Bank analysts turn bearish on royal commission outcome

Bank analysts are bracing themselves for a bruising 2018 with many fixated on the potential downside for the banks flowing from “moments of truth” which threaten to crimp returns in the year ahead.

On Monday UBS analyst Jonathan Mott revised his 12-month share price targets for the big four banks already down 5 per cent to 6 per cent on fears the banking royal commission’s interim and final reports could lead to a lasting impost on future profits.

“We believe this is a material risk point for the banks,” Mr Mott said, speaking of the potential for the “meaningful impact on the future earnings outlook for the banks”.

The glum view of the outlook appears shared by PwC’s banking and capital markets leader Colin Heath who pointed to the Productivity Commission’s competition review, the ACCC’s mortgage pricing inquiry and the royal commission reports as looming moments of truth for banking.

“While it is too early to speculate at this stage, it is a relatively small jump from the establishment of a royal commission on misconduct to a recommendation of a body in the style of the UK’s Financial Conduct Authority,” Mr Heath said in PwC’s December Quarter Snapshot.

Mr Heath notes the weak underlying revenue growth reported by Commonwealth Bank and NAB (the only two banks to have provided an update on FY18 so far) does not augur well for the rest of the sector at a time of record-low bad and doubtful debts.

Bank fundamentals are healthy, according to Mr Heath, but the backdrop of high levels of household leverage, high house prices and regulatory scrutiny may lead to future expectations being dampened.

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The focus on the banks and their conduct is not without precedent, with parallels between what has happened with the sector abroad providing a useful roadmap, Mr Heath said.

UBS analyst Mr Mott says the challenging macro-economic environment is largely understood and “largely in the price” however he has concerns about any surprises thrown up by a royal commission such as findings the banks have not adhered to responsible lending laws.

Mr Mott says if the banks are found to have breached these laws it could open the banks up to class actions with material consequences. Two weeks ago Commonwealth Bank revealed it had made provisions of $575 million for the royal commission and its role in the AUSTRAC money-laundering breaches.

“If investors believe the royal commission will have more bark than bite then the banks appear fairly priced. However if the market slows faster than anticipated or the royal commission leads to mis-selling class actions then the risks are to the downside,” Mr Mott said in a note to clients.

Mr Mott’s note followed a report published by Morgan Stanley analyst Richard Wiles on Friday where he eye-balled the implications of the multiple inquiries on pricing power and downgraded Westpac to the equivalent of hold. Morgan Stanley has the equivalent of a hold on ANZ and the equivalent of a sell on Commonwealth Bank and NAB.