Pete Wargent blogspot
Co-founder & CEO of AllenWargent property advisory, offices in Brisbane (Riverside) & Sydney (Martin Place) - clients include hedge funds, resi funds, & private investors.
4 x finance/investment author - 'Get a Financial Grip: a simple plan for financial freedom’ (2012) rated Top 10 finance books by Money Magazine & Dymocks.
"Unfortunately so much commentary is self-serving or sensationalist. Pete Wargent shines through with his clear, sober & dispassionate analysis of the housing market, which is so valuable. Pete drills into the facts & unlocks the details that others gloss over in their rush to get a headline. On housing Pete is a must read, must follow - he is one of the better property analysts in Australia" - Stephen Koukoulas, MD of Market Economics, former Senior Economics Adviser to Prime Minister Gillard.
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Tuesday, 13 November 2012
How can you particpate in the banks' profits?
I recently read an excellent article by Adam Creighton in the CA magazine Charter which discussed the implicit guarantee that the major banks receive from the Australian government.
This got me thinking. With banks recording profits in the region of $25 billion per annum, it might pay to ask: ‘how can I participate in this?’.
When banks fail
We have had timely reminders of what happens when it goes wrong for banks in Europe and the US. Spain’s banks have become the latest to need a raft of taxpayer-funded bailouts, which tends to lead to anger and unrest.
Banking can be a risky business. Fortunately for us in Australia, a major failure has not yet happened here.
Before the financial crisis, less than two thirds of housing loan approvals were soaked up by the four major banks (NAB, Commonwealth, ANZ and Westpac). Today, the figure is very close to four-fifths.
Therefore, our major banks have a very significant exposure to residential property. So what if China’s growth story stalls and house prices drop?
This tends to matter less to individuals with a long-term outlook. Even if you buy at the peak of a boom, most property owners put down a reasonable deposit and most property owners tend to look at property as a long-term venture, allowing the cycle time to return to growth.
For banks though, with billions on their balance sheets, it can be a major problem if asset values are severely impacted by a downturn.
Without getting bogged down in the legislation, BASEL III is a global regulatory standard (covering capital adequacy, stress testing and liquidity measures) which is to be implemented globally in the next half decade or so.
The standard mandates that, among other restrictions, banks’ leverage ratio should be capped at 33 times. Other restrictions are suggested including the amount of capital that banks must hold.
The good news is that Australia’s banks by and large are close to complying with most of the requirements of BASEL III. The bad news is that 33 times is still one heck of a big leverage ratio!
The implicit guarantee
Those with a passing interest in economic history will know that Karl Marx and Austrian Marxist Joseph Schumpeter famously discussed the idea of ‘creative destruction’ or ‘Schumpeter’s gale’ in the capitalist economy.
Later the term was somewhat twisted and popularised by free-market economists who suggested that just as species adapt and thrive through survival of the fittest, so it should be for companies.
Well, it doesn’t quite work that way now. The big four banks benefit from an implicit government guarantee that they will be bailed out should they so require.
In fact, in 2008, Kevin Rudd’s government placed a ban on short-selling, ostensibly to shore up the overall share market, but the word on the street at that time was that the ban was put in place to support the ailing fortunes of Macquarie Bank. So perhaps the guarantee runs wider than the big four banks?
Indeed, in the US, the government guarantee even ran outside the financial institutions, with taxpayers 'generously' bailing out the failed General Motors company.
3 reasons that the big banks can get bigger
The implicit guarantee can easily cause the big banks to get bigger for 3 reasons:
i) A bank which is guaranteed can borrow more – counter-parties and creditors feel comforted by the guarantee
ii) The bank is incentivised to take on more risk as its downside is protected
iii) If the bank gets bigger, its implicit guarantee becomes ever more certain – they will certainly become “too big to fail”!
2 ways to profit from the banks
While interest rates low, there are two main ways in which average investors can profit from the big 4’s oligopoly.
Firstly, you can buy shares in the banks and enjoy a generous dividend stream. Each of the big four banks pay a strong dividend to return excess cash back to shareholders and consequently the sector pays materially higher dividends than the market at large.
Short-term capital growth prospects are a little less clear as the graph below perhaps implies (Aussie banks are among the most expensive globally on a price-to-book basis, which is reflective as much of dreadful confidence levels in banks elsewhere as strong confidence in Australian banks, it has to be said), but over the long term shareholders also have the opportunity to participate in upside as the banks grow.
If this is to be your approach, remember the old adage – don’t put all of your eggs in one basket. Some diversification is preferable and strongly advisable.
Secondly, we can use the banks’ capital in order to invest in residential property.
At the time of writing the major banks have standard variable rates that vary from around 6.58% to 6.71%, which is very cheap on a historical basis.
Property markets were weak through 2011 and early 2012, so counter-cyclical investors are circling to seek out bargains.
3 year fixed mortgage rates are available lower still. Savvy investors will shop around and negotiate for the best deal.