More technically, some analysts are starting to lower what is considered the “risk free rate”, a forecast of what supposedly risk free government bonds will average over the next decade. Given markets value yield as a measure of risk, lowering the risk free rate equates to a higher return for the same risk. Again, fuel for share prices.
CLSA bank analyst Brian Johnson ran through the rate cut ramifications in a note citing six factors. The key ones were banks picking up margin on term deposits (where prices paid for deposits lag the cost benefit of official rates coming down), credit losses staying low due to subdued credit demand (one of the reasons the RBA cut) and low financing costs, foreign investors coming in and the dividend yield story.
So net-net a good story for bank share prices.
But what of the downside? Bank investors last week conveniently forgot the debate over bank capital levels, mandated by the G20 and the various Basel-based regulators (and geed on in Australia by the Financial System Inquiry recommendations) is still alive.
On Friday ratings agency Standard & Poor’s warned moves to implement formal rescue plans for banks deemed too-big-to-fail would likely lead to ratings downgrades for major American and European banks.
“We expect to place our long-term ratings on the (holding companies) of the eight US G-SIBs on CreditWatch with negative implications once we believe that US authorities have made sufficient progress towards implementing an actionable resolution plan,” S&P said.
The warning related to northern hemisphere banks and so-called globally systemically important banks (G-SIBS) but just because Australian banks are not G-SIBS they are not unaffected.
Early Saturday morning Australian time the Basel-based Financial Stability Board published submissions made on the subject of total loss absorbing capital (TLAC), the first wall of defence for a failing bank.
The Australian Bankers’ Association was a notable submitter. The ABA began its submission by doffing its cap to the global agenda. But it warned there were significant consequences for the Australian banking system if TLAC translated to more core capital – one of which, although the ABA didn’t mention it, would be a hit to bank shares.
“The ABA agrees with a key sentiment of the TLAC proposals that (improved stability) can be done through mechanisms other than holding further Common Equity Tier 1 (CET1) capital,” the submission said. “The broader definition of TLAC strikes an appropriate balance between ensuring stability while not adding significant cost which would be passed onto bank customers.”
Acknowledging the Australian banks are not G-SIBs and therefore the TLAC proposals are not intended to directly apply to them, the ABA argued “the proposals and the consequential increase in capital levels will affect all banks which compete for capital and funding in international markets”.
It added the FSI had emphasised Australia should follow international rules.
Bank stock investors in the run up to the Murray FSI report did have a bit of a heart flutter around fears of more capital, which with hindsight didn’t really lie in the inquiry’s domain, but they now seem almost blasé about the more clear and present work on capital in Basel.
The yield on bank stocks is very attractive. There are no present signs of operational dangers like higher bad debts. Official rates are now forecast to go lower. But the market in general and retail investors in particular having been dancing the bank dividend tango for quite a while now but there’s no indication the band will take a break.
Those overweight banks may well be contemplating the immortal lines of – former – Citigroup chief executive Chuck Prince: “As long as the music is playing, you've got to get up and dance.” Then the music stopped.