By Paul Rickard 

You would think that for a company with a market capitalization of $70bn and an annual profit of circa $7.5bn, an amount of $100m was almost rounding error. But such is the heightened sensitivity to news about banks, the announcement by ANZ of an increase in credit provisions caused the market to go into a meltdown on bank shares.

Admittedly, most of the meltdown occurred on a super quiet pre-Easter Thursday and post Easter Tuesday, with no obvious leads from offshore to follow. This highlights just how fickle sentiment is and how easy it is to push the market around.

Over the 3 trading days, ANZ lost 8.8% to close yesterday at $23.11, CBA lost 4.4% to close at $73.31, NAB lost 5.8% to close at $25.64 and Westpac 7.5%, finishing yesterday at $29.89. Still well above their February lows, but well off their mid-March highs.

For the record, ANZ’s half page statement updated a disclosure made with its first quarter trading update in February that said that the total group credit charge was anticipated to be a little over $800m for the first half of 2016. It said that “recent developments with these institutional exposures means that the total group credit charge for the first half is expected to increase by at least $100m”.

Although not specifically mentioned, the media speculated that most of this $100m related to exposures with Arrium and Peabody Energy.

Westpac also added a bit of fire to the mix by alluding to some mortgage stress in the resource exposed states of WA and Queensland. With home prices being crunched in places like Rockhampton or Karratha, it is not surprising that there might be some home loans in arrears in these states.

But banks are just out of favour at the moment - so any news, no matter how material, adds oxygen to the fire.

Overseas markets setting the tone

The Australian market is following a lead from offshore. In Europe, the STOXX 600 Banks Index is down 20.2% since the start of the year, while in the USA, the S&P 500 Financials index is down by 5.97%. While the US fall is a lot smaller, it does compare unfavourably to the overall market’s in the black position of +0.54%.

Banks are on the nose globally for a number of reasons. Firstly, there is the widespread concern about slowing economic growth. The IMF, for example, recently downgraded its 2016 forecast for world economic growth to 3.4%, and for 2017 to 3.6%. Slower economic growth means reduced opportunities for banks to lend money and grow income.

Couple this with the spectra of negative interest rates, which could really put the squeeze on bank margins.

And then there is the impact of falling oil and metal prices. Banks have lent money and provided accommodation to companies involved in the production, distribution and servicing of these industries. The market fears that there may be some horrible exposures, leading to large write-offs.

The Australian market is also suffering from the usual fears about the property market and banks’ exposure to housing. And many investors believe that Australian banks are overvalued compared to their international counterparts if ratios like price/book are used as comparators,  which has fueled  rumours that offshore hedge funds are selling short Australian banks. 

Are the short sellers active?

Yesterday’s ASIC data suggests that there has been an increase in the short selling of bank shares. For example, 2.80% of ANZ’s ordinary shares, or 81.7m shares worth about $1.9bn, are currently short sold.

As the following table shows, 228.3m shares of the major banks are short sold. While this number is on paper rather alarming, it is only 60% higher than the number of shares that were short sold 6 months ago, or roughly 2.5 times the number12 months ago. Short positions always increase when the market is under pressure (due to institutions and others hedging), and in comparative terms, the major bank average of 2.10% of ordinary share sold short wouldn’t even make the list of the top 50 companies most shorted. Woolworths, for example, is ranked 13th on the list with 8.83% of its shares sold short.  

Short Positions in Major Banks - % of ordinary shares and number

* ASIC reports short trades after they are settled

Brokers are positive

Despite what you might think from reading the AFR, the brokers as a group are positive on the major banks. According to FN Arena, sentiment on the major banks ranges from +0.3 for the ANZ to +0.6 for Westpac (scale is -1.0 most negative to +1.0 most positive), and in each case, the consensus target price is higher than the current share price.

On a forecast yield basis, both ANZ and NAB are yielding over 7.5%, which grossed up for franking credits, puts them on an effective yield of over 10%.

The question is can these dividends be sustained? While we can rule out dividend increases, most brokers (at this point in the cycle) see dividends remaining flat into FY17. NAB and ANZ are seen as most at risk of having to cut their dividends, but at this stage, the consensus is no change or negligible change. For example, broker consensus has NAB paying 195c in dividends in FY16 (compared with an actual amount of 198c in FY15), and this then falling to 191.7c in FY17. 

Where now for the major banks

While it would be nice to think banks can rebound rapidly from these levels, trading over the last few days has shown how fickle sentiment is. With the market on “credit alert” and offshore influences still negative, it is unlikely that there will be any material change of sentiment in the short term.

Banks are cheap, but they may stay cheap until we get some clarification over just what is happening with credit exposures. My take is that the overall credit environment remains broadly stable, and while employment remains strong, Australian banks will continue to enjoy relatively low levels of credit losses. Profits and dividends many not be growing, but they are not going to get smashed, either. The official bank reporting season kicks off in just over 4 weeks, with Westpac set to report on 2 May, ANZ on 3 May and NAB on 5 May. These results will be watched with keen interest, and maybe the fillip the market needs to start liking banks again.