#CommBank

The lost plot

Is anyone surprised that nothing was achieved at the COP25 summit? How is it possible that 27,000 disciples knelt at the altar of the UNFCCC to listen to a pigtailed teenager and came up empty handed?

UNSG Antonio Guterres lamented, “I am disappointed with the results of COP25…The international community lost an important opportunity to show increased ambition on mitigation, adaptation and finance to tackle the climate crisis.”

What annoys FNFM is the sanctimonious shame culture that consumes these meetings. Heretics are outed and slammed. Australia is never far away from a beating. Yet the show goes on. COP26 will misuse data and amplify the hysteria.

Even more disturbing is how this woke behaviour is finding its way into our financial institutions.

Instead of looking to diversify earnings and maximize shareholder returns they are taking stands on climate change. The Big 4 Aussie banks refuse to invest in anything related to the Adani coal mine. Another 35 global banks will do likewise.

One could make a clear case against investment were the Adani coal mine to carry excessive financial risks but it doesn’t. The end user in India has a giant thirst for decades. This is money for jam.

Bank boards should ask themselves, since when did any customers seek climate advice from their loan managers? It is ludicrous.

APRA should forget regulating the banks over fees or charging dead people but question the economic rationale behind decisions like Adani. It is not to say banks don’t have a right to deploy capital as they deem fit but there should be a sensible purely financial explanation behind it, not one wrapped in ideological dross.

The ultimate irony here is that banks, forever showing diversity in the workplace, don’t seem to want to apply it to the loan book which is so ridiculously skewed to mortgages. There is nothing prudent about that.

So maybe the UN COP summits are having the desired effect behind the scenes. Howl at the moon long enough and get teenagers to scream “how dare you” to shame our banks into folding to local public pressure, which in reality amounts to a handful of misguided students with placards and Twitter accounts who wish to wag class.

Wouldn’t it be ironic if a housing collapse sent some of our heavily geared Aussie banks toward insolvency which could have been averted were they to have made a rational decision to lend to Adani, the very business they told us would kill them.

On a final note, how do we have banks disinterested in taking advantages where little competition exists? Isn’t that the holy grail of financial strategy?

The beauty behind Adani (and other projects like it) is simple. No need to embark in competitive intelligence to find out what their banking rivals are doing. Just listen to their public statements on what they aren’t doing and take the spoils. Higher margin and lower risk. It is not rocket science.

CM on Sky

https://www.skynews.com.au/details/_6102427118001

CM appeared on Sky News to discuss the situation with our banks, the potential risks from the recommendations of the Hayne Royal Commission and the issue of mortgage stress.

Westpac reported a 40% increase in home repossessions

Mortgages Westpac

Don’t get CM wrong – this is still the law of small numbers.  Westpac reported this week that it repossessed another 162 properties in the latest fiscal year.  That is a 40% increase. While it is but a dribble compared to the 100,000s of total loans outstanding it is none-the-less a harbinger of things to come. Westpac made clear, “the main driver of the increase has been the softening economic conditions and low wages growth.”

The current status of 90-day+ delinquencies has been rising over time. As have 30-day +. While nothing alarming, the current economic backdrop should give absolutely no confidence that an improvement in conditions is around the corner. We are not at the beginning of the end, but at the end of the beginning.

Former President Ronald Reagan once said of the three phases of government, “if it moves, tax it. If it keeps moving regulate it. If it stops moving, subsidize it.” How is that relevant to the banks?

We have already had the government fold and attach a special bank tax on the Big 4. Phase 1 done. Now we are in the middle of phase 2 which is where knee-jerk responses to the Hayne Banking Royal Commission (HBRC) where banks will be on the hook for the loans they make. That is a recipe for disaster that could bring on phase 3 – bailouts.

Sound extreme? How is a bank supposed to make a proper risk assessment of a customer’s employability in years to come? Can they predict with any degree of accuracy on the stability of candidates who come for loans? The only outcome is to cut the loan amount to such conservative levels that the underlying purpose gets diluted in the process and prospective home buyers have to lower expectations. Not many banks will look positively at taking several loans on the same property with different institutions. That won’t work. SO loan growth will shrink, putting pressure on the property market.

What is the flip side? Given property prices in Sydney hover at 13x income (by the way, Tokyo Metro was 15x income at the peak of its property bubble), restrictions on further lending against loan books that are on average 63% stuffed with mortgages (Japan was 41.2% at the peak) won’t be helpful. A property slowdown is the last thing mortgage holders and banks need.

While equity continues to rise at Aussie banks, the equity to outstanding mortgages has gone down since 2007 i.e. leverage is up. If banks saw their average property portfolios drop by more than 20% many would be staring at a negative equity scenario. Yet, it won’t be just mortgage owners that we need to worry about. Business loans could well go pear-shaped as the onset of higher unemployment could see a sharp increase in delinquencies through a business slowdown. A concertina effect occurs. More people lose their job and a vicious circle ensues. It isn’t rocket science.

Of course, Australia possesses the ‘boy who cried wolf‘ mentality over the housing market. Yet it is exactly this type of complacency that paves a dangerous path to poor policy prescriptions.

In Japan’s property bubble aftermath, 40% of the value of loans went bang. 17% of GDP. $1.1 trillion went up in smoke. It took more than 10 years to clean up the mess and the aftershocks remain. Accounting trickery around the real value of loans on the balance sheet can hide the problems for a period but revenue tends to unravel such tales. 181 banks and building societies went bust. The rest were forced into mergers, received bailouts or were nationalised. Now the Japanese government is a perpetual debt slave, having to raise $400bn per annum in debt just to fill the portion of the $1 trillion budget that tax collections can’t fill.

The problem  Japan’s banks faced was simple.  If a neighbour’s $2m home was repossessed through mortgage stress and the bank fire sold it for $1.4m, the bank needed to mark to market the value of the loan portfolio for that area by similar amounts. In doing so, a once healthy balance sheet started to look anything but. Extrapolate that across multiple suburbs and things look nauseating quickly.

This is where Aussie banks are headed. This time there is no China to save us like in 2009. Unemployment rates in Australia never went above 6% after the GFC in 2008/9, unlike the US which went to 10%. We weathered that storm thanks to a monster surplus left by the Howard government, which we no longer have.

Sadly China has had 18 months of consecutive double-digit car sales decline. Two regional Chinese banks have folded in the last 3-4 months. China isn’t a saviour.

Nor is the US. While the S&P500 might celebrate new highs, aggregate corporate profitability hasn’t risen since 2012. The market has been fuelled by debt-driven buybacks. We now have 50% of US corporates rated BBB because of the distortions created by crazed central bank monetary policy, up from 30%. Parker Hannifin’s latest order book shows that customer activity is falling at a faster pace.

Nor is Europe. German industrial production is at 10-year lows. The prospects for any EU recovery is looking glib. Risk mispricing is insane with Greek bond spreads only 1.8% higher than German bunds.

What this means is that 28 years of unfettered economic growth in Australia is coming to an end and the excesses built in an economy that believes its own BS is going to leave a lot of people naked when the tide goes out.

The Australian government needs to focus on more deregulation, tax and structural reforms. Our record-high energy prices, ridiculous labour costs and overbearing red-tape are absolutely none of the ingredients that will help us in a downturn. We need to be competitive and we simply aren’t. Virtue signalling won’t help voters when the whole edifice crumbles.

All a low-interest rate environment has done is pull forward consumption. It seems the RBA only possesses a hammer in the tool kit which is why it treats everything as a nail. It is time to come to terms with the fact that further cuts to the official cash rate and the prospect of QE will do nothing to ward off the inevitable.

Pain is coming, but the prospects of an orderly exit are so far off the mark they are in another postcode. Roll your eyes at the stress tests. Stress tests are put together on the presumption that all of the stars align. Sadly, in times of panic, human nature causes knee-jerk responses which put even more pressure.

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The Aussie banks have passed their best period. While short term news flow, such as a China trade deal, might give a short term boost, the structural time bomb sits on the balance sheet and while we may not get a carbon copy of the Japanese crisis, our Big 4 should start to look far more like the rest of the global banks – truly sick. The HBRC will see that it becomes way worse than it ever needed to be.

Complacency kills.

You want Aussie Banks in your retirement fund far less than their advisory services

This is while things are still supposedly good for our banks. CM has written on the pickle Aussie banks find themselves for a year or so. Their relative value compared to banks such as Deutsche, Commerz or RBS is astonishing. So many global banks are worth 90% less than in 2007 while ours keep whistling Dixie. Mean reversion will hit hard and the complacency still baked into these supertankers is immense. Aussie banks could well be worth 90% less by the time this is all over. Forget the stress tests – meaningless – as they need pretty much all stars to align to be remotely accurate and markets in times of panic seldom play to script. Don’t be surprised if these banks require a taxpayer bailout in time.

With more interest rate cuts planned and inevitable QE down the line from the RBA, think of it more as a time banks must make considerable efforts to deleverage. Should banks consider a benign central bank as a virtue, they should seriously think again. People and businesses invest because they see a cycle, not because interest rates are low. Further cuts won’t make a difference.

In short, sell the Aussie banks. The impacts from the Hayne RC will only have adverse outcomes for the banks at a time they need maximum flexibility in order to be able to right the ship. Sadly, such outcomes are highly unlikely. Governments tend to be the most accurate contrarian indicators when it comes to introducing business stifling policy measures at a time, the industry can least afford it.

Maybe former President Reagan had it right when he said, “If it moves tax it. If it keeps moving regulate it. If it stops moving, subsidize it.” The government has already completed the first phase and in the midst of finishing up on the second…

Sell your Aussie banks. Headlines, like the above, will be regarded as extremely positive in the next 12 months.

Those selfish evil banks?

As is the case with nearly every rate cut, the media stirs up the fact that most of the major Aussie banks haven’t passed on the full 0.25% rate cut. As one can see from the RBA chart above, net interest margins are at the lowest level in 20 years. The banks, as much money as they might be making, are doing it very tough. What people often overlook is the fact that Aussie banks are 40% funded by the wholesale markets, meaning they need the benevolence of foreign and domestic institutions to buy their paper to lend. With a softening Aussie dollar that puts added pressure on funding margins.

Banks

We’ve written about this in previous dispatches. Aussie banks are in a far more precarious situation than we are often told. Global banks have already felt it. We are getting to the stage where we follow them into the morass.

As much as bashing banks has become a sport after the Royal Commission, bullying them into cutting rates by the full extent is actually making their position even weaker. The last thing Australia needs, on top of the ridiculous regulation set to follow the RC, is to force them to operate to the rule of the mob. Personal responsibility is what governments should be drumming home, not saddling the banks with more hoops. If people don’t like their bank that lent them millions for a home loan, switch banks! It is your choice.

The Grim Repo

What a surprise to see markets show little reaction to the negative repo (repurchase agreements) market in the past week. So much nonchalance and complacency remain in financial markets. It is as if there is this false belief that the authorities can keep the ship afloat with magical modern monetary theory. Not a chance. The tipping points in the financial markets are quantum levels bigger than any that Sir David Attenborough could conjure up in his wildest pessimistic dreams. If we want to cut carbon emissions, the coming economic slump will take care of that.

On average there are $1 trillion of overnight repo transactions every day, collateralised with US Treasuries. Yet many missed that the repo market seized up late last week. Medium-term repos surged from the normal band of around 2.00~2.25% to around 5.25% on Monday. Some repo rates hit 10% on Tuesday.

Essentially what this said was that a bank must have seen that it was worth borrowing at an 8% premium overnight in return for pledging ‘risk-free’ US Treasuries at 2%. In any event, it allowed that particular bank to survive for another day. Banks use the repo market to fund the loans they issue and finance trades that are executed. It is like an institutional pawn shop.

Looking at it another way, why weren’t other banks willing to lend and take an 8% risk-free trade? A look at the global bank’s share price action would suggest that these bedrock financial institutions that grease the wheels of the economy are not in good shape. We just pretend they are. We look at the short term performance but ignore the deterioration in underlying balance sheets. The Aussie banks are future crash test dummies given the huge leverage to mortgages. As CM has been saying for years, the Big 4 risk whole or part nationalisation.

This recent repo action is reminiscent of that before the GFC. The Fed stepped in with $75bn liquidity per day to stabilise markets by bringing rates into the target range. The question is whether the repo action is a short-term aberration or the start of a longer-term quasi QE programme which turns into a full-blown QE programme.

The easiest way to look at the repo market action is to say the private markets are struggling to be self-funding, requiring central bank intervention. Bank of America believes the Fed may have to buy upwards of $400bn of securities to back the repo market this year alone.  This is another canary in the coal mine.

CM wrote a long piece back in July 2016 titled, “Dire Straits for Central Bankers.” In that report, we described how the velocity of money in the system was continuing to drift. As of now, central banks have printed the equivalent of $140 trillion since 2008 but have only managed to eke out $20 trillion in GDP growth. That is $7 of debt only generates $1 of GDP equivalent.

This is the problem. Companies are struggling to grow. US aggregate after-tax profits have gone sideways since 2012. We have been lulled into a false sense of security by virtue of aggressive share buyback programs that flatter EPS, despite the anaemic trend.

Despite the asset bubbles in stocks, bonds and property, pension funds, especially public sector retirement schemes, are at risk of insolvency given the unrealistic return assumptions and nose bleed levels of unfunded liabilities in the trillions.

Also worthy of note is the daily turnover of the gold derivatives market which has hit $280bn in recent months, or 850x daily mine production. This will put a lot more pressure on the gold physical market and also to those ETFs that have promissory notes against gold, as opposed to having it properly allocated.

We live in a world of $300 trillion of debt, $1.5 quadrillion in derivatives – until this is expunged and we start again, the global economy will struggle. That will also require the “asset” values to be similarly wiped out. Equity markets will plunge 90-95% relative to gold. That suggests a 1929 style great depression. The debt bubble is too big. Central banks have lost control.

Buy Gold.

Banker Buster?

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Before the GFC in 2008, bank shares across the globe were flying. Financial engineering promised a new paradigm of wealth creation and abundant profitability. They were unstoppable.

However 12 years later, many banks look mere shadows of their former selves. We are told by our political class to believe that our economies are robust and that a low-interest rate environment will keep things tickety-boo indefinitely. After all the wheels of the economy have always been greased by the financial sector.

If that were true, why does Europe’s largest economy have two of its major banks more than 90% off the peak? Commerz has shrunk so far that it has been thrown out of the DAX. Surely, Japan’s banks should be prospering under Abenomics so why are the shares between 65% and 80% below 2007 levels?

Ahh, but take a look at those Aussie beauties! How is it they have bucked the global trend? How can Commonwealth Bank be worth 6x Deutsche Bank?

Although we shouldn’t look at the Aussie banks with rose-tinted glasses they have mortgage debt up to the eyeballs. Mortgages to total loans exceed 62% in Australia. The next is daylight, followed by Norway at 40%. Japanese banks, before the bubble collapsed, were in the 40% range. CM wrote a comparo here. There is a real risk that these Aussie banks will require bailouts if the housing market craps out. It carries so many similarities to Japan and when anyone ever mentions stress tests – start running for the hills.

If you own Aussie banks in your superannuation portfolio, it is high time you dumped them. Franked dividends might be an ample reason to hold them, but things in finance turn on a dime and this time Australia doesn’t have a China to rescue us like it did in 2008-09. More details contained in the link in the paragraph above.

In closing, Milton Friedman said it best with respect to the ability of central banks to control outcomes,

“… we are in danger of assigning to monetary policy a larger role than it can perform, in danger of asking it to accomplish tasks that it cannot achieve, and as a result, in danger of preventing it from making the contribution that it is capable of making.