Australia’s bankers are mired in scandals that make the country’s cricket team look virtuous by comparison.
Bloated bank bonuses down-under
On Wednesday (05 April), the Australian Prudential Regulation Authority (APRA), the country’s bank regulator, resumed a theme that has driven news headlines of late down-under. Wayne Byres, the APRA Chairman, told the Australian Banking and Wealth Summit in Sydney that Australian bankers were being rewarded for taking risks while not being punished for messing up. Sounds familiar?
This attack follows on from the publication of an Australian Royal Commission report which was tersely critical of the Australian banking sector further to a string of scandals. The Hayne Report exposed a slew of incidences when banks had acted to maximise profit to the detriment of their customers’ interests. Banks are fixated on short-term shareholder value while only relatively lowly executives pay for the bosses’ mistakes. This has brought about the Banking Executive Accountability Regime (BEAR) which is designed to ensure that senior bank executives are more accountable for their actions and to better align bonuses with effective risk management.
Because Australia sailed through the Credit Crunch – the financial crisis of 2008-09 – relatively unscathed, the urgency for prudential regulatory reform that gripped America and Europe eluded Australia. The country that went 27 years without a recession felt immune from modern financial strictures.
Until now, that is. Something fundamental has changed in the mood of The Lucky Country with many respected commentators fearful of the future. While I am here in Australia I aim to find out what that something is.
Mortgage brokers and lenders under fire
The Hayne Report also took aim at Australia’s thriving community of mortgage brokers. Basically, the bigger the mortgage, the more commission the broker gets paid. Therefore brokers encourage borrowers to mortgage to the hilt. After all, they have no come-back if the loan is never repaid.
As for the banks, the residential mortgage business is increasingly important. As the leader of the Australian Green Party, Senator Richard di Natale, pointed out in a speech this week: “30 years ago business lending was double that of property lending – now it’s the other way around”. One reason for that is that mortgage lending has been massively deregulated.
Morgan Stanley thinks that the remainder of 2018 looks challenging for the Australian housing market with the risk outlook skewed to the downside.
All this has made Australian banks unhealthily reliant on their mortgage portfolios to generate profits. Yet Australian house prices fell for the sixth consecutive month in March. Nationally, house prices fell by 0.2 percent last month with house prices down by 0.8 on a 12-month basis – Sydney’s house prices are now down by 4 percent since August last year. Morgan Stanley thinks that the remainder of 2018 looks challenging for the Australian housing market with the risk outlook skewed to the downside.
Evidence for this is that Singaporean developer Fragrance Group (SGX:F31) is struggling to find buyers for its iconic new Melbourne apartment block known locally as the Beyoncé Tower[i]. Around 200 units remain unsold in the 78-story curvaceous building. Sales at a second Fragrance tower just two blocks away at 555 Collins Street are also subdued with fewer than 45 percent of units sold.
Despite the prospect of more difficult conditions in the housing market, competition in the Australian mortgage sector has intensified, meaning that lending margins are under pressure. All this amounts to a drag on Australian bank profits.
A symphony of scandals
Commonwealth Bank of Australia (ASX:CBA) faces a slew of allegations that it facilitated money laundering and even the financing of terrorist groups. The Australian Transaction Reports and Analysis Centre (AUSTRAC), a Federal Government Agency, has been on the case for the last few months, threatening court action and sanctions. CBA has already set aside provisions of AU$375 million to settle the matter. The bank insists that the 53,000 breaches of money laundering regulations identified by AUSTRAC were in fact all part of the same systems error and therefore that they do not represent a systematic failure. It seems, for example, that CBA allowed its network of automated teller machines to be used to take drug money out of the country.
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Australian banks stand accused of fuelling one of the highest household debt-to-income ratios in the world at 190 percent. Thousands of Australians are trapped by persistent debt, so campaign groups[ii] claim. Credit card debt is at record levels at a moment when most analysts think that Australian rates are set to rise.
From stock market darlings to dogs
The major Australian banks – especially the Big 4, namely Westpac (ASX:WBC), ANZ (ASX:ANX), National Australia Bank (ASX:NAB) and CBA – have always been obligatory holdings for funds investing in Australian equities. Even despite years of underperformance in the sector, the Big 4 account for about one third of the market capitalisation of the Sydney Stock Exchange.
But the major banks lost 6.5 percent of their collective market value in March against an overall market loss of 3.8 percent. Over 12 months the Big 4 have lost 11 percent against the market’s gain of 2.5 percent. This leaves Australian banks at the cheapest they have been since June 2016 with an average forward price-earnings ratio of 11.9. That said their dividend yield looks attractive against cash at 6.5 percent. Currently, the best rate available to savers on a 12-month deposit is 2.8 percent (from ME Bank) while Australian Government 10-year bonds are yielding 2.6 percent.
Three things seem to have dampened bank stocks. Firstly, downward revisions in estimates for economic growth have subdued the upside potential for profit growth. Second, increased competition has put downward pressure on lending margins. Third, the prospect of a much tighter regulatory environment further to the Hayne Report has given pause. There is the prospect that lending criteria will be made much tighter, triggering a slowdown in credit growth. APRA has said that it is considering increasing banks’ reserve requirements, though this is not likely to happen until 2021. Moreover, as in the case of CBA, there is the prospect of hefty fines on several institutions.
Morgan Stanley thinks that the Dreamtime for Australian banks is over, and that investors should chase other themes with better growth prospects. That said institutional investors are likely to continue to allocate to the Big 4 for the foreseeable future.
Philip Lowe, governor of Reserve Bank of Australia (RBA), Australia’s central bank, took to the podium on Tuesday (03 April). Mr Lowe, who is regarded here as politically astute, observed that tightening conditions in US dollar short-term money markets were pushing dollar rates higher for reasons “other than the increase in the Fed Funds rate”. This was a reference to Mr Trump’s controversial trade policies. All this has flowed through to tightening money market rates in Australia as well.
I explained in these pages two weeks ago why expectations about future rate rises from a near-zero base can cause the yield curve to steepen dramatically. The spread between 3-month US Dollar LIBOR and the overnight rate has been increasing markedly. Similarly, in the Australian money markets, the rise in a key three-month rate has caused one lender, Suncorp Group (ASX:SUN) to increase its mortgage rate (though marginally). The Australians fear that the US Treasury is ramping up issuance of short-term securities in order to fund its estimated $1 trillion budget deficit this year – instead of issuing at the longer-term end. This is to take advantage of cheaper rates at the short-term end of the yield curve – but this has consequences. It exposes the US Treasury to rollover risk – which is in turn pushing up rates at the shorter end. Hedging costs for foreign borrowers are rising in tandem.
The Australian elite are worried about the potential fallout from the prospective trade war between America and China.
Overall, the RBA is satisfied that the funding structure of Australian banks is sound – they finance long-term assets generally with long-term liabilities. The RBA left the key cash rate on hold this week at 1.5 percent – as it has done for the previous 17 meetings.
But the Australian Institute of Company Directors (AICD) warned this week that “We haven’t taken the [measures] to prepare for the bad times which we know will come eventually”. Four weeks away from the federal budget to be submitted in Canberra by Treasurer (Federal Minister of Finance) Scott Morrison, the AICD warned that the federal fiscal position is “unsustainable”. Steady growth had created 420,000 new jobs over the last year but there was no “policy buffer” to prepare for a global shock.
In particular, the Australian elite are worried about the potential fallout from the prospective trade war between America and China. America is Australia’s closest military ally (along with New Zealand the three countries make up ANZUS, the equivalent of NATO in the Southern hemisphere); while China is Australia’s largest trading partner. It is becoming fashionable here to say that Australia is the meat in the sandwich.
Melbourne in autumn
There must be few cities with a higher quality of life than Melbourne. It is stylish, melding Victorian neo-gothic splendour with post-modern architecture, cosmopolitan and with a superb public transport system. (In the city centre the trams are free!) This is true café society with busy Scandinavian standard cycle lanes. It is a planned city full of delightful green spaces set along the banks of the Yarra River.
This doesn’t feel like a city of 4.6 million people – a figure growing rapidly. In fact, at the present rate of growth Melbourne will surpass Sydney as the nation’s most populous city within five years. While most global cities are losing residents at the centre to the outer suburbs, Melbourne’s city centre is attracting returnees to its luxury high-rise apartments.
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The autumn climate, however, can be a bit too British for my taste: Melburnians boast that they often enjoy four seasons in one day…Of course, you wouldn’t know it was autumn as there are no leaves on the ground. Indigenous Australian trees are all evergreens and mark the season by shedding their bark, not their leaves. For the British visitor Australia is an enticing mixture of the superficially familiar and the downright exotic. I rather like it here.
Sadly, this visit to Melbourne is far too short. I’m heading off tomorrow for the Gold Coast, where I hope to pop in on the Commonwealth Games, opened on Wednesday evening (04 April) by Prince Charles. Then there will be Sydney…
Look out for my feature article in the May edition of the Master Investor magazine. I have my eyes on a few investment opportunities down-under which are not well-known up-over.
[i] The official name is The Premier Tower.
[ii] For example Financial Counselling Australia.