Australian Banks

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#1
In Singapore, there are big 3. Down Under there are big 4 plus smaller regionals. Together, they share similarities - decent yielding and big components of mkt index...

Can you still bank on the banks?
PUBLISHED: 5 HOURS 34 MINUTES AGO | UPDATE: 2 HOURS 20 MINUTES

While the banks’ halcyon days have passed, investors still find their shares irresistible – particularly since the steep share price drop has pushed yields to about 6 per cent. Illustration: Michael Mucci
KAREN MALEY
As worries about spluttering global growth echo through global markets, investors around the world are being forced to question whether they should continue to own bank shares.

After all, if the global economy slumps back into recession and companies are hit with falling sales, the world’s big banks will be hit with a steep jump in problem loans. Then there are the huge losses they could run up on the billions of dollars lent to investors to play the rise in asset prices engineered by central banks. Investors in the big four Australian banks – which together account for a staggering 29 per cent of the ASX 300 – have seen the value of their investments fall by up to 10 per cent in six weeks.

As Perpetual’s head of investment market research, Matt Sherwood, points out, “Australian banks may be among the most consistent earnings and income growth stocks in the market, but they are not immune to corrections, economic shocks or risk.” And he says investors are wrong to believe they can diversify by owning shares in all four banks. They “tend to move in a pack” and “have the same impact from changes in interest rate settings, higher unemployment, greater regulation and any general economic downturn”.

Hugh Harley, financial services leader at PwC, also has reservations.

“Global over-leverage, which took 20 or 30 years, was always going take a long time – maybe 10 or 15 years – to build down.

“So any long-term view of banks needs some caution.”

But investors are obsessed with more immediate risks. They’re worried the financial system inquiry led by David Murray will recommend the big four be forced to hold more capital; this would reduce their re­turns on equity. Last month, UBS’s banking research team estimated in­creasing the risk weighting on the major banks’ home loan books and requiring them to hold a bigger capital buffer could force them to hold an additional $41.1 billion in capital.

As Perpetual’s Sherwood points out, “The banks are now facing significant headwinds. There’s clearly regulatory risk coming as the G20 moves to force the world’s top banks to boost their total loss absorption capital.”

And the economic backdrop is deteriorating. “The Australian economy is subdued and unemployment is near decade highs, so it will be increasingly hard to maintain bad and doubtful debts at their recent decade low, despite current interest rate settings providing more protection for borrowers.”

A final risk is that banks will not be able to sustain their payout ratios.

“Banks have boosted payout ratios to about 75 per cent – way in excess of international peers and unsustainable, as it would require bad loans to remain at historic lows.”

Sherwood argues the banks have been in a “sweet spot” for three years, but that this has passed. “They’ve benefited from record low rates and the search for yield, the domestic economy has been strong enough, and they’ve been able to lift their payout ratios. But this is likely to be as good as it gets – even though they’re sound and robust businesses that have performed well for domestic investors for the best part of a quarter century.”

YIELDS ABOUT 6 PER CENT
But while the banks’ halcyon days have passed, investors still find their shares irresistible – particularly since the steep share price drop has pushed yields to about 6 per cent, a level where even highly regarded fund managers find them tempting.

In a report note this week, Goldman Sachs argues that record low rates have eased debt-servicing costs for households and they predict “the low level of bad debts can be sustained for the next couple of years”. The major banks “are well positioned to meet any higher capital requirements” that the Murray inquiry might recommend. “While we expect uncertainty around capital levels may continue to weigh on sector valuation multiples until at least the G20 in November 2014 (the first key catalyst where we may get a better sense of where global regulators are moving to), we think the sector is looking attractive [on] domestic relative valuations,” the report says.

”This is particularly the case given our strategy team believes the downside risk for bank earnings is lower than the non-bank industrials over the next 12 months.”

What’s more, it argues, Australian banks are looking more attractive compared with their international peers. “In a global context, valuations for the major Australian banks are looking as relatively attractive as they have in about two years.”

But UBS analysts are more sceptical. They say banks’ cost of capital is about 9.3 per cent, compared with the implicit cost of capital in bank share prices of about 10.1 per cent, given forecast return on equity of 16.2 per cent. “This implies the banks are around 9 per cent cheap, or one standard deviation from historical average. This has usually been a ‘buy’ signal for the banks.”

But they note this calculation is dependent on bond rate movements and assumptions about bank returns. Using a bond rate of 4 per cent – and assuming after the Murray inquiry the banks’ return on equity will fall to about 15 per cent – they estimate banks are still around 5 per cent expensive.

One reason investors continue to bank on the banks is that they have demonstrated an impressive ability to adapt to changing circumstances. As PwC’s Harley says: “We know Australian banks are well managed and that the combination of market structure and business model gives plenty of flexibility for banks to respond as market circumstances change. That is very clear from the last five years.”

Perpetual’s Sherwood notes the banks enjoy a position of market dominance, which makes it hard for new entrants to compete. “We re seeing some big companies using their balance sheets to try and gain market share in some areas, such as insurance and credit cards. But the banks are very dominant in their primary industry.”

Thus Australian investors are unlikely to desert the banks in droves. “Retail investors are more likely to view the price decline as a reason to get buy more. Given their massive performance, it’s hard to see investors walking away and looking elsewhere.”

The Australian Financial Review

BY KAREN MALEY
Karen Maley
Karen Maley blogs on markets from our Sydney newsroom.

@KarenMaley
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#2
I would be very careful with Australian banks. Westpac and CBA are highly levered on the Australian property market, which by most measures is one of the most expensive in the world. Foreign buyers eg Chinese may help new apartment sales but the core residential property market is quite unaffordable so there is a big NPL risk. NAB and ANZ also have mortgage risk but are more business focused banks. NAB has has a serious of problems, and while ANZ has performed reasonay well on the face of their results, their aim is to grow into the next Standard Chartered which is a broken business model (take a look at STAN trading sub book value).

Despite this Aust banks are very highly valued vs international peers. While current ROEs are high they are boosted by extremely low levels of provisioning that is bound to change when the credit cycle turns.

Local Aussie investors have been buying the banks for strong dividend yields. This is wrong in my opinion but even if you like the dividend, don't forget Aust investors get tax credits which are not valuable to you, so their effective dividend yield is higher than yours.
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#3
Thanks for your review.

I can see your maturity via your analysis.

Your analysis is well balance.

Unfortunately, Aussie banks are a big weightage of the main index. Hence, its an integral part of the market.

Personally, I find that using a bottoms up approach to the entire sector does not work. However, if you use a bottoms up approach to pick the banks within the sector, it makes sense.

I have been observing the Australian banking sector for the longest time. The high loan to equity ratio has been there for the longest time and has been a concern for the longest time for fears of deteriorating quality of the underlying loans. However, since the GFC, none of the concerns have materialised. That is not to say that it will not happen but should one continue to allow the macro concerns bother with sector selection within a portfolio, that would mean that performance from this core sector will be excluded from one's universe.

On the last point of franking tax credit influencing one's choice to select Australian stocks as investments, it should be view from the point of view if one is interested to invest in ASX counters alongside domestic investors and international institutions. If the answer is YES, then zero value from franking tax credits is an irrelevant consideration. (Note franking tax credits in Australian tax system is equivalent to our old section 44 tax credit pre 31 Dec 2007)

No vested interests
GG

(18-10-2014, 01:22 PM)roxhockey Wrote: I would be very careful with Australian banks. Westpac and CBA are highly levered on the Australian property market, which by most measures is one of the most expensive in the world. Foreign buyers eg Chinese may help new apartment sales but the core residential property market is quite unaffordable so there is a big NPL risk. NAB and ANZ also have mortgage risk but are more business focused banks. NAB has has a serious of problems, and while ANZ has performed reasonay well on the face of their results, their aim is to grow into the next Standard Chartered which is a broken business model (take a look at STAN trading sub book value).

Despite this Aust banks are very highly valued vs international peers. While current ROEs are high they are boosted by extremely low levels of provisioning that is bound to change when the credit cycle turns.

Local Aussie investors have been buying the banks for strong dividend yields. This is wrong in my opinion but even if you like the dividend, don't forget Aust investors get tax credits which are not valuable to you, so their effective dividend yield is higher than yours.
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#4
Australian govt guaranteed deposits oct 2008- march 2010, the banks are not immune

That said their finance sector is actually more robust than people give credit for. I am sure they will be hit by the eventual unwinding of the property market but i doubt will be catastrophic. In fact i think sending children to study banking or finance down under if they are keen is not a bad idea
Before you speak, listen. Before you write, think. Before you spend, earn. Before you invest, investigate. Before you criticize, wait. Before you pray, forgive. Before you quit, try. Before you retire, save. Before you die, give. –William A. Ward

Think Asset-Business-Structure (ABS)
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#5
Due to high taxes and plenty of grey areas in terms of taxes and planning, there are plenty of "creativity" in areas of tax planning and hence the dynamism seen within the financial sector.

With government finances - both federal and state levels constantly in deficit, privatisation and asset light is always a constant theme.

I second your view that there are plenty to learn from the banking and finance sector in Australia. Must not forget that Macquarie Bank is amongst the top in global investment banking sector.

GG

(19-10-2014, 03:56 PM)specuvestor Wrote: Australian govt guaranteed deposits oct 2008- march 2010, the banks are not immune

That said their finance sector is actually more robust than people give credit for. I am sure they will be hit by the eventual unwinding of the property market but i doubt will be catastrophic. In fact i think sending children to study banking or finance down under if they are keen is not a bad idea
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#6
RBA’s warns banks on taking mortgage risks
JAMES GLYNN THE AUSTRALIAN OCTOBER 22, 2014 12:00AM

THE Reserve Bank last night called on the country’s banks to be prudent in lending for mortgages to avoid creating “unacceptable risk” in the sector.

Deputy governor Philip Lowe said in a speech that as a period of record-low interest rates continued, risk levels were changing in the economy.

“We all need to be cognisant of how risk is changing,” Mr Lowe said, adding that the level of risk in investment housing, where prices had surged in the past year, had risen. Lending to property speculators was now “unbalanced”, he added.

Lenders for mortgages needed to ensure their standards were sound, he said. “Careful attention to these issues will help ensure that in getting economic benefits of low interest rates we do not generate unacceptable risks on the financial side.”

Mr Lowe, who sits on the RBA’s monetary policy board, said the record-low rates were “absolutely appropriate” and were needed to support the broader economy, which was experiencing a slowdown in a decade-long mining-investment boom. The bank has kept interest rates at 2.5 per cent for 14 months to support growth, which has been hampered by a strong Australian dollar.

House prices have climbed sharply this year, prompting the bank to warn recently of wider risks to the economy if the property market were to weaken suddenly. The central bank and banking regulator plan to announce tighter regulations on mortgage lending before the end of the year, with property speculators the likeliest target.

“At least some parts of the housing market have become unbalanced and this has generated some increase in overall risk,” Mr Lowe said, flagging that some changes to regulation governing bank lending might be needed.

House prices have risen by about 10 per cent nationally over the past year and closer to 15 per cent in Sydney. But, Mr Lowe said, “We need to be realistic about what can be achieved through changes in the regulatory parameters alone.”
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#7
APRA eyes incentives over laws on banks lending to property investors
THE AUSTRALIAN OCTOBER 23, 2014 12:00AM

David Uren

Economics Editor
Canberra
THE prudential regulator wants to give banks incentives to ­reduce lending to property ­investors rather than imposing fixed regulatory limits, as has been applied in countries such as New Zealand and Britain.

The new Australian Prudential Regulation Authority chairman, Wayne Byers, confirmed he was considering imposing ­additional capital requirements for investment property loans, but told the Senate Economics Committee yesterday that no decisions had been made.

“We’ll take advice on the most appropriate thing to do … and the most appropriate thing to do may be nothing,” he said.

Mr Byers said neither APRA nor the Reserve Bank used the term “macroprudential” to des­cribe the approach APRA would take to managing risks in the housing market, saying he rejected New Zealand’s hard limits on the allowable loan-to-value ratio or the British limits on how much banks could lend where the loan was more than a fixed multiple of the borrower’s income.

“We tend not to reach for those tools of hard caps or limits because they tend to be blunt and harsh.

“Our focus will likely be looking at things that are more ­incentive based, such as tweaking capital requirements, which will still allow banks to set their own lending standards and decide who they want to lend to and the terms they want to lend to them on, but will make sure that, to the extent they want to lend to people who are higher risk, they have more capital to back that up.”

This would be a supervisory policy response based on APRA’s own mandate, which required it to ensure the financial services industry operated with prudential standards, rather than for a broader macroeconomic purpose that might be the Reserve Bank’s concern.

Asked if APRA could change capital requirements to target the investment housing markets in Melbourne and Sydney, Mr Byers said this was one of the challenges being considered.
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#8
RBA warns on lending standards
AAP OCTOBER 23, 2014 11:00AM

The central bank boss is keeping a close watch on lending standards and the rapid rise in house prices.

Reserve Bank governor Glenn Stevens told a conference in Sydney on Thursday that he's concerned about the rapid rise in loans to people investing in the housing sector.

The RBA says that investors are pushing up prices and shutting owner occupiers and first-home buyers out of the market.

"The key points here are that we are keeping a close eye on the buildup of credit to investors in the housing market," Mr Stevens said.

"Lending standards are things that need to be carefully watched in a time when house prices are rising quickly and competition from lenders are increasing."

The RBA and the Australian Prudential Regulation Authority (APRA) are getting ready to use rules and regulations rather than interest rates to restrict that lending.

"Those discussions are continuing and when there is something to be said it will be said, all in good time," Mr Stevens said.

The RBA, in early October, said it hopes the details of the reforms will be released by the end of 2014.

It wants lending standards toughened to slow the rapid housing price rises in Sydney and Melbourne.

Dwelling investment rose by more than eight per cent in 2013/14 and housing prices rose 10 per cent.

Leading the charge was Sydney, with prices up 15.6 per cent, while Melbourne had a 9.3 per cent gain.
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#9
Lending crackdown may force rate hikes, analysts say
THE AUSTRALIAN OCTOBER 24, 2014 12:00AM

Michael Bennet

Reporter
Sydney
Lending crackdown may force rate hikes
Stricter capital requirements may force banks to pass on the regulatory burden by raising mortgage rates, analysts say. Source: Supplied
THE major banks may have to ­increase mortgage rates on ­almost half of new loans by up to 150 basis points to compensate for a potential crackdown on lending to investors and maintain their bumper returns, new analysis shows.

After the banking regulator this week suggested banks may have to hold more capital against riskier loans, JPMorgan crunched the numbers and found their ­return on equity for investor loans might halve.

But the banks have over time successfully passed on regulatory burdens to customers by “repricing” loans, which experts believe would occur if regulators try to cool the housing market and the Murray inquiry imposes more ­onerous overall capital rules.

“Applying a standardised or ‘default’ risk weighting (similar approach to the ‘2003 precedent’) to an interest-only mortgage sees front book ROEs halve from 45 per cent to 22 per cent,” said JPMorgan analyst Scott Manning. “This would require about 150 basis points of repricing to attain a neutral ROE outcome.”

Given investor lending makes up about 45 per cent of new loans, almost half of new variable mortgages would be repriced to about 6.08 per cent, up from 4.65 per cent.

Concern surrounding so-called “macroprudential” tools has spiked after the Reserve Bank last month revealed regulators were discussing options to cool the Sydney and Melbourne investor-led property booms.

Wayne Byres, the new chairman of the Australian Prudential Regulation Authority, this week added that banks “undertaking higher-risk activities do so with commensurately higher capital requirements”.

“There are clouds looming over the domestic property market,” said Macquarie analyst Mike Wiblin, pointing to the potential for foreign buyers to also be curtailed. “Last time RBA looked to ‘cool’ the market in 2004-05, the bank (stocks) underperformed by about 7 per cent.” APRA and the RBA are considered most likely to target investor lending, rather than use “hard limits” such as ­capping lending at high loan-to-value ratios as in New Zealand as it would further price out first-home ­buyers.

Under a more “contemporary” scenario, Mr Manning said APRA could increase the so-called “loss given default floor” on interest-only loans from 20 to 30 per cent, leading the banks to increase mortgage rates a smaller 60 basis points. A higher floor, which feeds into the majors banks’ risk weighting calculation for mortgages, would require more capital, but not be as onerous as them having to use APRA’s “standardised” modelling to assess the riskiness of investor loans.
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#10
Bendigo Bank faces growth 'challenge'
MICHAEL RODDAN OCTOBER 27, 2014 2:15PM

Bendigo and Adelaide Bank has ruled out lower underwriting standards as its managing director flagged challenging market conditions at the group's annual general meeting today.

Managing director and chief executive officer of Bendigo and Adelaide Bank, Mike Hirst, told shareholders current market conditions are posing challenges for the bank.

"Spending is subdued, interest rates are low and people are taking advantage of this to pay down debt and improve their financial position," Mr Hirst said.

He said this poses a growth challenge for the banks, but ruled out lower underwriting standards or pricing as a means to lift growth.

"While lending demand is reasonable judging by our new lending approvals, the competition for loans and pay down of debt make growth hard to come by," Mr Hirst told shareholders.

Chairman Robert Johanson said the bank had been an active participant in the Murray Inquiry into the financial services sector, saying the system was geared against smaller lenders.

He said the competitive disadvantage suffered by deposit-takers which are not accredited under the Basel II advanced model, which means they must hold significantly more capital for identical low-risk loans, needs to be corrected.

"The security and stability of the financial system is a paramount requirement but we also need to have a level playing field open to new and smaller participants," Mr Johanson said.

Bendigo and Adelaide Bank director, Jenny Dawson, also announced her retirement from the bank's board at the AGM today.
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