Westpac And The Australian Housing Bubble

| About: Westpac Banking (WBK)

Summary

The macro pitch suggests that WBK is a good long term short.

WBK is a better candidate for housing-specific short than its peers.

The pitch does require certain macro factors.

Yahoo! Finance writes that:

Westpac Banking Corporation (NYSE: WBK) provides banking and financial services worldwide. The company operates through five segments: Consumer Bank, Commercial and Business Bank, BT Financial Group, Westpac Institutional Bank, and Westpac New Zealand. It offers personal banking services, such as term and retirement deposits; savings and bank accounts; home, investment property, equity access, investment and protected equity, personal, and car loans; overdraft facilities; and home, contents, landlords, motor, travel, boat, caravan and trailer, life, credit card and loan payment, and income protection insurance products.

The core business model of Westpac is traditional for a commercial bank. They are broken into different operating segments and are spread out all across the financial industry. The one thing, however, that may distinguish Westpac from the field is the quality of the loans that they hold.

Shorting Westpac needs to be first examined from a top-down Macro perspective. Take a look at some salient facts about the Australian debt market and national economy:

  • The AUD/USD is down approximately 8.4% in the last year.
  • Household debt to disposable income has reached over a 100% spread.
  • Australian residential debt to GDP is now over 100%.
  • Residential mortgages in Australia as percentage of total loans is above 60%, with the next closest country only at just above 40%.
  • Mining makes up 8% of Australian GDP (think about commodity prices).
  • Unemployment in Australia is up from 5.0% to 5.8% from 2012 to 2016, which creates an environment of increased credit risk for the loans which expire in the next 1-5 years (which represents 23% of Westpac's entire loan book).
  • Inflation is at a 5 year low of around 1.4% in Australia. Many economists like Grant's Interest Rate Observer project an increase in inflation globally, which raises the question about the quality of loans in WBK's books when they're fire tested by heightened credit risk that inflation naturally brings.
  • AUS GDP fell around 7% in the last year.
  • Wage growth is at a 10 year low, and yet mortgages are at all time highs.
  • Construction output is now at 5 year lows.
  • The new home sales growth since 2012 grotesquely outperform wage growth in that same period.

So, I guess the natural question arises after applying the most cursory scrutiny: does this constitute a bubble? Maybe, maybe not. I personally think it does. The way I define and short a bubble may be different than the industry's definition. I think that when you have abnormal and unwarranted flow into a certain part of the economy (like mortgages), and the numbers for that country's economy are an outlier from a global view, you've got a bubble. Even if there isn't a bubble here, I think that WBK among other AUS FIGs, have positioned themselves with higher levels of risk susceptibility given a natural boom and bust cycle that Australia's red-hot mortgage lending is due to see the downside of.

I am personally very confident that the macro piece is there. So, let's take a look at Westpac and see why it's a good candidate to access the AUS housing bubble.

Is Westpac a pure-play on the AUS housing market? Possibly, possibly not. Will it get you exposure to it? Yes. Is it THE best way to get that exposure? I believe yes, but you can feel free to look at the comparables and disagree. WBK is one of 5 or so Australian banks. They're roughly equal for most comps including:

  • EqV/Loans: four of the five banks are between .09x and .10x (Macquire (ASX: MQG) being the one outlier at .21x).
  • P/E: Westpac trades as the second most expensive of the five with a still relatively cheap 12.20x.
  • WBK has the highest loans outstanding of the comps, and their Loans + Debt are equal to 4x their equity.
  • Despite making a play at foreign lending, Asia expansion, and their NZ presence, the gross majority of income and loan exposure come from Australia.

This play, like any long-term short recommendation is dependent on maintaining a certain level of risk tolerance. As it's been said, being early on a short is the same thing as being wrong. I don't presume to be The One who is know calling the bubble pop, which many people who are smarter than me have studied for years. However I feel that the current global market climate is as favorable now as it has been in recent years for a short play like this to produce returns that would beat the both market and cash for your portfolio.

Notable summary of this Westpac's 2015 Annual Report:

  • "Net interest margins declined 5 basis points to 2.09% in 2014 from 2.14% in 2013. The lower net interest margin reflected increased competition in lending and lower Treasury revenue, which were partially offset by improved margins from retail and wholesale funding costs."
  • "Total loans in 2014 were 8% higher compared to 2013, with the key feature being 7% growth in Australian housing loans."
  • "Australian business lending increased $10.6 billion or 8% driven by acquisition of Lloyds ($5.4 billion) and a rise in institutional lending mainly in property, infrastructure and natural resources."
  • Australian housing loans increased $22.5 billion or 7%.
  • "Approximately 14.0% of the loans at 30 September 2015 mature within one year and 23.1% mature between one year and five years. Retail lending comprises the majority of the loan portfolio maturing after five years."
  • Total impaired loans to total loans is 0.3%.
  • "From 2014 to 2015 lending increased $15.3 billion or 6%. Mortgages were the main driver of the increase, rising $13.1 billion or 6%."
  • "From FY14 to FY15, Operating expenses increased 4% with most of the rise related to investment spending, including higher amortisation. Salary and other annual increases were largely offset by productivity savings."
  • For St. George Banking Group "Mortgages increased $10.6 billion (or 8%)."

For all divisions of WBK, from 2014 to 2015, mortgage lending was the driver in overall lending increases, generally between rising between +5-8%.

Housing Loans represent the gross majority of WBK's overall outstanding loans in both AUS, NZ. Housing loans constitute $414,199m, out of the $623,316m total loans.

Moody's posted an article today describing the pressures that Australian banks will likely face for the remainder of 2016.

Possible risks to this short include:

  • Being too early.
  • The company has impressive topline growth in the recent past for a FIG company (although I would counter by adding that this is likely from overlending).
  • The economy and AUS PMI numbers stay strong, the unemployment doesn't happen and commodity pricing increases.
  • WBK finds a way to hedge prolifically against mortgage default risk.
  • I could be biased, as I am bearish on credit from a macro perspective.

Conclusion

Basically, shorting Westpac successfully is reliant on a few things. To overly simplify it (at the risk of sounding obtuse), if wages stay stagnant, inflation upticks, and export-driven mining companies start laying off employees because of depressed commodity prices and a weak AUD dollar, then the risk on WBK's books begins to increase dramatically. But again, this could take a while so get comfortable.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in WBK over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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Tagged: , , , Foreign Money Center Banks, Australia, Sohn Canada Pitch
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