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.”

Phil Hof­flin


Lazard se­nior fund man­agers Phil Hof­flin and Rob Os­born are urg­ing in­vestors to di­ver­sify their in­vest­ment to re­duce risk

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