A must read for all investors

Those not subscribing to the largest hedge funds in the US would do well to heed the voices of Wall Street as to the Australian economy and in particular the banks which announced record profits.  The following interview piece, in respect of expat fund manager Matthew McLennan explains just why the banks are risky and with low capitalisation (amongst record high private sector debt levels):

Asked if he had invested in Australian banks, which are highly profitable by overseas standards, Mr McLennan said he was put off by the major banks’ lofty leverage, which averages 27 times their underlying equity capital, and their exposure to fickle wholesale bond markets. 

“We haven’t been investors in the Aussie major banks, because the raw equity-to-asset ratios . . . are lower than our comfort zone,” he said. 

While the banks have profited from a “fair amount of cumulative credit growth over the last generation” Mr McLennan said their “reserves-to-loan losses” appeared to be “pretty low in the scheme of things”. 

He warned the Australian economy, which was dubbed by The Economist magazine as the “wonder Down Under” for 22 years of uninterrupted growth, may soon start to struggle.(here).

More on those lofty banks here. 

Banks fine if miners default?

...senior executives at Australia’s largest banks are expecting an increase in bad debts from mining and mining services companies as the value of commodities continue to fall amidst the decline in growth in China.

According to The Australian Financial Review, the survey found that the bad debt situation in mining over the next 12 months is expected to “deteriorate somewhat” with Chinese authorities now becoming more concerned about China’s growth prospects.

The looming threat didn’t stop ANZ from offering up $1 billion in finance to Gina Rinehart last week however, in order to bridge her Western Australia iron ore project. Whilst the prospects of the mining sector have remained quite bleak in recent times,(here)

Too big to fail?

Or big boys being set up to fail?

While global financial markets are on the precipe, check out this piece lionising the oversized Aussie banks - here.

The byline makes a point about the lack of competition in the Australian market - too right.  But not the only worry for regulators and savers.

Dump the banks!

It is early at this stage to tell how the skid to the rally in Australian banking stocks is likely to play out, but a quick skim of the headlines is enough to suggest a real evaporation in sentiment:

Dollar puts an end to banking's party 

Our much-loved bank shares are coming under pressure, although at this stage it looks not so much a violent pricking of the bubble, but a gentle deflating like the forgotten balloon behind the couch after the raucous party (here).

and 

Australian bank stocks fell the most in a year as investors sold out of a rally that had driven financial shares to a record high last month....The rally pushed bank shares to record highs with UBS AG (UBSN) analysts led by Jonathan Mott calling Commonwealth Bank the most expensive lender in the world on May 15. 

 “The market run has been so skewed towards high-yielding stocks and financials in Australia, and now with worries about China, foreign investors are withdrawing,(here)

and also:

Foreign investors dump big four banks 

The Australian dollar faces further sharp losses in the next 12 months as it rediscovers its historic link to commodity prices, analysts say.

The dollar sank to a fresh 11-month-low of 95.94 yesterday. It was trading at 96.8 US cents this afternoon following a rollercoaster overnight session....The revised forecasts from analysts come as HSBC flagged Australia’s entry into the global “currency war”, which has seen central banks print billions in cash to push their currencies lower (here)

Dollar bust?

The Australian dollar has been hit by a fresh wave of selling, plunging to another 11-month low as investors continue to pile into its US counterpart. 

The currency fell as low as 97.98 US cents in offshore trade, a level not seen since early June 2012, and down from 99.12 US cents about midday on Thursday. In early trade on Friday, it had recovered to 98.22 US cents.... 

The Aussie dollar has dropped 5 per cent this month. It started tumbling amid more signs of a slowdown in China and after last week's interest rate cut by the Reserve Bank. (here)

Aussie banks need a cash call

Australia's four largest banks have been warned by Fitch Ratings that they need to improve their funding mix if they are to meet Basel III liquidity requirements and retain their coveted AA- credit ratings.
The banks have been told to scale back their dependency on offshore funding, bolster deposit levels and lengthen the duration of their wholesale funding.
Fitch warned the steps are especially necessary after the Australian Prudential Regulation Authority (APRA)earlier this week declined to push back the planned 2015 start date for new liquidity rules.
APRA's decision prompted Fitch to warn Australia's banks that they will have to meet liquidity coverage ratio targets by 2015 and net stable funding ratio targets by 2018, despite the revised Basel rules allowing phased implementation.
“Their reliance on wholesale funding, particularly from offshore markets, is high compared with international peers,” Fitch senior director Tim Roche said in a statement. (here).

Farewell good times

Colebatch in the Sydney Morning Herald with a firm take down on the Australian economy's growth aspirations.  Building on Ross Garnaut's recent assessment which was profiled in this blog, it makes for a really shocking read - the China bust, uncompetitive currency and interest rates, falling tax revenue, unfunded commitments and an aging society.  Ouch.  Is this the opening of a door into the bad old days of the recession we had to have?

Our economy is poised to go bust and only tax rises and spending cuts can save us.... One of Australia's most respected economists, Ross Garnaut, of the University of Melbourne, warns that when the mining boom busts, the economy is likely to bust with it. History is on his side. Since 2005, mining investment has reared up like a tidal wave, from 2 per cent of GDP to more than 8 per cent. If it breaks like a tidal wave, it will swamp the economy.... 

The bottom line is that something's got to give. Australia cannot continue this level of spending with this level of revenue.....

The end of the mining boom, however, could throw all this out. Garnaut, a former ambassador to China, says we underestimate the seriousness of China's rulers in planning to shift its economy to a more gradual, less resource-intensive growth path...But every mining boom since the war has ended in a bust, and there is no reason to think this time will be different. It was a very big boom, so it could be a very big bust. (here) 

Japanese curse? or mining the AUD bust?

Not yet but expect the peaked Aussie dollar to trend downwards with the commodities bust according to the Financial Times:

...Traditionally, Australian assets have been particularly attractive to Japanese investors, with the yield on the Australian dollar still the highest of any developed country at 3 per cent. Higher yielding emerging market currencies such as the Russian rouble at 8.25 per cent, the South African rand at 5 per cent and the Chilean peso at 5 per cent are also popular with income seekers.
Still, the BoJ effect could prove to be temporary.
“We would expect the commodity currencies to gain some near-term support from a Japanese investor reallocation, with their attractive yields, liquid bond markets and high ratings,” says Ian Stannard, foreign exchange strategist at Morgan Stanley. (here)

And Japanese mega-easing is cutting into the Aussie banks' profit margins too.  Not entirely convinced by the argument but anyway:

FLOODING the financial system with liquidity has worked a treat in refloating the global economy, but don't ask ANZ boss Mike Smith about the impact on his wholesale banking margins, particularly in Asia.
The Bank of Japan is the latest convert to quantitative easing (QE) -- central banks buying assets such as government bonds to pump money into the economy directly.
If the impact of similar QE programs by the US Federal Reserve and the European Central Bank in 2008 and 2011-12 is any guide, liquidity will expand and pressure will intensify on Asian wholesale banking margins.
The problem for the banks is that they make money by charging higher interest rates on their loans than they pay on their deposits. Once official rates start heading to zero, and deposit rates follow, any further reduction in lending rates squeezes the margin. (here)

Penny dropping?

Thanks to FMG magnate Andrew Forrest, the Australian media has been abuzz with an enhanced sense of importance, reporting from the sidelines on the political-investment shindig the miner organised for China and Australia's business and political elite in Hainan, the "Boao Forum".

More interestingly was reports from another regional conference and comments from RBA Governor Glenn Stevens:

...RBA Governor Glenn Stevens has some concerns about China’s “shadow banking” system. He poses questions about the role of non-bank entities in the Middle Kingdom. (here)

The linked Crikey article gives a good run down of the shadow banking problem in China and quotes from Fitch analyst Charlene Chu, who has led the pack in rating the Chinese bank sector in recent years:

“The [Chinese] banking sector is significantly exposed to shadow banking. We could see an asset quality problem in the financial sector in fairly sizable magnitude within the next few years.”

Actually I disagree with Charlene on one point.  The asset quality problem is happening now. A senior auditor warned China's local government debt (to which the banking system is tied) is "out of control" (here).

And yes Australia is exposed front and centre.  The economy is at risk.

Receivership - coming to a company near you

Recent reports of failed businesses include high-tech Adelaide engineering company Priority Services, Potato company Mondello Farms and Victorian manufacturer the Starmaid Group.

....Priority Engineering Services had been operating in Elizabeth South since 1984 but a downturn in contracts has led to receivers moving in and staff yesterday being made redundant....Receiver Ferrier Hodgson was already talking to parties interested in leasing or buying the company's 10,000sqm site.

What links all of these together apart from general slowdown and industry specific factors?

...It is no secret that ...manufacturers are facing extremely challenging times...Companies are struggling under a high cost, high wage, high currency environment."

If you are confused about how the high currency and other policies could be causing damage to the economy while being proclaimed as good by the Reserve Bank of Australia, then you are not alone - so are we!  In fact we think the RBA is suffering from short sightedness or only looking through one eye

Real victims in currency wars

While the RBA and the banking industry have been showing off their resilience to the ebbs and flows of currency markets, in the space of the real economy, real businesses are going to the wall. 

Focussing on the iconic sauce maker Rosella this Bloomberg piece said:

....Rosella’s receiver today said it was unable to find a buyer and will shut the saucemaker, leaving 70 workers without a job. The failure -- along with receiverships at book seller Angus & Robertson, founded in 1884, and Allans Music, in business for 16 decades -- illustrate Australia’s lopsided economy. A mining- investment boom is delivering the quickest growth in the developed world even as it masks other weaknesses....

....“It’s disappointing that these Australian icons are either disappearing or being severely diluted and undermined,” said Kumm, who spoke before today’s announcement. His great- grandfather Frederick Cato helped found the company in 1895. “We’re used to seeing those things on our shelves and there’s a sense of belongingness.”....

Bob Gregory, a professor at Australian National University in Canberra and former central-bank board member, predicts joblessness will worsen this year. The investment phase of the mining boom, which has been construction-oriented, will wane and government-budget cutbacks will curb infrastructure projects, hurting workers without college educations, he said....Some blue-collar enclaves in Australian capital cities already have unemployment approaching recession-plagued Spain’s record 26 percent...(here)

Meanwhile for another consumer retail business, footwear there was also bad news:

...SHOE Superstore is the latest retailer to fall into administration as the chief of parent company RCG Corporation warned that some sections of the consumer market were still reeling from the impact of the global financial crisis....RCG put Shoe Superstore, which includes nine stores employing about 50 staff, into the hands of administrators yesterday, less than four years after it acquired the business... (here).

Like a Sydney cappuccino

One of the delights to be enjoyed in Sydney thanks to the heritage of the city's Italian community, is a decent espresso and Sydneysiders all over come to depend on their regular "cuppas".  Of these the cappuccino is a particularly popular variety, which stands out for the amount of its froth - the hot aerated milk at the top of the cup (usually with a signature sprinkling of chocolate powder).

The other Sydney love affair is with property and glowing reports of a return of buyer interest in the Sydney property market and statewide (in New South Wales) was reported in a number of publications.  "Back to boom time" screamed the Sydney Morning Herald:

...LOW interest rates, rising confidence, an improving sharemarket and Chinese buyers all helped Sydney achieve a ''boom time'' auction day as the property market faced its first big test of the year on Saturday.........''Sydney's 76.3 per cent rate is the highest recorded for years and reflects boom-time activity similar to what the market experienced in 2010,'' the senior economist for Australian Property Monitors, Andrew Wilson, said.....(here).

This is froth.  Pure and simple.  A market divorced from fundamentals.  And the optimism on display was elsewhere, in other markets - reporters wrote of an expected bull year in the sharemarket (here), while bank regulators voiced concern about perceived increase in business lending (here). A glowing advertorial for some financial advisers told the story of Tim with all his amassed savings and how he was getting ready for the "good life" (with more saving and spending to come)(here).

So what is really going on? Businesses are looking to cut costs drastically - Insurer QBE noted to be ruling out job cuts (here) and one mining town is dying (here).  Anyone paying attention to global developments is right to think that Australia will not be immune for much longer.  Time to move from frothy cappuccino to regular black coffee...

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).