Trust Charlie Munger, the Yoda of capital markets, to get to the heart of the key issue that should be on the minds of Australian banking investors before a week of earnings results from National Australia Bank, ANZ, Macquarie Group and Westpac, starting on Thursday.
“It’s not nearly as bad as it was in 2008,” the legendary investor and wingman to Warren Buffett told the Financial Times. “But trouble happens to banking just like trouble happens everywhere else. In the good times you get into bad habits … when bad times come they lose too much.
“It’s not that damned easy to run a bank intelligently; there are a lot of temptations to do the wrong thing.”
As the FT noted, Munger was speaking from the porch in Los Angeles as the fate of Californian regional lender First Republic hangs in the balance; JPMorgan has reportedly made a last-minute bid for the bank, and the US government will probably be forced to place the bank into receivership if a deal can’t be done.
To be clear, Australia’s big banks are, on the whole, run intelligently. This, combined with a strong prudential regulation and conservative capital settings, means the drama that has engulfed this part of the US banking sector isn’t immediately comparable.
In the next seven days, the four banks will produce record earnings, or go very close to it, thanks to the way surging interest rates have lifted bank profit margins, while bad debts have remained at record lows.
But it is an environment where those same rate rises are slowing the economy in an uneven way, insolvencies are rising sharply and banks are battling for market share amid falling credit growth.
So, analysts and investors will rightly be looking hard for any pockets where, to use Munger’s words, the Australian banks have fallen into bad habits or succumbed to pockets of temptation.
Munger shares the widely held concerns about commercial property: “A lot of real estate isn’t so good any more. We have a lot of troubled office buildings, a lot of troubled shopping centres, a lot of troubled other properties. There’s a lot of agony out there.”
No doubt investors will want to double-check the banks’ assertions that their exposures to this sector remain much lower than in the 1990s, when a commercial property bust took some banks to the brink.
But there are other pockets for Australian investors to consider, too.
It’s now widely acknowledged that new mortgages are being written below the banks’ cost of capital across the sector. Have any institutions exposed themselves to outsized risk, whether in the form of dud loans or longer-term drags on profit?
The comparatively fat margins on offer in business have the big four scrambling for business in this sector of the economy. Is this new land grab occurring at exactly the wrong part of the business cycle? Is any bank overexposed to weak sectors, such as construction, hospitality and retail?
There may be little to see or fear in this week’s numbers. But the lag in passing through rate rises to customers means the banking sector’s real-life stress test probably won’t start until late this calendar year.
This reporting season is about hunting for any signs of trouble ahead.
One more tangible area of stress to keep an eye on right now is bank funding. Although equity markets have largely brushed off the US regional banking crisis – the ASX 200 banking index is up 3.35 per cent since Silicon Valley Bank collapsed on March 12 – investors will be rightly looking for any lingering signs of contagion as First Republic’s fate is sealed.
Matt Haupt, the portfolio manager at Wilson Asset Management’s WAM Leaders’ fund, is closely watching US money markets, where the Australian banks go for wholesale funding. He noted last week that the yield on four-week US Treasuries is lower than the overnight rate, which he says is explained by the fact that four-week Treasuries are being held to help with collateral shortages.
“There are signs of stress which we’re watching at the moment,” Haupt says. “All is not well.”
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