Weekly Broker Wrap: RBA Cuts Cash Rate And Banks Respond

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-Banks respond to RBA's cash rate cut
-Credit demand weak
-Bank margins compress
-More official rate cuts possible
-Australian dollar takes it in its stride

By Eva Brocklehurst

In the wake of the latest cut to official interest rates Australian banks are under scrutiny again. Not only are they copping compression in margins they are also being punished by weak credit demand, which seems impervious to the easier policy that has abounded this year. The Australian dollar also seems impervious to the lower cash rate.

Moreover, while the banks were working on responses to the RBA's cash rate decision, which delivered a 25 basis point reduction to 3%, some economic data descended and it didn't provide for any euphoria. Macquarie noted the latest capital expenditure figures from the Australian Bureau of Statistics show that non-mining investment intentions are not stepping up to meet sagging mining capex. Macquarie is concerned with the impact that reduced capital expenditure will have on bank exposure to small-medium enterprises. The broker has identified a strong positive correlation between business credit growth and capex, ex-mining, growth. It all looks pretty soft. Also, from the RBA's November data, month-on-month credit growth deteriorated across the board, with housing, business and personal lending losing momentum. Macquarie noted deposit growth declined on an RBA and APRA basis, with the decline in business deposit balances the main driver.

How did that translate to the banks? It appeared to Macquarie that Westpac ((WBC)) and ANZ Bank ((ANZ)) had a better month, outperforming the other majors in business credit and housing credit. National Australia ((NAB)) and WBC were strongest in deposit growth. While the major banks outperformed the market over the week, as interest rates came down, for the month-ending 30 November 2012 the majors have underperformed the S&P ASX200. Nevertheless, for the year to November, the major Australian banks still outperformed the S&P ASX 200, by 10.9%.

Credit Suisse has observed that housing lending growth in October was marginally lower than its most recent peak of 3.0% in June 2012, and the fourth consecutive month of deceleration. Growth was also significantly lower than the series peak of 5.4% in September 2010 and series average of 3.4%. The broker also notes credit card lending declined in October, after recently turning negative in the six months to September 2012. Wait, there's more. Corporate lending sustained a rapid deceleration in growth from November 2011 to May 2012, the broker maintains. The deceleration may have eased up recently but, with only 2.7% growth in the six months to October 2012, it's well off the series peak of 6.0% growth in the six months to November 2011.

Citi  notes the impact of flat credit and soft deposit growth in October has translated to ANZ being  up 0.5% in mortgages and broadly consistent with its performance over the past 12 months. Its household deposits were up 0.8%. Commonwealth Bank ((CBA)) continues to cede a share in mortgages, adding just 0.2% in October while growth was 1.1% in household deposits. NAB is holding its own with 0.6% and 0.7% growth respectively. However, Westpac is losing mortgage share, adding 0.3% while continuing to grow strongly in household deposits, adding 1.6%. For the regionals Bendigo and Adelaide Bank ((BEN)) grew 0.2% in mortgages, having slowed in recent months, while adding 1.1% in household deposits. Bank of Queensland ((BOQ)) saw 0.2% growth in mortgages and a drop of 0.6% in deposits, the former stable and the latter continuing the trend of rapidly slowing growth evident over 2012.

As the major banks respond to the 25bps reduction in the cash rate with their rate cuts of 20bps,  JP Morgan observes that the proportion of bank funding of interest earning assets unable to be re-priced is in the order of 10%. In order for banks to recoup the deposit compression, re-pricing of around 4bps is required for every 25bps of rate reductions. The banks have the option of not passing the rate cut on in full or delaying implementing rate cuts. They've opted to do both. JP Morgan estimates that each day the major banks delay passing on a rate cut they make around $2m. The broker makes the calculation thus: the time between the rate cut and the effective date for lower standard variable mortgage rates and associated first half revenue benefit is 17 days for ANZ and $25m, six days for CBA and $14m, six days for NAB and $11m and 13 days for Westpac and $28m.

In view of the latest easing,  JP Morgan has noted NAB has retained its position offering the lowest standard variable home loan rate of the major banks in 2012 (6.38%) with CBA at 6.40% and WBC at 6.51%. ANZ has stated it will announce its rates on December 14. It is expected to follow the others and cut by 20bps which will give 6.4%. ANZ would need to cut its rate by 22bps to match NAB's new rate. For the second tier banks, BEN cut by 20bps as did BOQ. For BOQ, with 73% of its loan book in housing and a lower relative proportion of deposit funding, a 5bps re-pricing will deliver a slightly more positive balance sheet benefit relative to its peers. JP Morgan forecasts a broadly flat margin outcome in FY13E of 1.63%, in line with published management targets.

CIMB said, if the market was looking for a clearer picture from the RBA on the trajectory for the cash rate in the new year it wasn't forthcoming. In fact, the broker suggests the lack of forward-looking commentary from each RBA meeting in this easing cycle is probably a reason why the economy hasn't responded to the changes made to settings so far. CIMB believes this means policy is eased more than would otherwise be necessary. The broker continues to expect the bank to ease policy by 25bps in both the March and the June quarters next year, taking the cash rate to 2.5%. The crux of the matter, in the broker's view, is the response of households and businesses to the policy easing has been relatively subdued but uncertainty surrounding how quickly mining investment will decline appears to be holding back the bank from more aggressive easing. All we are left with is the fact the non-mining investment parts of the economy are still weak and the Australian dollar remains high.

The stubbornness of the Australian dollar in the wake of cash rate reductions has puzzled many. CIMB noted the correlation of the Australian equity market with the USD/AUD exchange rate has been somewhat lower over the past year (48%) as compared with its peak two years ago at 81%. However, it remains significant. Reasons given for this risk reduction include the notion that the Australian dollar is being seen as a temporary safe haven currency. Despite the overall easing of currency risk to equities, CIMB still sees significant currency correlations in individual stocks and sectors. In analysing the short-term and long-term correlations between the USD/AUD rate, equity sectors and stocks, CIMB has flagged a positive currency view – the Australian dollar strengthening – would mean buying the materials sector and selling healthcare. Alternatively, portfolio risk, in the event of currency volatility, may be mitigated by reducing weighting in these sectors.
 

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