The most important thing to watch during next week's bank reporting season

This profit reporting season for ASX banks will be a particularly anxious time for investors amid the COVID-19 fallout. Here's the key thing experts will be watching for, and it's not dividends.

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This profit reporting season for ASX banks will be a particularly anxious time for investors amid the COVID-19 fallout.

As it stands, the sector is underperforming the S&P/ASX 200 Index (Index:^AXJO) since the coronavirus pandemic hit.

The National Australia Bank Ltd. (ASX: NAB) share price, the Westpac Banking Corp (ASX: WBC) share price and the Australia and New Zealand Banking Group (ASX: ANZ) share price are down around 40% each over the past three months.

In contrast, the top 200 stock benchmark lost 27% of its value over the same period.

Provisions more important than dividends

While big bank shares are looking good value on some measures, investors are reluctant to buy until they have greater clarity on the impact of the medical crisis on the banks.

While mum and dad shareholders will be keenly eyeing dividend news from the banks, this isn't what the experts are most interested in.

The single most important thing that experts will be watching is bad debt and the provisioning for loan defaults.

Balancing act

"Given timing, the banks will use overlays to top-up their Collective Provisions. This is a balancing act," said UBS.

"If the banks are seen to under-provide the market may view them as unrealistic and imprudent. While if they are seen to over-provide, the market may be equally shocked.

"We believe that overlays of $1.0-$1.5bn per bank for 1H20E (in addition to the underlying charge) appear reasonable and are consistent with the numbers implied by current share prices."

Why this balancing act is so important is because it will likely determine how the share prices for the big banks will trade in the near-term.

The right provisioning will help banks re-rate

Credit Suisse is also singling out bad debt as the single most important number to watch.

"We expect the bulk of the bad debt number to be driven by increases in collective provisions/overlays given little in the way of stress has been observed to date," said the broker.

"On the surface, a lower‐than‐expected number might appear good, but if it is not realistic then the market will ignore it as an increase in outer period provisions."

Investors will need to feel confident that banks have padded their balance sheets sufficiently against the worst-case scenario from the COVID-19 recession. If the management teams can achieve that goal, the share prices of our largest home lenders will re-rate!

The bank more likely to suspend dividends

Of course, this doesn't mean dividends aren't a point of worry too. Morgan Stanley points to two probably outcomes on this front.

In the first instance, the big banks will pay a small dividend, which could be 40% to 60% below what they paid this time last year.

A second outcome is a deferral with no guidance on when dividend payments can resume.

"Payment of a modest dividend can be justified, but we believe Boards may take an even more conservative approach at this point in the cycle in order to reduce the risk of future capital raisings," said Morgan Stanley.

"Dividend suspension seems more likely at NAB and WBC than ANZ given their lower capital ratios and new leadership."

Motley Fool contributor Brendon Lau owns shares of Australia & New Zealand Banking Group Limited, National Australia Bank Limited, and Westpac Banking. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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