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Which bank faring best amid regulatory shift

Glenn Freeman  |  04 Jul 2017Text size  Decrease  Increase  |  

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With Australia's financial regulator tightening up requirements at the more speculative end of the residential lending market, the big four banks are responding.


All indications are that the Australian Prudential Regulation Authority (APRA) will continue to toughen its stance on property investor loans, if recent comments from APRA chairman Wayne Byres are any guide.

In last week's speech on international standards and national interests, delivered to an American Chamber of Commerce briefing in Sydney, he emphasised the need for banks that are "unquestionably strong".

"In Australia, we have long taken the view that we should aspire to a higher standard of safety than provided by solely adhering to minimum Basel standards.

"We seek to ensure that Australia’s banking system is considerably more resilient than has generally been the case for international banking in recent decades," Byres said.

The regulator's tightening of lending criteria for investor loans, interest-only loans and high loan-to-valuation ratio (LVR) loans is "sensible" and entirely justified, says Morningstar's senior analyst covering banking and finance, David Ellis. He believes tighter lending criteria is "good policy" that will "strengthen the banking system," but concedes it will likely slow new residential lending.

However, Ellis also emphasises that "APRA’s crackdown on investor and interest-only home loans does not change our risk assessment of major bank financial strength and creditworthiness".

"Despite the likely slowdown in lending volumes, the major banks still dominate the residential home loan market, while simultaneously protecting substantial profits in consumer banking divisions.

"We are encouraged by regulatory initiatives to maintain strong capital levels, and we retain our fair value estimates," Ellis says. Westpac (ASX: WBC) is considered the most undervalued, and at current prices (as of Tuesday 4 July, 2017) is the most attractively priced Australian bank. As Ellis explains, it benefits from high exposure to the economically strongest and most populous states of New South Wales and Victoria.

"The bank is well-positioned for higher expected regulatory capital requirements and should, over time, successfully manage down its exposure to interest-only home loans.

"The key attraction for Westpac is its globally impressive operational efficiency, underpinned by a peer group cost-to-income ratio," he says.

Despite some concerns within the marketplace about APRA's tightening of requirements for Australian banks having a detrimental impact on their profitability--including from Peter Warnes, Morningstar's head of equity research, Australia and New Zealand--Ellis believes these "are not as bad as the market fears".

"We maintain our position that Australia’s four major banks benefit from wide economic moats…we firmly believe that Australian interest-only home loans are definitely not in the same class as US sub-prime home loans, which were central to the disastrous global financial crisis," he says. Westpac has the highest flow of interest-only loans--46 per cent for the six months ended 31 March,2017--followed by Commonwealth Bank (ASX: CBA) on 42 per cent.

Overall, Ellis sees bank balance sheets continuing to strengthen and loan quality remaining strong, even as the economy "continues to muddle along".
"However, during the past 33 years at least, the major banks have very successfully controlled the health of the Australian residential property market… [where profits] continue to be maximised and losses minimised."

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Glenn Freeman is a Morningstar senior editor.

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