As we briefly noted in our shares to watch note Australian bank shares are a leverage bet on the Australian economy. Given where we are in the credit cycle with no material economic weakness for over 2 decades, there is significant leverage built into the systemic that make us uncomfortable.
On the surface the dividend yield spread to cash or term deposit rate provides attractive prospect for yield hungry investors. The reality is that the prospective risks for a bank like Australia New Zealand (ANZ) include higher bad debt provisions from cycle lows, regulatory constraints and downside risk from any fall in house prices.
The potential risk of higher bad debt provision materialized when it announced that the bad credit charges that were $100m above market expectations for the 6 months ending March 31. The driver of the downgrade is the resources sector weakness.
For full transparency we have listed the reasons ANZ was our preferred pick for the sector. We are withdrawing the reason for owning the stock for the time being until credit outlook is more certain.
Key question we as our selves: was the ANZ provision on the low side (stock specific) or is the sector performance is worse than expected?
We think it is a mix of both. The corporate lending environment is challenged, residential housing market is evidently slowing and banks are facing higher capital requirements. All these factors are not conductive for earnings.
(was) Best of the Big 4 Australian Banks
We have always preferred ANZ over the other big 4 banks (which makes up one of the largest components of the Australia 200 Index) for investors that must include some Australia banking position in the portfolio. This is due to:
1. Smallest the domestic Australian lending exposure relative to overall lending booking
2. Asia Regionalism model – bar current challenges from HSBC and Standard Chartered in the region, we prefer this over pure domestic banking model (CBA) or whatever NAB strategy is.
The key factor for the Australian banking sector is getting better visibility on bad credit charges. This will take time. Home loans are a key product segment for all major banks. The banks like to note that their residential lending standards are conservative.
Time will tell if the decline in house prices which are slowing seeing will put further pressure on bank balance sheets. As the above mostly relates only to Australia. See below the detailed breakdown of the New Zealand business. It is the largest bank in NZ so the broader weakness there is a double pincer for sentiment going forward.
ANZ Share Price
Australia New Zealand share price dropped more than 5% on the day of the announcement. We feel that we would not be a buyer at this level while leaning towards the short side. This feel like the start of the bad news rather than the kitchen sink write down that calls the bottom.
Current owners of the shares collecting dividend can add to position through the DRP plans. If the Australian credit situation deteriorates the dividend could be at risk.
ANZ in New Zealand Overview*
ANZ owns the largest bank in New Zealand. Here are some of the interest charts we found in the their NZ investor day last year. Bank composition shouldn’t have changed much since then.
It is the largest lender in NZ as measured by lending book size. The makes a large portion of the Australian earnings dependent on the NZD exchange rate.
Below are some interesting charts that highlights the NZ segment of the lending book.
Any discussion on the New Zealand economy cannot avoid 2 major issues. Dairy prices and housing prices.
Analysis on the affordability of the New Zealand housing market marks a parallel on the debate on the hot Australian housing market. The chart shows the pricing index of New Zealand house prices over the last 15 years.
Just to burst the bubble for those that think real estate prices never go down. We compared the NZ house price chart with one we found for the US market. The 15 year timeframe from 1990 to 2005 looks familiar.
We as student of the market believe everything goes in cycles. While prefer to owning anything that goes up like a hockey stick we are not married to any position for life. So seeing a run this far over the last decade, it is always prudent to take something off the table.
Another interesting chart on New Zealand house price is measuring relative price of the asset verse the income. This is really the eye watering chart showing the housing price multiple relative to income.
Buying a median Auckland house is equivalent of purchasing an almost 30x multiple stock. Whenever we see a 30x P/E stock, it better have a great growth story.
Summary of ANZ New Zealand Segment
NZ makes up almost 20% of the group by NPAT, Lending and Deposit ratios. Recovery in Net Profit After Tax since 2010 with lending and deposit growth are positive. By any measure the NZ division is a strong tailwind for ANZ.
Breakdown of the residential lending shows that less than 15% of the lending book has LVR above 80%. Although important to note this can change once any decline in house values are taken into consideration.
New Zealand has a housing boom without a subprime equivalent of the lending boom. Credit can be given to central bank and regulators. Gives me a feeling price increase due to supply constraints rather than credit flows.
One headwind we can see is the deterioration of the agriculture credit quality. Dairy being the primary export commodity has seen better days. While the provision has ticked up, we feel the cycle has turned. Greater provision is expected in this area.
Similarly overall provisions in the country has declined steadily. The tailwind from decrease in provision has been largely priced in the current return on equity.
*Note All ANZ charts from ANZ ASX release.