has provided a substantial tailwind to the banks and enabled the majority of the RBA’s 50bp rate cuts to be passed through to mortgagors.”
However, with the RBA expected to continue to cut rates in coming months, passing through further cuts becomes increasingly challenging as many deposit products have already hit or are approaching zero interest rate.
“Cheap deposit funding is seen as the banks' primary competitive advantage. This is eroded as rates approach zero, opening the door to competitors,” said the asset manager.
“Should rates continue to fall, banks are left with a choice of either protecting net interest margins/ return on equity share. Earnings and dividends would be under threat in either scenario. We do not believe this situation is sustainable.”
While UBS said the reelection Coalition Government and regulatory actions, including the removal of APRA's permanent interest rate serviceability floor has reduced the risk of a credit crunch, the Australian housing market is not out of the woods and the fundamentals remain very stretched given house price-to-income multiples.
“While it is also possible that RBA rate cuts could lead to a reflation of the housing market, if prices rise moderately then the stimulatory monetary policy would likely be removed, putting renewed pressure on housing,” it said.
“We believe the policymakers are walking a tightrope trying to balance the housing market given household debt to disposable income is at a world high 200 per cent.”
With interest rates now ultra-low, the ability of the banks to generate a lending spread and return on equity appears very challenged, said UBS.
“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 could come into question once again,” it said.
Miranda Brownlee is the deputy editor of SMSF Adviser, which is the leading source of news, strategy and educational content for professionals working in the SMSF sector.
Since joining the team in 2014, Miranda has been responsible for breaking some of the biggest superannuation stories in Australia, and has reported extensively on technical strategy and legislative updates. Miranda has also directed SMSF Adviser's print publication for several years.
Miranda also has broad business and financial services reporting experience, having written for titles including Investor Daily, ifa and Accountants Daily.