The future for Australia's Banks

[tinhat]

You may not get the answer you want on a stock market forum as the bias from a lot of members is going to be towards shares.

In the depths of the bear market of late 2011 I had similar thoughts to you. I looked around at what bonds and hybrids were on offer at the time. Woolworths had a hybrid offering which started out with about an 8% yield.

At the end of the day however, I couldn't find a case to sell my WOW shares for their hybrids or sell my bank shares for theirs either. Firstly, with bonds, hybrids there is no franking credit. For a SMSF in pension phase that's a 30% difference on your return right there. Secondly, hybrids seem to have just as much risk and uncertainty of return as shares without any of the upside. What is the guarantee on the yield of the hybrid? It is not fixed. If you need to sell in a hurry on the secondary market there is no guarantee of what price you will get. As for bonds, what is your low yielding bond going to be worth on the secondary market if interest rates go up through the business cycle?

IMHO bank shares are fully priced at the moment given that there is not a great outlook for earnings growth over the next couple of years. Yet, they still represent a better grossed-up return that their hybrids in my assessment. As for risk to capital, well, keep a couple of years pension income as cash and don't worry about the "volatility". There is no volatility in the dividends! I don't have any trouble sleeping at night with one third of the SMSF total assets invested in the major banks shares (25% in CBA alone). But you have to sleep at night too. Some time ago in another post I did some analysis of the return on CBA shares. Even if you had purchased at the height of the boom in 2007, you would be well ahead on the dividends since then.


You might find this video of interest. It sums up my views as well:
http://www.switzer.com.au/video/peter-thornhill/

 

[doctorj]

Re: Alternatives to term deposits

I don't have any trouble sleeping at night with one third of the SMSF total assets invested in the major banks shares (25% in CBA alone). But you have to sleep at night too. Some time ago in another post I did some analysis of the return on CBA shares. Even if you had purchased at the height of the boom in 2007, you would be well ahead on the dividends since then.

Each to their own, but personally I'd be having a very hard time holding such a large exposure to Australian Banks in my super fund. Compare the price/NAV multiple of Aussie banks to any western market and you'll see they're trading at a massive premium to other countries. Then consider that denominator will be under pressure as NPLs continue to increase which, when combined with declining NIM caused by increased funding costs, is also likely to impact NPAT. Who knows how they'll move in the coming years, but the risk/reward is not for me.

 

[doctorj]

Re: Alternatives to term deposits

Each to their own, but personally I'd be having a very hard time holding such a large exposure to Australian Banks in my super fund. Compare the price/NAV multiple of Aussie banks to any western market and you'll see they're trading at a massive premium to other countries. Then consider that denominator will be under pressure as NPLs continue to increase which, when combined with declining NIM caused by increased funding costs, is also likely to impact NPAT. Who knows how they'll move in the coming years, but the risk/reward is not for me.

At the risk of rattling on about this, I had a look at some numbers this morning to substantiate my claims. 3 out of 4 of Australias big banks are amongst the 20 largest in the world by market cap. CBA is worth nearly twice as much as Sberbank despite being around 40% of the size. Sber is the largest bank in an emerging market of around 142mm people.

CBA is also worth 37% more than Mitsubishi UFJ, despite being a third of the size. CBA is worth more than Barclays and Lloyds combined, only slightly less than BoA and Citi.

With the market cap of the Australian banking system, you could buy RBS, Standard Chartered, Lloyds, Barclays, Deutsche Bank, Credit Suisse and Soc Gen and still have change.

The market cap of Australian banks is larger than Japan, Brazil, Spail, France, India, Russia,Italy, Germany, South Korea... All with just 22mm people.

The average price/book that the big 4 banks are trading at today is 1.74. US banks are trading at 0.9. Japanese banks are trading at 0.6. Chinese banks, with that large unbanked population and growth potential is only trading at 1. Even Canada, a country with much in common with Australia economically is only trading at 1.4.

 

[skc]

Re: Alternatives to term deposits

At the risk of rattling on about this, I had a look at some numbers this morning to substantiate my claims. 3 out of 4 of Australias big banks are amongst the 20 largest in the world by market cap. CBA is worth nearly twice as much as Sberbank despite being around 40% of the size. Sber is the largest bank in an emerging market of around 142mm people.

CBA is also worth 37% more than Mitsubishi UFJ, despite being a third of the size. CBA is worth more than Barclays and Lloyds combined, only slightly less than BoA and Citi.

With the market cap of the Australian banking system, you could buy RBS, Standard Chartered, Lloyds, Barclays, Deutsche Bank, Credit Suisse and Soc Gen and still have change.

The market cap of Australian banks is larger than Japan, Brazil, Spail, France, India, Russia,Italy, Germany, South Korea... All with just 22mm people.

The average price/book that the big 4 banks are trading at today is 1.74. US banks are trading at 0.9. Japanese banks are trading at 0.6. Chinese banks, with that large unbanked population and growth potential is only trading at 1. Even Canada, a country with much in common with Australia economically is only trading at 1.4.

Great research. Never seen the Big4 compared this way. And yes at a top down level I'd agree that those banks in bigger markets should worth more. I guess the descrepency ultimately comes down to credit per capita (which Australia leads the world) and perceived loan book quality (as expressed in the price/book ratio).

While it doesn't look right it is also difficult to sell the Aussie banks. They do make good cash profits with relatively undemanding PE ratios (by their own historical standards) and with little evidence of loan book deterioration. It's like my belief that Australian properties are a bubble since 2006... I still don't think I am wrong, just that the market doesn't agree with me :

 

[doctorj]

Re: Alternatives to term deposits

While it doesn't look right it is also difficult to sell the Aussie banks. They do make good cash profits with relatively undemanding PE ratios (by their own historical standards) and with little evidence of loan book deterioration.

I had a look at PE and it seems to support your argument. Taking a simple average, Aussie banks are trading at 11.8x, compared to Germany (24.9x), UK (14.9x) and US (22.1x). On the other side Canadian banks are at 8.9x, French at 5.5x and Chinese at 5.5x.

I'd have to do more digging to get a high level picture of NPL levels and NIM to give the PE levels more context, but I'd say the state of commodity prices and concentration risk on resi mortgages means NPLs are more likely headed up than down and the Aussie banks relatively small deposit base and dependence on wholesale funding means NIM could come under pressure as well.

 

[skc]

Re: Alternatives to term deposits

I had a look at PE and it seems to support your argument. Taking a simple average, Aussie banks are trading at 11.8x, compared to Germany (24.9x), UK (14.9x) and US (22.1x). On the other side Canadian banks are at 8.9x, French at 5.5x and Chinese at 5.5x.

I'd have to do more digging to get a high level picture of NPL levels and NIM to give the PE levels more context, but I'd say the state of commodity prices and concentration risk on resi mortgages means NPLs are more likely headed up than down and the Aussie banks relatively small deposit base and dependence on wholesale funding means NIM could come under pressure as well.

The fate of Aussie banks are directly linked to that of the property market that's for sure. I think what is interesting is how these two can in fact hold each other up.

Imagine a single playing card which cannot stand up on its own. But if you take another single playing card and lean them against each other, you can build a two-card structure that is stable. Two single playing cards that are not stable on their own can be made stable together...

So the property market and the Aussie banks are like those two single cards - for them to stand up on its own would be gravity-defying. But because they lean against each other - it is relatively stable. Credit creation supports property valuation which in turn supports bank balance sheet, which in turn supports further credit creation.

Until of course some one blow too strong a breath on this two-card stable structure - and it collapses. The GFC probably almost did it. It wobbled a bit but didn't fall down. So it's in a stable state at the moment.

 

[Klogg]

Re: Alternatives to term deposits

The fate of Aussie banks are directly linked to that of the property market that's for sure. I think what is interesting is how these two can in fact hold each other up.

Imagine a single playing card which cannot stand up on its own. But if you take another single playing card and lean them against each other, you can build a two-card structure that is stable. Two single playing cards that are not stable on their own can be made stable together...

So the property market and the Aussie banks are like those two single cards - for them to stand up on its own would be gravity-defying. But because they lean against each other - it is relatively stable. Credit creation supports property valuation which in turn supports bank balance sheet, which in turn supports further credit creation.

Until of course some one blow too strong a breath on this two-card stable structure - and it collapses. The GFC probably almost did it. It wobbled a bit but didn't fall down. So it's in a stable state at the moment.

Funnily enough, I'm working an I.T. contract one of the major banks... We're told by management that the "low-doc" loans, or anything with an LVR > 80% is something of the past and that their lending criteria are much more stringent...
If this was the case, the GFC has probably strengthened, rather than weakened them.

I haven't validated this of course, but I'd love to know if anyone can confirm or deny this in any way...

 

[Julia]

Re: Alternatives to term deposits

Funnily enough, I'm working an I.T. contract one of the major banks... We're told by management that the "low-doc" loans, or anything with an LVR > 80% is something of the past and that their lending criteria are much more stringent...
If this was the case, the GFC has probably strengthened, rather than weakened them.

I haven't validated this of course, but I'd love to know if anyone can confirm or deny this in any way...

I was told a few months ago by ANZ that the lo doc loans are absolutely a thing of the past.
All is well and truly tightened up now. Have heard of people unable to get housing finance whom I'd have thought would have qualified as borrowers.

 

[Klogg]

Re: Alternatives to term deposits

I was told a few months ago by ANZ that the lo doc loans are absolutely a thing of the past.
All is well and truly tightened up now. Have heard of people unable to get housing finance whom I'd have thought would have qualified as borrowers.

That's a good point - credit for housing has tightened, so I guess that would be a good indicator as to whether the banks are cleaning up their balance sheets...

I just hope they don't reverse it in a hope to get housing moving again.

 

[McLovin]

Re: Alternatives to term deposits

That's a good point - credit for housing has tightened, so I guess that would be a good indicator as to whether the banks are cleaning up their balance sheets...

I just hope they don't reverse it in a hope to get housing moving again.

That's not a low-doc home loan. This is a low-doc home loan...

Yet even by WaMu’s relaxed standards, one mortgage four years ago raised eyebrows. The borrower was claiming a six-figure income and an unusual profession: mariachi singer.

Mr. Parsons could not verify the singer’s income, so he had him photographed in front of his home dressed in his mariachi outfit. The photo went into a WaMu file. Approved.

http://www.nytimes.com/2008/12/28/business/28wamu.html

I guess it's only when/if housing actually imploded that we'd start to find out if such things happened in Australia.

 

[MR.]

Re: Alternatives to term deposits

Some good reading there Docj

The Com bank has been praised as one of the soundest banks because of their high levels of real-estate collateral holdings. At least their assets can’t completely vanish like many of their overseas cousins experienced.

Although, I would have thought the banks reining in their lvr’s would be enough to upset that card balance. Once they have started to lean (as the market is witnessing at present in property) what’s going to steady them up again? Something will try no doubt, but it seems reasonably clear to all property buyers now to stand back and buy something cheaper a little further down the track.

Mean while the investment property seller owing X to one of the big 4’s maybe in a little predicament. So where does this leave the big 4 and say the Com bank and their realestate profits?.... Is that why I received a plant recently that read on the side “CAN”? Trying hard to expand in the business department of late are we? Wonder why that is exactly?