By Andrew Main
Maverick fund manager and short selling specialist John Hempton of Bronte Capital has fessed up to being short Australia’s big banks because of what he sees as a bubble in the property market.
That’s quite a call and he is not alone, given there are now around $9 billion worth of short positions in the Big Four.
Is he mad? Probably not. For a start, he’s talking his book. That’s hardly the act of an unhinged person.
Two, he’s got form as a savvy finder of companies in trouble. Not only is he the bloke who reportedly first alerted ASIC in late 2009 to the Trio/Astarra scam that saw SMSF investors say goodbye to well over $50 million of their hard earned retirement savings.
He’s also done nicely in recent months out of highlighting problems at US listed company Valeant Pharmaceuticals, which he’s publicised via his Bronte Capital blog. Its shares have dropped from around $US110 to just over $US30 so far this year alone and he’s predicting they will go to zero.
But there’s a world of difference between a dodgy company/fund manager and a multibillion dollar bank.
To be fair to John, he’s not running a big short, and he’s right they are facing some negatives in the short to medium term.
So let’s have a look at some of the underlying factors at work making our bankers sweat.
Our banks are indeed very exposed to the housing market. In the absence of significant commercial borrowing post the GFC, some banks pushed their home loan books out past 70% of the total. It’s a no brainer for banks to lend on housing as prices climb.
And climb they have. Average house prices are at historic highs in their ratio to average annual earnings. In places like Sydney, they are out past 13 times versus an historic average of just under five, which means that in the long run, either wages have to double in relation to house prices, or the latter have to halve.
Lenders can limit their exposure on new loans by adjusting Loan To Valuation Ratios (LVRs) downwards, and because most mortgages in Australia are at variable and not fixed rates, their only concern is to be able to pass rate rises on to borrowers. It used to be said that the shortest measurable period of time was between the time the traffic light ahead of you turns green and the man in the car behind you toots, but the banks will run that close when the RBA eventually starts pushing rates up.
Apartment building, meanwhile, is running at very high rates and only yesterday Macquarie Bank was revealed to have cut back its maximum LVRs on high rise dwellings to 70%, quite aside from identifying 120 postcodes in at least seven cities that it thinks risk overdevelopment.
What’s really worrying is that the apartment market is significantly at the mercy of offshore Chinese investors and the Chinese government is cracking down on the export of currency at the same time as our banks are cutting back on lending to non-resident borrowers. There’s a strong likelihood, particularly in Sydney and Melbourne, that some buyers won’t be able, or keen, to settle on off-the-plan sales when projects are completed.
Also, in the event of some offshore buyers looking to sell in a couple of years’ time, those apartments will be part of “existing housing stock” and thus only saleable to Australian residents. And locals aren’t that keen on 55 square metre apartments.
But there are other factors that bankers, in particular, like to consider. One, every home loan with an LVR of 80% or more has to be insured…by the borrower. That might not be great news for the Genworths of this world but it takes the risk off the lender’s balance sheet.
Two, regulator APRA and the RBA have been leaning hard on lenders, either to restrict high LVR loans or to stress-test loan applications by theoretically increasing borrowing rates by 200 basis points.
It’s going to be a while before rates move up by that much, given we’d require eight 25 basis point moves to get there.
So clearly the banks are aware of the risk areas in home lending. It’s the developers who have some worrying to do, given that supply is threatening to overcome demand.
That’s where the banks should be looking, once they’ve sorted the non performance of a growing number of the loans they made to the resources sector.
Having said that, this information and more is baked into the price of Big Four bank shares, all of which have gone south so far this year.
And there’s a further point to discourage short selling. Self managed super fund trustees not only adore bank shares for their yield, but to a great extent, they are “buy and hold” fans who see the sort of pullback we have had this year as a buying opportunity.
Those bank shares, wobbly or not, are the cornerstone of a big part of the 500,000-plus SMSFs in Australia, and any short seller will confront an army of believers who individually don’t have a lot of buying firepower, but who collectively can negate the effects of everything but a big scale meltdown.
And then there’s timing. The late stockbroker Rene Rivkin spent ten years in the 1990s betting that the Japanese sharemarket was going to crack, based on fundamental valuations.
Where he went wrong (he was right eventually, but had been financially kippered by then) was that he didn’t allow for the Japanese political and economic institutions’ ability to forestall the crash for as long as they did, by rigging property valuations.
Australia’s a fair bit less opaque than Japan, but there are traps aplenty for short sellers all the same.
The inherent government guarantee of the Big Four banks, plus SMSF investors’ arguably slavish adherence to bank stocks, makes them a very hard target for shorts to tilt at, on anything other than a week-by-week basis.
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