RBA responds...with a damp squib

Readers may recall recent action taken by the Reserve Bank of New Zealand to counter rising property prices in New Zealand and prevent a housing price bubble which could throttle the economy (link here).  And not to be outdone, the central bank of Australia, the RBA has responded with...some strong words! (or as we call them, a damp squib!):

the RBA has told the big banks that a housing price boom is currently its "greatest fear" as prices are already high by most world standards (here).

Meanwhile growing calls for real action in the form of loan to value restrictions could lead to the RBA doing something concrete.

And it should not be forgotten the opposing forces in play - how likely is the RBA to raise interest rates to kill the property bubble if that pushes the economy into terminal decline and only exacerbates the inflows which fuel the speculative property bubble?  

Taper victims

Chances are if you've been looking at the news recently you may have heard something about the likely slowing of bond purchases by the US Federal Reserve.  Referred to as the "Taper", financial commentators have been speculating as to what will be the likely impacts, progression and victims of the US central bank changing the course of markets as it removes the support of its bond buying program which has been providing liquidity to global markets since the financial crash (now 5 years old).

Hedge fund managers have been looking for likely victims however and Australian banks fit the bill (even without the Taper they remain overvalued relative to the domestic Australian economy and their overseas operations, but why deny the hedge funds their fun?!).  As the Australian Financial Review has noted:

Foreign hedge funds are ­betting Australia’s banks will suffer big share price falls as a slowdown in emerging markets spreads here....Major banks’ shares have surged this year to record highs, prompting several investors and analysts to speculate they are in bubble territory.

International fund managers and Australian companies attending an investment conference in New York last week were told that some big hedge funds were convinced the major banks were overvalued and would inevitably fall to more normal levels....“I should warn you I was in London last week and one of the bigger questions I got was ‘why the hell are the Australian banks performing so well?’” Bank of America Merrill Lynch chief global equities strategist Michael Hartnett told his bank’s conference.

Global investors are bracing this week for a meeting of the US Federal Reserve, which may decide to modestly or aggressively scale back the $US85 billion-a-month bond purchases known as quantitative easing that have driven up share prices around the world. (here)

Precious Aussie banks

Only a week after a series of headlines celebrating the renaissance of Australian banking with the major banks' high share valuations it is interesting to see signs that all is not well.

Firstly a downgrade from Moody's on certain subordinated debt:

GLOBAL credit ratings agency Moody's has followed through with a threat to downgrade billions of dollars in subordinated debt issued by Australian banks due to "bail in" risks, as global regulators take a harder line on bank bail-outs. 

After kicking off a review in June, Moody's yesterday downgraded the subordinated debt ratings and some junior subordinated debt ratings for Basel II-compliant securities of eight Australian banks.... 

The ratings of the big four banks -- the Commonwealth, Westpac, National Australia Bank and ANZ -- were lowered by two notches, while the regional banks -- Bank of Queensland, Bendigo and Adelaide Bank and Suncorp -- were cut by one notch.(here)

And meanwhile markets are pricing Aussie banks as more risky as well:

...over the past month, Australian bank CDS prices have jumped again and fast. As of Friday prices were back above 100 at 108. This has transpired within the context of the sudden jump in yields in everything from US Treasuries to Brazilian junk bonds. But it should be noted that Australian bank CDS prices have risen much further than those of comparable major banks in other developed nations, almost 50% in a month. This is a  legacy of our particular dependence upon offshore wholesale funding such a leap is in some measure also a reflection of the sudden realisation in global markets that Australia is not the miracle economy it thought it was, CDS prices being the reverse of what’s being expressed in the falling Australian dollar.(here)

Arguably two signs of the same coin with deteriorating conditions for Aussie banking? 

Times changing for big Aussie banks...

Some details about CBA and ANZ shifting their strategies to meet new challenges - CBA stripping back its balance sheet to meet stricter capital requirements (although question if a recent private wealth scandal had anything to do with it) and ANZ looking to expand beyond Asia.

But changing is hard to do and to what extent will problems in the core outweigh any escape attempts at the periphery? Mutterings of increasing mortgage insurance costs don't bode well.

Interestingly though there seems to be a divergence between those with a domestic focus at the moment (CBA and Westpac) and those focussing overseas (ANZ and NAB).  It was noted previously that CBA and Westpac have larger domestic lending books and as this article indicates they are busier than ANZ and NAB due to integration of their Australian subsidiary groups (BankWest, Bank of Melbourne, St George, Bank of SA).

In the event of Ozzie contagion could it be that ANZ and NAB survive better due to less local exposure? Could be worth a study of long/short strategies!

Ozzie banks vulnerable

Business press seized on comments from Moody's as to overexposure of Australia's banks to a housing crash:

According to the Financial Review, Australia’s biggest banks have been fighting over the mortgage market for too long and if property prices fall too far, we could be in for a US-style banking collapse.
With the exception of ANZ (ASX: ANZ), our top four banks are not exciting from an investing perspective and are too heavily leveraged on growth through their mortgage books. If Australia were to experience an unemployment boom, loans would struggle to get paid, leading to more defaults and eventually lower housing prices.
This would paint an ugly picture for our biggest mortgage writers like Commonwealth Bank (ASX: CBA) and Westpac (ASX: CBA) (here)

And worringly this is structutal - a function of the market and simply how the banks are:

Banks in Australia have the highest concentration of residential mortgages than any other type of institution in the world, making them vulnerable to a possible house price correction according to the analysis of a leading credit market economist.
Moody's Analytics managing director Tony Hughes says that house prices in Australia were overvalued which could pose a major concentration risk for banks.  The high exposure to residential mortgage represents a valid risk for banks and the Australian economy. (here)

Nothing like being so exposed in one asset that you become the market (when it plummets):

Australia’s banks have the highest exposure to residential mortgages of any financial institutions in the world, leaving them vulnerable to a “looming” house price correction, a leading credit market economist has warned.(here)

TBTF (Too big to fail)

An interesting analysis of the Canadian banking system from FT Alphaville, following former Canadian Central Banker Mark Carney starting as head of the Bank of England, with a useful comparison to Australia.

Australia and Canada are very similar economies and jurisdictions - English heritage, resource and commodity exporters to the major economies of China and the USA and structural booms remaining in place (barely) with suggestions of currently overvalued property markets.

On the banking side both have conservative sectors with several (four or five) major banks at the pillar.  Interestingly the FT hailed one of the strengths of Canadian regulators recently was that they stopped the banks growing too big during, blocking earlier mergers amongst the top pillar banks.  A couple of questions:

i) while they look in good shape now (helpful for looking at Mark Carney today) will this hold into the future?  If not will Australian banks follow down a similar path? (hard to imagine given they are rated a world leaders at the moment on some metrics)

ii) in Australia it could be argued that one bank, CBA succumbed to merger fever when it acquired ailing BankWest, as CBA now has absorbed the loan book and swollen its income to be the leader of the pack of Aussie banks.  Might CBA now be too big to fail?  Certainly signs from the recent private wealth adviser frauds at the CBA aren't a good sign.  

The money is betting against the Dollar and the Banks

The Fed's tapering looking to hit Australia hard - 

When Stanley Druckenmiller, the legendary hedge fund manager, told an investor conference in New York a month ago that the Australian dollar was overvalued and would “come down hard”, local traders took note.They reasoned Mr Druckenmiller’s comments would be the cue for the hedge fund world to gang up on the Aussie, particularly as it was already struggling against a resurgent US dollar.
They were right.
Bearish wagers against Australia’s currency have risen to the highest level on record, according to the latest figures from the US Commodity Futures and Trading Commission. They show a net 58,600 contracts worth a notional A$5.86bn (US$5.5bn) are betting against the Aussie.(here)

And as for the banks (only weeks ago market stars):

International investors are bailing out of Australia's banks as the United States prepares to wind back its economic stimulus programmes and the Australian dollar tumbles.
Shares in the big four banks were sold off this month after US Federal Reserve chairman Ben Bernanke said the central bank would begin slowing the pace of its quantitative easing stimulus later this year.
Among Australia's big four banks, only shares in Westpac and ANZ are traded on the NZX. Westpac shares fell from a high of $41 in May to a low of $32.70 on June 21, a decline of more than 20 per cent. ANZ shares dropped from $38.30 on May 1 to $32.60 on June 21. (here)

ANZ in a bind

Readers may have spotted commentary about ANZ had released results recently which showed it was under greater pressure than some of its rivals (including CBA which managed to scoop up Bankwest for a song).  And not surprisingly come the job cuts...

...Australia & New Zealand Banking Group Ltd. (ANZ), Australia’s third-largest bank by market value, plans to cut about 50 jobs in institutional and international banking as lenders trim costs amid weak credit demand....Australian banks have relied on staff and pay cuts to protect profit as they confront the weakest demand for home lending since 1977. In 2012, ANZ announced plans to shed 1,000 jobs by September of that year as part of Chief Executive OfficerMichael Smith’s efforts to offset slumping loan growth (here)

But in fact all banks are trimming...

...Commonwealth Bank of Australia, the nation’s biggest lender by market value, will freeze base salaries for people making A$150,000 or more in its institutional banking and markets division, an internal memo showed in July....Westpac Banking Corp. (WBC), eliminated more than 500 roles early last year. National Australia Bank Ltd., is scheduled to brief investors on its technology program and its cost management plans on March.13.

The elusive banking culture

Watchers of the UK financial system will have noted the new head of global giant Barclays Bank in London recently attempting to draw a line under all of the recent scandals by launching the bank's renovated set of values (here).  Its peer HSBC, was more pragmatic in the US when confronted with money laundering charges and was able to argue it was too systemically important, or too big to fail (here).

Throughout the various scandals of the last few years has been the understanding that not only were banks and their stakeholders let down by individuals, but there was a systematic culture which favoured profit and criminality over ethical behaviour.

In comparison the last few years have been favourable to the Australian sector, with few scandals on an industry wide scale.  A recent case involving the Commonwealth Bank (here) has shed some light, but also attracting attention is perennial outperformer Macquarie (the millionaires' factory).  

Reviewing the recent press about the activities of the holey dollar's private wealth division show all the similar signs.  Not only were there compliance failures leading to the resignation of the head of division, but a flawed culture:

....this is a big deal. Macquarie Private Wealth is the largest full-service stockbroker in Australia. The findings of the internal audit by the adviser services unit were that some 365 advisers of the 420-strong team coast to coast were in breach of compliance....Though the number itself is big, the bigger deal is what the regulator's investigations say about that elusive yet critical aspect of the corporation, culture....In contrast to previous ASIC ''enforceable undertakings'' penalties - which mostly pertained to individual rogue activities - the Macquarie action is squarely aimed at management....

...Macquarie Private Wealth is a marginal proposition economically. If deal-flow rises and capital markets return to full swing, this regulatory nightmare may drift away.....(here)

The bankers will be hoping for rising deal flow, but so far no encouraging signs on the deeper issues.

CBA too big to fail and to jail?

A Hat tip to the Australian Property Forum for its coverage of the ongoing Bankwest/CBA scandal.  In case you missed it Bankwest was a victim of the GFC and after the insolvency of its English parent, HBOS was taken over by CBA.  While previous coverage had focussed on malpractice at Bankwest (such as this Four Corners special here).  The other issue is CBA's handling of the takeover and how it may have committed fraud to extract further value from the takeover, at the cost of Bankwest customers.

The following video provides a nice diagram and explanation - here.  The coverage on the Australian Property Forum is here.

As has been pointed out in the above sources this raises several disturbing questions:

- if such behaviour has not been prosecuted, when crisis hits the Oz banking sector again (GFC2) surely it will happen again and entrap more customers at different banks?

- given CBA is now the 7th biggest bank in the world and has released glowing results (here) surely this will mean it is even less likely to be prosecuted and more likely to continue its conduct?

As the video notes - Australian bank customers need to beware - they will not necessarily be safe from Australian banks!

Tall tales

There is a level of confusion as to the state of the Australian economy and likely risks and even those at the top can't agree.

...Three of Australia's big four banks have given market updates this month. You'd be forgiven for wondering if they were discussing the same market....The discrepancy in viewpoints is partly explained by the different business models of the three banks. Commonwealth Bank is the country's biggest retail lender, which means it benefits most from rising consumer confidence....
.
..NAB and ANZ are both more exposed to business lending, where sentiment is weaker. A survey from East & Partners, for instance, last week found that demand for all types of business banking services fell between November and January by an average of 1.9%....Despite their differing outlooks, investors overall still seem to like Australia's banks, deemed to be among the most credit worthy in the world. (here).

Yet meanwhile the central narrative underpinning the actual (or purported) growth was in fact being unwound by the central bank, the RBA:

...The Reserve Bank of Australia (RBA) says the mining investment boom will peak sooner and at a lower level than previously expected.

The central bank also says that while commodity prices are likely to drift lower over the next few years, Australia will continue to benefit from China's economic expansion...."And as mining investment tails away, we'll increasingly move into the operational phase of the mining boom," he said.(here)

Just to spell it out - the mining boom has been and gone....and there is not so much to prop up the Oz economy...

Oz banks - on the edge of the precipe

Or as the Financial Times' Lex Column put it - Australian lenders could, with a downturn in the economy - suffer what it termed an "Oz-pop".  Noting the sector's current strengths, banks unlike property developers have not written down the value of their  loan portfolios collateralised by residential properties (for which Australia is one of the most overvalued markets globally according to the Economist).

....The markets of the world are littered with the victims of housing bubbles – those that bet against them too soon as well as those that did not see them coming. Australia is no different. Developers are writing down land values but the big banks, which rely heavily on homeowners for profits, are still investor darlings...

....[Commonwealth Bank] has the sort of stodgy balance sheet regulators everywhere now praise as the model [vast majority home loans and local]. But if the Aussie housing market stumbles, so will its big lenders and market headway from here looks uncertain at best. Stockland and Mirvac, two large developers, have knocked a combined A$600m off the value of their properties in the past fortnight....(here).