The share prices of Australian banks have been hurt by widespread perceptions that they face earnings pressure due to slower economic growth, reducing loan growth, higher funding costs, increasing bad debts, and softer consumer and business confidence eroding earnings power. While many northern hemisphere banks are still stressed, Australian banks remain robust and profitable. Australian banks operate in an economy that is actually growing, they provide solid earnings growth potential, low fundamental investment risk and high fully franked dividends. Most importantly, none of the major Australian banks is going to default. They have no direct material exposures to PIIGS' (Portugal, Ireland, Italy, Greece and Spain) sovereign debt, but their share prices continue to suffer from “guilt by association.” Standard & Poor’s (S&P) recently downgraded its long-term senior unsecured debt rating for each of the four majors from AA to AA-. Regional bank Suncorp’s long-term credit rating was affirmed at A+. Bank of Queensland was downgraded from BBB+ to BBB and Bendigo & Adelaide Bank was upgraded from BBB+ to A-. The changes follow a review of S&P’s global bank rating methodology. CBA Group Treasurer Lyn Cobley said: "CBA remains one of very few banks globally in the AA category. Since the onset of the financial crisis in 2008, the Group has increased its capital base and improved its funding and liquidity position by increasing customer deposits and long term wholesale debt and reducing our use of short term wholesale funding. At this point we do not expect this to have any material impact on our funding plans or expected pricing of our new issuance.” We agree with this assessment. The downgrades do not significantly change the position of the major banks relative to other global banks relying on wholesale funding. The four majors are part of just a handful of AA-rated banks worldwide. The four major banks source 20–25% of their funding from offshore wholesale debt markets. Due to the recent debt issues in Europe, wholesale funding for banks is becoming more expensive worldwide. Australian bank earnings could come under pressure from higher funding costs. The Australian banks have strong funding positions, which have been underpinned by customer deposit growth exceeding loan growth. Strong customer deposit growth reduces the need for wholesale funding, with customer deposits now accounting for 55% of total funding compared to 50% pre-GFC. Offshore wholesale funding now represents 50–55% of total wholesale funding.
Despite price competition in home loans, banks have significant pricing power. Generally banks do not lose large market share when they re-price their loan books by passing on less than official interest rate reductions. However, there is some tradeoff of net interest margins for customer satisfaction and market share. In December 2011, ANZ hit the news after announcing it would review interest rates independently of official interest rate announcements. “By reviewing key variable lending rates each month we can more accurately reflect the sustained changes in funding costs we incur through the interest we pay to customers for their deposits and to investors in wholesale money markets,” said ANZ chief executive Australia Philip Chronican. Australian banks have strong balance sheets, with capital levels already exceeding the minimum requirements under Basel III. The International Monetary Fund (IMF) recently called on Australia’s major banks to increase their levels of capital even further, warning the sector may not be able to withstand the dual shock of a residential property downturn and losses on corporate lending. Despite the warning, the IMF highlighted that the major Australian banks all have capital well in excess of the regulatory requirements with high quality holdings. The current political and economic turmoil provides an attractive buying opportunity for investors prepared to look beyond the doom and gloom. Historically low valuation metrics and fully franked dividend yields of 7-8% make bank shares worth considering for diversified share portfolios.