Bank stocks to play catch-up to credit spreads
After a sharp sell-off in the COVID bear market, corporate credit spreads have fully recovered and appear to be discounting a relatively low default risk. By contrast, major bank share prices have significantly underperformed during COVID, appearing to discount a major bad debt cycle. With three vaccine breakthroughs, successful COVID management allowing Victoria and border reopenings, substantial monetary stimulus and unprecedented fiscal stimulus, we believe risks of a major bad debt cycle are low, skewing the outlook for major bank share prices to the upside.
Whilst the banks also have large exposure to home mortgages, capital city home prices fell just 0.7% during COVID, recovered 0.2% MoM in October and are still up 3.6% YoY, mitigating any risk from mortgage portfolios. Loan deferral trends have also been extremely positive, with NAB and WBC’s home loan deferrals falling by c.$30bn each from their peak to Oct-20 and SME business deferrals declining by c.$9bn across the major banks.
One area of default risk we are watching is commercial real estate, which may be structurally impacted by increased work from home arrangements as well as increased retail vacancies.
Whilst bank dividends have been reduced due to APRA-mandated payout ratios and lower earnings, forward-looking yields (although lower than historic levels) appear extremely attractive compared to record low corporate bond yields.
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