Is Australia’s Banking Industry Going Under?

Westpac Banking Corporation (NSYE: WBK), Australia’s second largest bank, missed earnings on May 1, when it reported the biggest loan impairment charges in six years for the six months ending March 31.

Profits clocked in at A$3.9 billion, lower than the expected A$4.025 billion.

#-ad_banner-#This miss sent shares into the weeds, as low as $22.71 on Monday, down from $23.59 at Friday’s close. At the heart of the miss were corporate debt loans and lower commodity prices. This isn’t good news for Australia’s banking industry, and Westpac is the first big bank to report in the country, with other major institutions reporting later this week into next.

And they’re all in the same boat.

Many of these Australian banks made loans to the coal and steel industry. Both of these industries are struggling massively right now.

The world is moving away from coal as a power source faster than ever before, and China’s slowing growth is slashing demand for iron ore and steel. These factors could mean Australian banking debt could climb to its highest level in eight years by 2018, according to Bloomberg:

[Commonwealth Bank of Australia (OTC: CBAUF), Westpac Banking Corp., National Australia Bank Ltd. (OTC: NABZY)  and Australia & New Zealand Banking Group Ltd.(OTC: ANZBY)] posted combined bad-debt charges of A$3.8 billion, up 9.3 percent from 2014, and the first time the measure had increased in six years, according to their filings.

Money banks need to set aside for loans deemed likely to sour is set to hit A$7.2 billion by 2018, the highest since 2010, according to the mean estimate of five analysts surveyed by Bloomberg.

Does this spell the demise of Australia’s banks? Not quite…

This slump comes on the heels of six consecutive years of record profits for these four banks. And get this… The percentage of total loans exposed to the mining industry is less than 2% for Westpac, National and Commonwealth, with Australia & New Zealand’s exposure coming in at a hair above 2%.

Back in early March I warned you about the possible bad debt U.S. banks were holding in the oil industry. Well, JPMorgan Chase’s (NYSE: JPM) exposure to the oil industry is three times as high as these Australian banks (as a percentage of total loans).

So while the banking industry in Australia could be in for a rough patch, the underlying fundamentals could mean stability and a return to growth over the long term.

Share prices in the four major banks experienced a sharp pullback in the first few days of May after Westpac broke the news that it missed earnings. I think this could be a good opportunity to take a position.

Take a look:

Over the past year, these four banks have traded down, as commodity prices have steadily declined. But each have bottomed out in February, and again in April to set up the start of a bullish run higher.

From a technical perspective, Westpac is the first to break higher out of its downtrend.
That’s why I see this blip in Westpac’s earnings as a buying opportunity.

Beyond the corporate loans to companies in the commodity industry, Westpac — indeed all four major bank s– have a great track record. In 2015, according to the World Bank, only 1% of all loans made by Australian banks were non-performing.

That’s better than banks in the United States, Germany, Japan and the United Kingdom, and far better than struggling economies.

In fact, one of the reason why Australian banks are so stabile is that the Australian economy hasn’t been in recession for 24 years.

Not even during the Great Financial Crisis did Australia’s economy slip into recession.

And this stability translates into the highest returns in the sector of all the developed countries.

The banking sector, for sure, has some hiccups coming, but Australian banks stand to fare better than most.

Risks To Consider: The downturn in the Chinese economy is not over. Its appetite for coal, iron, steel and other industrial commodities is waning. As Australia is a major supplier of these commodities, the downturn could still affect Australian companies, or — as noted — banks that loan to companies in the commodities arena.

That means commodity prices and the Chinese economy could be long-term weaknesses for Australian banks, even though loans to companies in these markets make up a small percentage of total loans. It’s a knock-on effect.

The other risk is in the extreme short-term. The other Australian banks are set to release earnings very shortly. If they release similar reports to Westpac, the whole sector could see more red.

Action To Take: It would be prudent to wait until the rest of the banking sector releases earning before taking a position in any of them.

But once earnings are all out in the open, consider adding Westpac Banking Corporation (NYSE: WBK) to your portfolio. With the strength and stability of an economy that’s gone 24 years without a recession, WBK, and the banking sector in general, could yield steady gains over the long term.

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