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BFCSA: Shorting the big four banks: widow-maker no more?

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Shorting the big four banks: widow-maker no more?

Australian Financial Review 03 Feb 2019 11:00 PM

Jonathan Shapiro


After years of trying and failing to make money from an apparent housing bubble, betting against Australia's profitable big four banks has been dubbed the "widow-maker" trade.

But the 2018 vintage of big bank bears fared well, and that has lured more hedge funds into believing the "widow-maker" will be a "money-spinner" in 2019.

That is borne out by data complied by Macquarie analysts, which showed institutional investors had doubled their big bank shorts ahead of Monday's release of the Hayne royal commission final report.

Whatever the report delivers, the bears see plenty of reasons to bet against the banks and a host of retailers that suffer if the property correction lasts through 2019.

And with the big banks still trading at premiums to their global peers, and certain retail-exposed stocks priced at relatively rich multiples, there could very well be money to be made on the short side.

One investor who's becoming more convinced that shorting the banks is no widow-maker is Singapore based Nick Ferres, of Vantage Point Asset Management.

Vantage Point has been shorting consumer discretionary stocks since October last year, and has the view that the large lenders would be more resilient. But last week, it added a position to short a basket of the major Australian banks in addition to the regional lenders.

Ferres still believes the consumer discretionary stocks are the front-line as house prices fall and consumers cut spending. But he says three factors have changed that have compelled the fund to initiate the bank short earlier than they anticipated.

The first has been a sharp rally in bank stocks in the first three weeks of the year, which increased valuations.

The second, he said in a note, is that the deterioration in fundamentals has accelerated increasing their conviction that trouble is brewing.

And the third reason is that Australia's banks still trade at a material premium to their global peers that he does not believe is warranted any longer.

He described recent construction data as "catastrophic". Building approvals are highly correlated to loan growth and therefore bank profits and share prices; a 33 per cent decline in total approvals is "consistent with the last recession", he says.

The risks to the banks associated with contracting credit, falling house prices and a pull back in spending may be "well appreciated", but Ferres does not believe they are well priced.

Even if the banks trade at a discount to the Australian market, he says they are at a substantial and increased premium to the global banks that also got battered in 2018.

The message is to caution against buying into the banks, at least on valuation grounds.

It's not just offshore hedge funds that have turned dark on the banks and retailers.

The research analysts at the large brokers are becoming equally concerned about the prospects of the big four banks. Some of this bearishness is based on extensive household surveys, which aim to provide a snapshot of the financial position of Australian households.

Investors crunched

This week Morgan Stanley presented the findings from a survey of 1800 mortgagors, the second one it has conducted. The 2017 version concluded that households were stretched and overly exposed to property prices, and would cut back spending and eat into their savings.

It did foreshadow much of what did play out in 2018 as house prices declined, and retail sales proved patchy.

But steady employment growth proved an important offset, and that along with a lower savings rate meant consumer spending and GDP growth were more resilient than they predicted.

The 2018 survey found that 70 per cent of investors, and 80 per cent of interest-only investors, have problems getting a home loan, and 45 per cent of interest-only borrowers were not in a position to switch to principal and interest.

Their prediction for this year is that credit will get tighter, household finances will get squeezed by stagnant wages, and rising costs and sentiment will deteriorate.

For that reason, they are cautious on the banks and have cut their earning per share estimates for the majors by 3 per cent.

The analysts believe the earnings of Super Retail Group and Harvey Norman are most at risk, but are already trading on "relatively cheap" multiples of 10 times earnings.

Wesfarmers, on the other hand, trades on a 19 times forward earnings multiple and generates more than 80 per cent of its earnings from non-food retail, which Morgan Stanley believes puts it at the greatest risk of a de-rating.

While the survey has drawn some bearish conclusions, it showed that households themselves are more confident the property market. Only 20 per cent of respondents expected house prices to decline in 2019.

If Morgan Stanley and others are right, and credit tightening further pressures house prices, that could have further implications for consumer sentiment.

The big switch

What makes this housing downturn unique, and potentially terrifying, is that it has not been driven by increasing interest rates and higher unemployment.

As Rob Mead of global bond fund PIMCO points out, for housing, "this time is different".

There will be continued downward pressure on property prices, he says, because the availability of credit extended to individual borrowers has been reduced, foreign demand has dried up, there is uncertainty over tax-policy in relation to negative gearing, and the big switch from interest only loans to principal and interest will further reduce borrowing capacity.

Morgan Stanley says this final factor – the roll-over of interest-only loans to principal and interest – could be the cause of a darker and more painful housing correction than they envisage.

The analyst's base case is for a "benign deleveraging" as credit tightens and house prices fall but in which the economy remains resilient enough to limit the fall-out.

And some lenders are confident, the property market will recover.

Mario Rehayem the chief executive of Pepper Group, the largest non-bank lender points out that given the perfect storm of tighter credit, increased scrutiny on expenses, retreating foreigners and pressure on serviceability, the market has held up well.

This year is complicated by a federal election but Rehayem says bargain hunters could ensure it's a strong year, and one in which growth continues for the non-bank lender.

The bear case is house price falls accelerate due to forced selling that results from "trapped interest-only" borrowers that either cannot refinance or are unable to service a principal-and-interest mortgage. A quarter of all loans in the survey were interest-only while just under half of the borrowers were considered trapped.

So, as long as the economy holds up, the undeniable pull back in credit shouldn't derail the economy and trigger Australia's first recession in over a quarter of a century.

But the evidence is that 2019 is going to be tough, potentially brutal.

And the brave counter-consensus call of the year now? Buy banks and retailers in the hope that she'll be right.


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