That the ASX 200 could swing from an 8 per cent fall to close up 4.4 per cent at the same time the Prime Minister Scott Morrison was announcing the banning of large public events suggests investors are even further disconnected from the reality of what this virus will do to the real economy.

And it's that damage – particularly the near certainty of a recession – that has bank investors rightly worried.

The concerns around the sector were neatly summarised by UBS banking analyst Jonathan Mott, who on Friday morning delivered what must go down as one of the strangest bank upgrades ever.

Mott upgraded ANZ to a buy and Commonwealth Bank, NAB and Bendigo & Adelaide Bank from sell to neutral – and at the same downgraded their earnings for the second time in 10 days, and predicted that the majors will be forced to take bad debt provisions of at least $500 million each.

It’s not that long ago – 37 days, to be precise – that Mott declared CBA had set a world record for a developed market bank, when it was trading at a price-to-earnings ratio of 18.3 times 2020-21 earnings.

But after falling 10.2 per cent over the week, the nation’s biggest bank is now trading on a more reasonable 15 times. The stock is now down 24 per cent since the market peak on February 20.

It’s an even more remarkable story at ANZ (down 15 per cent this week and 30 per cent since February 20), NAB (down 16 per cent this week and 33 per cent since February 20 and Westpac (down 15 per cent this week and 29 per cent since February 20). Mott says the trio are now trading below book value – essentially the value of the assets on their balance sheets, minus liabilities – for the first time since 1993. That was back when Whitney Houston sat on top of the charts.


That’s as good a window into just how dramatic events are right now, and how quickly they’re moving.

The big change to Mott’s thinking is really driven by the UBS economic team, whose base case for the economy now sees GDP growth slowing to 0.8 per cent, with a recession in the June quarter. The bank sees unemployment rising to between 6 per cent and 6.5 per cent and the RBA cutting rates to 0.25 per cent before launching quantitative easing via yield curve control.

The worry for the banks over the longer term is the RBA’s expected use of QE, which would smash the banks' net interest margins.

This flows straight through to bank bottom lines. For the former world-record holder CBA, for example, Mott now expects a cash profit of $7.6 billion in 2020-21, down from $8.5 billion in 2019-20. In total, the big four’s profit pool is likely to fall from $27 billion to $24 billion over that period.

Mott expects CBA can hold its dividend in 2020 at $4.31 and cut in 2021 to $3.47. He tips the three other majors will need to cut their payouts in both 2020 and 2021. By 2021, ANZ’s dividend is expected to be 14 per cent lower than today, while Westpac (down 16 per cent over this period) and NAB (down 9 per cent) are also likely to deliver bad news.

Things are changing fast, and not for the better

The deteriorating economy, of course, means an increase in the bad debts that banks will face. But Mott points out that because of changes in accounting standards – specifically AASB 9, for those playing at home – the banks will be forced to recognise the stress in lending before it actually emerges.

So UBS has increased its credit impairment charges for the major banks by $500 million – with a rather ominous-sounding caveat. “However, we have a low level of confidence in these numbers as it could change materially as the situation unfolds,” Mott told investors in his note.


Mortgage delinquencies, personal lending arrears and an increase in the number of companies on the banks’ watch lists will be crucial to watch, and things could get much worse.

In this new base case, Mott is assuming credit impairment charges are 24 basis points; under the scenario of a protracted pandemic, he believes this could hit 60 basis points as unemployment rises to as high as 8.25 per cent.

Still, if there’s a positive to be taken from this it is that bad debt charges are coming off historic lows; on the new base case, credit impairment charges will only head back towards what Mott describes as “mid-cycle median levels”.

QE would smash the banks' interest margins

But arguably the worry for the banks over the longer term is the RBA’s expected use of quantitative easing. This would smash the banks' net interest margins – Mott tips NIMs to fall by 12 basis points by the 2021 financial year under its current base case, and as high as 20 basis points in a protracted pandemic scenario. At CBA, for example, NIM would fall 2.1 per cent to 1.92 per cent under the base case.

Returns on equity will also be under pressure. Mott’s base case sees industry ROE falling from 11.1 per cent in the 2019 financial year to 9.2 per cent by 2021. The danger here is that we head towards a similar situation to Europe, where a protracted period of ultra low (sometimes negative) rates and QE have pushed ROEs down to around 7 per cent.

Earlier this week Evans & Partners analyst Matthew Wilson dramatically called QE the “point of no return for the Australian banking industry”. He argued the stagnation and debt saturation in Europe and Japan seen as a result of QE had underlined “the ultimate cost of the financialisation of everything”.


Such philosophical concerns might be above the heads of some investors, but they’re certainly not missing the message that the world is changing rapidly for Australian banks. The cornerstones of so many portfolios – both retail and institutional – are being ripped apart.

And yet Mott’s message that these once expensive banks now look to be of reasonable value shouldn’t be missed. Banking returns are clearly under pressure, but the sector remains extremely well capitalised, very well run from an operational point of view, and very much open for business.

The comparisons with 2008 and 1987 are justifiably coming thick and fast right now, but it’s worth remembering there have been few crashes where the strongest businesses didn’t emerge in the best shape.

The problem for would-be investors is when to buy in. Don't be surprised if the positive finish for the banks enjoyed on Friday is quickly forgotten as the reality of the economic slowdown Australia is facing becomes clear.