The bull trap for banks

Advertisement

Today the AFR does its usual preening act this time for banks:

Ahead of a week when the major banks are expected to report combined earnings of about $30 billion this financial year, fund managers dismissed comments from the banking regulator that they should lower expectations.

“It makes sense in financial theory, but when you combine that with a very strong oligopoly, I don’t know the elegant financial theory works out in practice,” Aurora Funds Management portfolio manager Hugh Dive said.

…The return on equity of the big four is between 14 and 18 per cent, while the regionals is between 9 and 11 per cent, according to Bell Potter bank analyst TS Lim.

…Watermark Funds Management analyst Omkar Joshi​ said lower returns were unlikely and noted that Westpac had committed to an ROE above 15 per cent. “The banks are wedded to higher returns and have made it very clear they will keep returns where they are,” he said. “And that is at the expense of the customer.”

…”For the major banks, we see mortgage repricing as essential to restoring profitability and preserving dividends per share,” Citi analyst Craig Williams said in a note.

…George Boubouras, chief investment officer at Contango Asset Management, said the lowering of returns was “a very reasonable assumption to have” but remained confident dividends would continue to grow.

…Argo Investments managing director Jason Beddow said returns may be buffeted by future capital raisings, but said banks would continue to protect profitability by raising interest rates.

Always focused on the rear vision mirror. And what do you think that passing the costs onto the customer will do as we head into the end of the business cycle and interest rate sensitive sectors are the only part of the economy that is growing? Regulatory capital is yesterday’s headwind for bank profits. Tomorrow’s is deteriorating asset quality.

The bank boom we’ve witnessed since the easing cycle began in 2011 is over:

Advertisement
tvc_e92bce10373d2974e1c363dc27b22052 (1)

We’re in our last hurrah today as another round of global easing (and soon local) creates a bull trap for banks. It’ll have room to run for a little while as the late comers to the chase for yield pile in. But the headwinds for banks are mounting as their cost of funds rise, and will continue to do so as the global commodity and emerging market debt bust gathers pace, and asset quality deteriorates across the nation from West to East because the mining bust has much further left to run, the car industry closure approaches and the housing boom is now complete as well.

This final bank rally is based exclusively upon the increasingly rich valuations based upon yield as interest fall to new lows. Given the dividends themselves will first stop growing and then start shrinking as the asset cycle deteriorates, now is the time to be taking profits or lining up your bank shorts not longs.

Advertisement
About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.