Credit Research

2020 Credit Outlook: Financials

Andrew Mayes Associate Director - Bank and Financials Credit Research

Andrew Mayes

January 14, 2020 - 25 minute read

2020 Credit Outlook: Financials

Credit fundamentals to remain sound despite income headwinds, as authorities lean on low rates and rising house prices to entice households to spend up, again.

Executive summary

  • We remain comfortable with the credit outlook for financials--both lenders and insurers--despite a number of earnings’ headwinds, which are more of a concern for equity investors, in our view. We see credit fundamentals remaining sound in 2020, with earnings healthy overall, capitalisation strong, while the threat from rising arrears and an increased incidence of natural perils should be relatively limited for lenders and insurers, respectively.
  • We see many of the prevalent themes of 2019 continuing into 2020. In-light of a soft outlook for wage growth and seemingly structurally elevated underemployment, we expect households to prioritise saving and debt repayment over consumption. Rising house prices in the latter portion of 2019 should continue into 2020, although we expect the resultant ‘wealth effect’ from rising asset prices to have a limited effect on consumption.
  • In the absence of fiscal reform, we see a strong likelihood of further monetary policy accommodation in 2020--generally a negative for both commercial banks and insurers, although they can offset some of this through certain measures.
  • Margin headwinds for commercial banks show little signs of abating in 2020, in our view. Additional interest rate cuts will put further pressure on bank margins, although we expect the banks to withhold some of the change in rates from borrowers. Households prioritising debt repayment will continue to present a drag on lending demand and margins for commercial banks. However, short of a substantial rise in either interest rates or unemployment, neither of which appear imminent in 2020, earnings stability should persevere.
  • With otherwise benign economic conditions and very accommodative interest rates, we expect asset quality to remain strong, although arrears should continue to trend higher--from a low base. Capitalisation will continue to strengthen, much in the form of additional Tier 2 capital, although we may see further equity raisings from some of the major and regional banks.
  • Credit fundamentals should persevere for general (property and casualty) insurers in 2020, despite the elevated exposure to natural peril events (bushfires) throughout much of Australia in late-2019 and into early-2020. The bushfires are likely to see claims surpass local insurers' natural peril allowance in the first half of 2020, although reinsurance arrangements and other loss-sharing arrangements (including quota sharing and stop-losses) should temper the final financial impact. Falling interest rates will also impact insurance earnings in 2020, although we don’t expect it to be considerable. Capitalisation is a strength for local insurers, and we see little change to overall levels.

2020 Financial Services’ Themes

If 2019 was challenging for Australia’s banking sector, 2020 is unlikely to offer much respite. With markets pricing in at least one further interest rate cut in the first half of 2020, we expect forward-looking margin headwinds to remain meaningful. Heavily-indebted households continue to prioritise saving and repayment of debt, seemingly unmoved to-date by falling interest rates (as well as tax cut relief for low and middle income households) (see Figure 1 and 2). The law of diminishing returns from historically low interest rates, it would seem, is starting to emerge as an unwelcomed development (for the central bank), despite the predictable response from households who have endured years of structurally elevated underemployment and poor wage growth (see Figure 3).

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