Housing debt, bank stocks ‘carry risks’
HAVING sub-underwritten Westpac’s emergency capital raising to stay afloat in the early 1990s, Phil Hofflin and Rob Osborn know Australia’s esteemed banks can actually run into problems.
Needing to plug a capital hole after suffering a whopping interim loss from the commercial property meltdown, Westpac went to investors for cash at $3 a share. But after they shunned the offering, sub-underwriters like Kerry Packer and Tyndall, where Mr Hofflin and Mr Osborn worked at the time, were on the hook for the shortfall.
It was initially painful, as Westpac slumped to $2.49 by November 1992. But as value investors who buy stocks on the cheap, rewards ultimately flowed as bank shares began their 15-year run until the GFC.
More than 20 years on and no recessions since, the Lazard Asset Management fund managers are concerned about the banks’ skyhigh valuations and the risks of a housing market correction.
And rather than corporate debt overload in the last recession, this time it’s record high household debt in a hot property market — a more worrying scenario for it tends to cause deeper economic pain.
“Property prices, bank valuations — we’re still in the pre-2007 paradigm: as soon as we get a rate cut, we go out and buy another property,” Mr Hofflin said, citing higher median prices in Wagga Wagga than Chicago.
“What happened in the US in terms of the wealth effect when property fell could be worse here because property dominates Australians’ balance sheet … and because prices are so high in the first place.
“If you have an asset that is expensive but there’s no debt against it, we think it’s much less dangerous to the economy ... in this case there is a lot of debt against it.”
While there is a view that Australia’s circumstances such as tight land supply and tax incentives protected the nation from a property collapse, regulators are growing increasingly concerned, particularly in Sydney.
As chief banking regulator Wayne Byres noted last week, the nation’s good housing fortune over the years “doesn’t mean that will always be the case”.
Mr Hofflin, fresh from speaking at the national “Big Day Out” events for financial advisers,
shares regulators’ concerns about the state of lending, where almost half of new loans are to investors and 45 per cent on interest-only terms. He added that if you use gross rental yields, costs and taxes to generate, residential property is trading on a massive 60 times earnings — four times the value investors ascribe to the stockmarket.
The housing credit boom and insatiable appetite for yield stocks has pushed bank market capitalisations to about 35 per cent of the stockmarket, a level Mr Hofflin said he’d never seen before.
“It got to 21 per cent in Japan at the peak of their property and bank boom in 1990. Globally, it averages 9 per cent,” Mr Hofflin said.
“Globally people are chasing yield and they’ve bid up American utilities, etc. In Australia people chase the banks and think they are defensive. Given banks are levered 20 to one, we think they are cyclicals and this is where I think there is a disconnect.”
The views are reflected in Lazard’s $4.4 billion of Australian equities under management, which only includes NAB — the “value” bank that has long traded at a discount to peers.
It’s been an unrewarding trade, with head of Australian Equities at Schroders Martin Conlon telling clients this month that investing with a long-term view of businesses and the economy has been “wholly unrewarding” in the past year.
But Mr Hofflin and Mr Osborn are no strangers to sitting on the sidelines when valuations skyrocket away from what they deem are long-term fundamen- tals. “During the dotcom boom our style of investing was very much out of favour because we avoided the high prices being paid for those types of stocks, but it came home to roost when those stocks fell, and our strategies outperformed,” Mr Hofflin said.
“It’s also happened with commodities, where those stock prices were also very high. These anomalies will keep coming and this is where we are with bank stocks at the moment.”
The comments — as bank stocks last week hit fresh record highs — come as central banks pump trillions of dollars into markets to stimulate demand and growth.
This has led to concerns of a painful fallout once the music stops, with Mr Conlon saying that “valuations always matter in the long run” and “the powerful momentum engineered by globally negligent monetary and government policy” could be “myopic and damaging”.
As “fundamentals guys” who normalise valuation inputs like bad debts charges, Mr Hofflin and Mr Osborn broadly agree. They don’t even bother trying to predict the economy in coming years, focusing on long-run conditions. “It’s like the weather — we all know it’s impossible to forecast the weather in two weeks time, but you can make a pretty good guess that in June and July it’s going to be colder than now,” Mr Hofflin noted. But Mr Osborn sympathises with retail investors attracted to banks’ yield, with returns on deposits near zero.
While people needn’t panic and sell all their bank holdings, he urges taking some profits and diversifying into other dividend paying stocks like Transurban and buying offshore earning stocks such as Brambles, Amcor, Sonic Healthcare and Aristocrat Leisure.
He said it’s particularly important because most investors are overexposed to the banks through ownership of their home, bank shares in superannuation, investment properties and cash savings.
“In my view if you are buying bank shares, you’re also getting exposure to the same risk as you have in property. Investors should diversify,” he said. “(Also) we don’t think that yield is likely to be sustainable over the long term.
“People think ‘the banks are safe, we don’t have to worry about them’. What we’re saying is that there is a risk. It may not hit you to- morrow, but over the long term we think people should take some risk off the table.” As interest rates look to be heading lower, some investors however argue analysts can focus too much on valuing the banks compared to past, rather than current, conditions.
Indeed, Deutsche Bank analysts this month found they are trading around “fair value” and have lower risk due to higher capital levels and more mortgages on balance sheets.
But Mr Osborn disagreed, making the apt point that “there’s not many people we know that actually worked in that last recession in Australia”.
“The difference with the last (recession) in the early 1990s was it was effectively driven by corporate debt. The next one we think will not be driven by that because corporates are actually in pretty good nick. Household debt is the problem,” he said.
“Back in 1992, credit to GDP was much lower and the banks’ lending books were more about equally exposed to corporates and mortgages. Now, mortgages are two-thirds and that’s a real concern.”
While the banks say households are on average 21 months ahead of their repayments, Barclays this week said debt at 130 per cent of GDP was the highest on record. Indeed, Schroders’ Conlon points out banks’ organic revenue growth of mid-single digits is outpacing most other sectors in the economy.
“Population growth of 1.5 per cent does not equate to 6 per cent housing credit growth unless someone is growing their debt balance,” he said. Mr Hofflin agreed, saying the strong lending to property since the GFC is a misallocation of capital as rather than investing in productive assets. “It also means households haven’t de-geared.”
Lazard senior fund managers Phil Hofflin and Rob Osborn are urging investors to diversify their investment to reduce risk