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BFCSA: Australian Dollar down and Big Banks make $10 billion cash in two weeks!

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Bank revenues go up as dollar loses ground

Banking and FinanceBusiness

Date October 2, 2014

The  fall in the dollar has delivered Australia's big four banks up to $10 billion in cash in just two weeks, as hedging contracts put in place over their massive offshore funding programs come into the money.  Australian banks' offshore borrowings are hedged for the term of those bonds. As the dollar slipped to just below US87¢ on Wednesday, counter-parties to the banks' hedging contracts – mostly the large, global investment banks – have been forced to deposit cash with the Australian banks under collateral agreements.

Sensitivity analysis conducted by veteran banking analyst Brian Johnson, from CLSA, shows that every 1¢ fall in the AUD/USD exchange rate generates $1 billion of "collateral cash-backs" for Commonwealth Bank of Australia and Westpac Banking Corp, and $500 million for ANZ Banking Group and National Australia Bank.  This means that for every 1¢ fall in the value of the Australian dollar, the big four banks receive $3 billion in cash from their hedging contracts, and that dollar has fallen from above US90¢ cents over the past fortnight to below 87¢ on Wednesday.

The funds, which are sometimes posted in a foreign currency such as the euro, become an asset for the bank and are typically invested in short-term, liquid assets. Because the cash must be returned to the counter-parties if the dollar rises, the payments are not treated as profit.  One member of the treasury team of one of the big four banks said on Wednesday the CLSA analysis "revealed a peculiarity in the way in which Australia's banks are hedged", and that Mr Johnson's numbers were about right, albeit at the top end of the range.

Australia's big banks raised $125 billion by issuing bonds into wholesale markets last financial year, the highest level of borrowing in several years, as lenders sought to lock in cheap funding.  After slumping 7 per cent last month, bank stocks have come roaring back over the past two trading sessions.  ANZ Banking Group was up 1.7 per cent on Wednesday, while CBA added 1.2 per cent and Westpac and NAB rose 1 per cent and 0.9 per cent respectively.  Omkar Joshi, an investment analyst at Watermark Funds Management, said the bounce back "was to be expected, given the falls were so quick".

"But going into the end of the year, bank dividends are under pressure," he said, pointing to last week's Reserve Bank of Australia Financial Stability Review, which warned the banks to build up higher capital buffers.  "The major banks are well placed to adjust to these higher [global capita] requirements through earnings retention if current profitability persists. However, given their overall task and the potential for market scrutiny of their progress, the major banks may want to build up common equity at a faster pace," the RBA said.

Analysts have pointed to concerns about more regulatory intervention against the banks as a key reason for the recent weakness in bank stocks.  The financial system inquiry has also suggested that capital levels should rise, while the RBA last week foreshadowed new macro-prudential tools are being considered to curb housing lending.

The Australian Prudential Regulation Authority released statistics on Tuesday backing the RBA's concern that the composition of the housing and mortgage markets has become "unbalanced". The numbers show owner-occupier mortgage balances have grown by 5.2 per cent over the 12 months to August but loans to investors were up 9.2 per cent year-on-year.

But while equity holders have been fretting about the impact of the Murray inquiry, and APRA and the RBA's attention, attempts to delever the banks may work to the advantage of bondholders and owners of bank hybrid debt.  "If you reduce the leverage of a bank, you make them less risky and that is good for bond and hybrid holders", Michael Saba, head of income products at Evans & Partners, said.

Ratings agency Standard & Poor's downgraded its ratings on Tuesday on a range of bank hybrids after changes to its methodology, which reduced the ratings on recent hybrids issued by Westpac, Macquarie, NAB and Bendigo and Adelaide Bank. However, the affected hybrids remain investment grade and most of their prices rose on Wednesday on strong volumes.  As the dollar has eased, the credit spreads on bank debt have remained flat, reflecting stable funding costs.

The big four banks have shown little re­straint in accessing wholesale markets this year, raising $125 billion in wholesale money in the 12 months to June 30, according to Bloomberg data, up from $107 billion raised in the 2012-13 calendar year, and $118 billion in 2011-12, when the big banks flooded into the debt markets after being granted permission to issue covered bonds.  Standard & Poor's said in a report released in late July the banks are benefiting from "cheaper funding conditions as a result of the unprecedented levels of accommodative monetary policy, both locally and abroad".

Australian dollar to fall below US75¢, says fund manager

Date October 2, 2014

Sally Rose


Even after losing more than 7 per cent of its value over the past month Australia's currency is still over-valued against the United States dollar, with the exchange rate set to drop below US75¢.  That's the opinion of Thomas Clarke, a portfolio manager and asset allocation specialist based in the London office of $62 billion funds management house William Blair & Company.

At 8am AEST on Thursday morning, the Australian dollar was trading at US87.32¢.  The efforts of Reserve Bank of Australia governor Glenn Stevens to "jawbone" the dollar lower are reassuring, the fund manager said.    "From the perspective of an overseas investor it is great to see a central bank governor come out and call a spade a spade," Mr Clarke said.  "When Mr Stevens goes on record saying the RBA thinks the dollar is overvalued, and not just a little bit, that is a nice confirmation of our strategy."

Fair value on the Aussie dollar is somewhere between US74¢ to US75¢, but given the push and pull of diverging global interest rates and the slowdown in China it is very difficult to pick when it will get there, Mr Clarke said.  He said Australia's currency had been artificially elevated for a number of years as the US Federal Reserve's quantitative easing program has been flooding global markets with liquidity. Those central bank asset purchases have been tapered since late 2013 and are expected to conclude this month.  With expectations rising the US will start to lift interest rates in mid-2015, the Australian dollar lost more than 7 per cent over September.

"Global interest rate differentials are such that the Aussie dollar still has a carry-trade, but it is no longer enough to offset the depreciation in fundamental value," Mr Clarke said.   "Despite its recent falls the Australian dollar is still over-valued against the benchmark US dollar, but the Aussie is even more expensive when measured against a batch of Asian currencies," he said.  The William Blair macro allocation fund, a multi-asset strategy that Mr Clarke co-heads, has a big short on the Aussie dollar.  "In addition to our strong conviction the Australian dollar will eventually fall, shorting it also diversifies the portfolio against the risk of US and European equities falling," Mr Clarke said.

Typically the Australian dollar has tended to trend in the same direction as major developed market equities.  Alongside the Australian dollar, other currencies Mr Clarke thinks are set to fall are the New Zealand dollar, the euro, and the Swiss franc. He has a neutral view on the US dollar.  The currency he has the brightest outlook for is India's. The macro allocation fund currently has 19 per cent of its total assets held in Indian rupee.


"India's rupee got swept up in a sell-off of the so called "fragile five" economies when the US Fed flagged tapering in early 2013, when it was never really that fragile," Mr Clarke said.  "Since then a new central bank governor and prime minister have been elected who improve the outlook for global investors, so the currency has both the fundamental and macro-economic factors in its favour."  After the Indian rupee, Mr Clarke's next most favoured currency is the Indonesian rupiah. He also has significant allocations to the Malaysian ringgit and Mexican peso.  Mr Clarke sees little opportunity to make money from Australian shares at the moment. In global equity markets he favours European stocks, particularly Italian and Spanish shares.

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