Over the weekend, the headline financial news for Australia was Wall Street hedge funds were short Australian banks. Primary drivers: over-valued bank stock prices and over-valued property.
Although I would tend to partially agree with the former, its hard to justify the latter. Property prices hit trough levels during the last quarter of 2012 after declining since early 2011. Currently, prices are tracking an annualised growth of 8-10%.
Australian property dynamics are different from that of the US. How?
- Property development happens primarily along the coastlines (predominantly along the Eastern/South-Eastern seaboard) where a significant majority of the populace resides.
- Australia's major cities (Sydney, Melbourne and Brisbane) account for over 50% of its total population (Source: ABS*) and land/home availability around the city & inner-city is depleting driving construction both upward and inland. As a corollary, city and inner city real estate demand is expected to increase and eventually the property prices.
- Influx of second-wave of immigrants into Australia from Asia is driving demand for housing at all levels. Although migrants from UK and New Zealand are still predominant, migrants from China (2.5-3%), India (2-2.5%) and rest of Asia (3-4%) are making headway into Australia (Source: ABS).
Specific dynamics of the Australian banking sector:
- Mortgage lending forms approximately 60% of the major bank lending portfolio. Also, Australian banks have indirect exposure to mortgages through SME business lending with mortgages used as collateral and commercial real estate lending with residential focus.
- Current record low interest rates (RBA Cash Rate at 2.5%) are expected to go lower over the next 6-9 months to the tune of 25-50 bps could drive property demand/prices further north.
- Domestic mortgage lending market share for Australian major banks is about 90%, with the remaining part of regional banks and credit unions.
- Demand for higher yield drove herds of investors to Australia in the first instance over the past few years and specifically to banking stocks in Australia in the past 15-18 months.
Other factors contradicting the view of the shorts:
- Australian banks (similar to their Canadian counterparts) are profitable and generate ROEs ranging from mid-high teens. However, I do expect this rate to stabilize or even moderate marginally in 2014.
- Australian banks are market leaders in cost management and also one of the top-3 developed market banks with highest revenue and profit per employee. Productivity through digitization and technology are one of the key drivers.
- Past dues and default rates are at trough levels, and issuance of high LVR loans (>80%) are at a manageable level.
- Australian major banks are focusing on diversifying into Asia (ANZ Bank is already a significant player in the Asian Business/Institutional Market) and into transactions and flow business (FX, Rates).
- One key development last week was the outcome of the elections, which was driving an element of uncertainty. The Coalition Party's pro-business mandates in the form of development of infrastructure, focus on labour reforms and productivity, and abolition of policies related to Carbon and Resources tax introduced by the earlier Government is expected to improve business sentiments further. This could potentially be positive for bank lending.
To conclude, although there are potential downsides for banks in the medium-term, the depth of the decline could be a lot shallow than expected by the shorts. Also, I tend to believe that major banks are a tad over-valued from a P/B or P/E perspective and could retrace some of the upward move later this year or early next.
*ABS: Australian Bureau of Statistics
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.