FYI | Oct 19 2016
By Peter Switzer, Switzer Super Report
Are the banks a buy or should you wave them bye-bye?
A column in The Australian newspaper linking an oversupply of apartments in Melbourne, Brisbane and Sydney to having a potential to rock our banks’ balance sheets, and, by definition, their share prices, prompted one of our subscribers to ask me to interrogate my TV guests this week about their banking concerns.
I will be away for a couple of days — Thailand for a quick speech — but Marty Switzer has been instructed to do a bit of bank questioning in my absence. Why?
Because a lot of us have bank shares, especially for dividend purposes and if they’re going to dip, the question is: would they be a buy? Call me a less than courageous investor but I like a company that dominates its industry, makes record profits, employs 10 of thousands of Aussies and was named in the best 10 in the world when the GFC decimated names such as Citigroup, Goldman Sachs, JP Morgan and co.
I also like a company that pays a consistent good dividend, which grows more attractive thanks to franking credits.
For example, NAB pays almost $2 a year and its share price is $27.76, so the yield is 7.2% plus franking credits, so we’re looking at a near 10% return for someone retired! Even if some over-arced apartment-led crisis hurt profits and the dividend went down to 5%, it’s still a damn good yield. Sure the share price would be slugged but as long as you are a non-seller, your income is solid and you should have few worries.
That said, these apartment concerns on face value are worrying, just look at these two quotes from the Reserve Bank (RBA) in the Oz story:
- “There are signs that some settlements are taking longer and lending valuations are coming in below their contract price, though settlement failures to date remain low.”
- “It [the RBA] has modeled the effect on the banks if between 5 and 15% of the contracted buyers of apartments defaulted. However, it found that bank losses would remain low, at less than $200m, provided apartment prices did not fall by more than 25%!” (I added the exclamation mark!)
So that’s the bet. If price falls end up being a pretty big 15% the losses for the banks might be under $200 million on profits and that’s on profits of over $35 billion! That would be a 5.7% drop in the banking industry’s profits and it makes me think that maybe this argument that banks are exposed terribly to apartments could be a little alarmist. Sure, I’d prefer it was not there but a hell of a lot of profit and share price improvement has come via developers building over the past few years and would-be buyers buying them. Economies are swings and roundabouts and as long as none of the market ‘play equipment’ does not fall over and crush the players, then I’m going along for the ride.
Let’s look at NAB over the past year, as it and ANZ seem to be always mentioned as the big improvers.
Before the over-the-top, recession-fear driven sell off in January and February, it was a $31 stock. It then slumped to a tick over $24 in February and is now about $28. If you bought NAB shares in December during a Santa Claus rally, your dollar cost-averaging policy would put you just in the money at $27.50 but of course, you would’ve had to time it totally wrong last year and totally right in March.
I would have hoped you bought NAB on the last few dips — in the past year there were six sub-$25 opportunities. And if you buy at $25 and it’s now $28, well that’s a 12% gain plus the dividend, which makes it look like a growth stock to me!
The point is buying the banks on dips pays and you do wind up with a really good dividend.
But the question is: can banks go up with the general market rise I expect for 2017?
Over the weekend, CNBC’s Jeff Cox made this interesting observation: “Amid a sluggish month for the stock market overall, banks have been an unexpected bright spot.”
Halfway through October and the S&P 500 was down 1.5% but the KBW Nasdaq Bank Index was up a solid 2.6%. US banks, like ours, are under regulatory pressure and low interest rates aren’t helping their bottom lines.
Dick Bove, the vice president of research at Rafferty Capital Markets in the US thinks psychology plays a role in what happens to bank share prices.
Cox explained Bove’s thinking this way: “After the first quarter in 2016, the psychology changed. The oil price issue disappeared. Interest rates were in fact rising so no one cared that earnings growth had weakened. Thus, bank stock valuations started returning to the mean.”
Now this was written before Friday’s bank earnings revelations, which were all better than expected but on Bove’s argument, even if they weren’t great, bank share prices are on the way up because of a more positive psychology towards them.
Given this, I wanted to see if the charts showed that there is a fair correlation between US bank share prices and ours. On many occasions I have commented to my Final Count colleague, Carson Scott, on our Sky News TV program, that there often is a follow the leader tendency, not only with the overall indexes generally, but there can be sector rises and falls that seem to mirror each other.
CBA and Bank of America rose and fell pretty well in lockstep until September, where our banks had a bigger fall but the uptrend resumed. Probably our apartment story plus the Royal Commission calls and bank CEOs grilling in Canberra haven’t helped but also the fact that the US is closer to an interest rate rise would be a plus for American banks over our banks here.
I know there are better growth stocks out there and someone like Roger Montgomery thinks Challenger and REA are two of them, with the latter looking a little ironic if a real estate problem is set to scupper our banks.
And even on Challenger he thinks any rising interest rates here would actually help the annuity-maker because their returns would become even better.
However, that could be the issue for us and our banks — when will rates rise? I noticed the NAB economics team thinks we could see two rate cuts next year and I hope they’re wrong on that score.
I’d like to see one rate rise around mid-year 2017 because if that happens then the global economic scenario would be on the improve and our economy would be following the RBA forecast script which says our upper range of growth goes to 4% by the end of next year!
I posed this question in Switzer Daily today and I have to share it with you as well — if the RBA is so worried about the apartment oversupply then why is it forecasting a 4% growth number?
The answer is easy — the apartment problem might be bad in the Bank’s worst case scenario. We don’t know if that will happen and it looks like the nation’s premier forecasting bank — the RBA — is not banking on that, given its 4% growth guess.
One last point has to be made. If apartment prices have to fall say 15% and first home buyers can come in to replace investors, who give up their off-the-plan 10% deposit to avoid a lower price completed property, then the developers might cop a lower profit but sales will happen.
And if Melbourne apartments become 15% cheaper, then I and people like me might seriously see these repriced properties as a buying opportunity, which is something I often recommend to you. That’s what investors trying to build wealth should always be on the look out for. Funny that.
And so if I see NAB back at $24 or lower, I will be a buyer — quality businesses at favourable prices are hard to resist. I’m not waving our banks bye bye, especially when an ABC report meant to embarrass our banks made the point that bank profits here in Australia are the best in the world. As a share of GDP, our banks make 2.9%, China 2.8%, Sweden 2.8% Canada 2.3%, USA 1.2% and the UK 0.9%.
I’ve always argued if you have a gripe with our banks, then invest in them so you can get even!
Peter Switzer is the founder and publisher of the Switzer Super Report, a newsletter and website that offers advice, information and education to help you grow your DIY super.
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