13/07/2015 - 13:26

Banks squeezed in volatile market

13/07/2015 - 13:26

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There is a range of reasons why bank shares have fallen lately, some from self-inflicted injuries and some due to a changing marketplace.

SLIDING: Westpac shares have dropped 23 per cent during the past three months.

There is a range of reasons why bank shares have fallen lately, some from self-inflicted injuries and some due to a changing marketplace.

Australia's big banks have been an investor’s best friend over the past few years, but like all good things the bank boom is coming to an end, as a four-way squeeze stifles growth and profits.

At the top end of banking (wealth management for rich people), there is a growing awareness that traditional banks lack the skills needed to generate reasonable returns for customers, with a move under way to outsource what had been expected to be an important growth sector.

At the bottom end of banking, low-cost internet-based lenders are eating into the market share of traditional banks; and while the newcomers are probably a disaster waiting to happen, they will cause problems until they too hit a wall of bad debts caused by lending to dodgy borrowers.

In the middle, Australian households are fading as a growth sector; older customers are busily retiring debt rather than asking for more, and younger customers are wary of plunging too deeply into the debt market for fear of being lumbered for life with a mortgage they can never hope to service.

It’s those three problems that can be traced to the sharp fall in bank share prices over the past six months, and which lie at the heart of the fourth and most serious problem – a lack of confidence in banks as a good investment and reliable generator of strong dividends.

No-one is suggesting you rush out and sell bank shares because conditions have tightened and profits are becoming harder to earn, but there is a growing belief that Australian banks are entering a down-period after a terrific performance in the wake of the GFC.

Before looking at each of the four problems confronting the banks, a reasonable investor should consider one of the tests applied by US billionaire Warren Buffett when he considers an investment – take the product of the company concerned for a test drive.

In Mr Buffett’s case, that means using the card services of a company such as American Express to test its customer appeal, and then loading up on Amex shares, or enjoying a can of Coke and then buying a pile of shares in Coca Cola. The same test has been applied to other big name firms such as household consumables firm Proctor & Gamble, and big retailer Walmart.

In Australia, the best way to test a bank before buying its shares is to visit a branch to test it for customer service, an experiment that yields a roughly equal share of good and bad experiences, with the bad a reminder that in a boom everyone gets a bit lazy and can be inclined to take customers for granted.

Unfortunately for bank staff (and shareholders in banks) the good times are over, as shown in the share price falls and a series of warnings about growth options drying up.

In some cases the share-price falls constitute a technical crash, which is what defines a fall of more than 20 per cent in a market, with a 10 per cent fall defined as a correction. In the case of Westpac Banking Corporation, the fall over the past three months has been an eye-catching 23 per cent.

National Australia Bank has been the second worst performer, down 17 per cent. ANZ and down 15 per cent and Commonwealth Bank is down 12 per cent from its peak.

It would be easy to explain what’s wrong with the banks if there were a single reason for the bank correction/crash, such as a countrywide economic recession. But the problem runs far deeper than a simple slowdown and concern about the banks needing to raise more capital to bolster their balance sheets.

Take the wealth management business, which was supposed to one day rival the cornerstone business of providing mortgages for middle Australia. Rather than booming, the banks have found wealth management beyond their skill set, failing to provide good advice and failing to attract the real boom sector – self-management retirement funds – while also attracting increased levels of government regulatory control.

Cut-price internet-based lending is another sector that is foreign to traditional bankers; and while management at the big four might not like the rise of so-called digital finance, it’s certainly not going to go away.

Slow growth at the top and bottom of the banking business, or even erosion of market share, is being compounded by slow growth for corporate lending as Australian businesses squirrel their cash away in case the troubles of Europe and China wash up on the local market.

The changed outlook for banks is reflected in investment advice being dispensed by stockbrokers, with ‘sell’ recommendations on some the big banks. For example Macquarie is advising clients to sell ANZ because it needs to boost its tier-one capital base – code for a fund raising or lower dividends – and sell on Commonwealth Citi because of weak cash earnings.

Diamond ring

Ellendale has never been an easy diamond mine, and its closure last week by Kimberley Diamonds was a reminder that the company, which made the discovery more than 30 years ago, never regarded it as a viable project.

Rio Tinto spent years and tens of millions of dollars examining Ellendale, located inland from Derby, only to conclude that it was a marginal proposition and a poor option when another discovery, the Argyle mine, represented a world-class opportunity to get into the diamond business.

Failure by Rio Tinto to develop Ellendale caused the state government to threaten applying the Mining Act’s ‘use it, or lose it’ laws, a warning that encouraged Ellendale’s sale.

Several changes of owner later, it is now painfully obvious that Rio Tinto was right. Ellendale really is a marginal proposition.

But what the closure of Ellendale shows is that diamond mining (and diamond retailing) is a tough business and what just happened to Western Australia’s original diamond discovery must be ringing warning bells at Rio Tinto’s second discovery, Argyle.

Copper call

All eyes in the WA mining industry are on Monty, the latest copper discovery by Sandfire Resources near its DeGrussa mine in the Pilbara, where thick and rich copper grades have been reported from the discovery hole.

One hole, however, is never enough to claim commercial viability, but a second strike will have stockbrokers reworking their Sandfire spreadsheets.


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