The aftermath of COVID-19 on the banking industry
While COVID-19’s story will be written by historians, April 2020 will be bookmarked by financial decision makers. Every CFO and business owner was hastily securing their financial positions expecting a prolonged period of uncertainty. In the banking sector, credit teams were working in overdrive alongside their relationship management colleagues to keep businesses alive, pay checks flowing and the economy running. The task was so large and unprecedented that the alliance ‘Team Australia’ was unofficially formed to synchronise government, central bank, regulatory and financial sectors to navigate a path forward. 12 months on Australians are still dealing with the impact, however, are in a far better position than expected.
There are several key reasons why now is an opportune time to discuss margins with your bank, particularly if your business has demonstrated trading resilience throughout.
5 reasons to chat with your bank
Decreased Funding Costs
COVID-19 stimulus provided to banks has materially decreased bank funding costs
Bank funding costs have declined to “historically low levels”, as per financial media, the RBA’s assessment and the major banks own disclosures. Funding costs determine a sizeable part of your margin therefore any overall fall provides opportunity for margin reductions. For select clients, banks have proactively offered a partial pass through via margin reductions. Whilst not unheard of, the very fact that banks have been voluntarily handing back margin to some savvy clients is a good indication of the capacity created by decreased funding costs.
Readjustment of Provisions
Early in the COVID-19 crisis banks adopted prudent but, with the benefit of hindsight, overly-cautious economic views. As outlook improves, the assumptions of economic downturn that drove large increases in collective provisions are being reassessed. The release of provisions featured prominently in the 1H2021 trading updates provided during the first week of May by ANZ, NAB and WBC.
A small portion of your facility margin contributes to a bucket of funds waiting to cover defaults. This collective provision protects the bank’s portfolio and was reason to increase margins as default risk increased with the uncertainty of COVID-19. As economic outlook has improved materially, it is harder to justify any existing or new increases is due to future uncertainty and provisions.
Importance of maintaining portfolio volumes to cover provisions
With inevitable defaults that will occur across the book, banks cannot afford to lose well performing sizable clients. Any reduction to a bank’s balance sheet has an impact on its ability to absorb losses. If the business is performing well, it follows that the bank should want to retain you…and acquisition costs to replace lost balance sheet should outweigh a sharpening the margin by a few basis points.
Reset hastily agreed funding
During April and May 2020, you may have negotiated extended tenor or additional emergency funding lines – at elevated margins. During those uncertain conditions, the objective was certainty of funding. It is important to acknowledge the role the banking sector (especially the mid-market and institutional divisions of the major banks) played in providing critical access to funding.
Of course the banks were paid well for their role through acceptance fees and elevated margins. Their risk-adjusted returns were further improved thanks in part to APRA’s capital relaxations and more importantly the taxpayer provided ‘tail-winds’ ($200bn free 3yr term funding). One must also consider the oceans of liquidity injected by the job-keeper program much of which found its way to bank balance sheets. These factors combined to provide a ‘significant Funding Gap reduction 10x higher than during the Global Financial Crisis’.
A lot has changed from 12 months ago as we have navigated a world with COVID-19. Now would be a good time to look at the price of funding that you agreed to in the midst of the crisis.
Approaching normalisation of funding costs
30 June 2021 is the expiry of the RBAs Term Funding Facility. For the 15 months prior to this date nearly $200bn of government subsidised 3-year fixed funding will have been provided to the sector at a cost over swap benchmark of around 0.00%. This compares to more typical 3-year major bank senior unsecured funding spreads around 0.50% – 0.90%.
Logically it follows that once major banks re-enter term wholesale funding markets this will become the leading justification for an upward revision to your margin. This is to preserve net interest margins that have benefited significantly since the RBAs TFF began.
Why act now?
If you don’t have a discussion and try rebase your margin lower whilst the opportunity is there, then you will be on the back foot for the inevitable upwards pressure post 30 June 2021.
As a CFO or business owner, you are acutely aware of your company’s specific circumstances and bank relationships. COVID-19 was a timely reminder of the importance of bank support and the need to value this alongside pricing and credit terms. However a productive business relationship is two-way. When the banks themselves have benefited significantly from a coordinated ‘Team Australia’ and the taxpayer’s purse, it is only fair that the customer pose these valid questions and form their own views based on the bank’s response.