ANZ shares are under extreme pressure. Less than one year ago they hit a high above $37, yet this week, they’re trading around $23. At the February low, ANZ shares were down 41%. What’s gone wrong? Perhaps more importantly, are ANZ shares good value at current prices?
Internationally, Australian banks rank highly. All four major banks are among the ten most highly valued and rated banks in the world. The big four banks also have a strong grip on local banking markets. While regional and newer banks compete in the space, the potential for a disruptive competitor challenge faded in 2008 when Westpac consumed St George – at the time the fifth largest Australian bank. The dominance of the big four is likely to prevail for now.
Industry wide threats
However, there are a number of potential threats to the Australian banking industry that dragged the sector down by around 28% over the last year. These may divide into two main categories – credit concerns and threats from technology. The longer term question –“where does growth come from?” - is an issue financials share with many other stock market sectors.
For a closer look at Westpac's situation, see Ric Spooner's "Behind the Bank Sell Off".
An explosion of bad debts
The most commonly argued reason to sell Australian banks is that they are about to reap a tsunami of bad and doubtful debts. This line of thought usually comes from overseas. Most of the time, it is based on a structural misunderstanding of the Australian housing market. An example is the almost exclusively full recourse nature of local lending.
The current downward pressure on ANZ’s share price follows the announcement last week that the bank would increase its provisioning for the half year from $800 to $900 million. While not good, an investor selling on this news must expect that this is the first of many more, much larger provisions to come. Unlikely in my view.
In the USA, a borrower whose house has fallen in value below the amount of any borrowings can simply hand the keys to the bank, and walk away. This lack of recourse to the borrower’s other assets encourages default. In contrast, Australian borrowers are faced with responsibility for any shortfall. As demonstrated in the 1990-92 recession, most Australian mortgage holders will cut back on food before defaulting on their mortgage.
In the hedge fund community the short selling of Australian banks is known as the “widow-maker trade”. From 20112 to 2015, many hedge fund traders lost millions, and some their jobs, from shorting the banks. The slide over the last year has sparked greater confidence among the bears, but most trades are built around the idea that there is a bubble in Australian house prices. I demolished this argument last week (Blowing Housing Bubbles).
Despite being dead wrong for four years, bears are still pushing this line. The most recent example was the paid for research that relied on one ratio and a couple of anecdotes to make the argument, on behalf of a hedge fund with a large short position in Australian banks.
When reality bites, the debt explosion theory morphs to other forms. An example is the recent scuttlebutt that exposure to resource companies would start the fire, despite the facts – lending to resource exposed companies makes up around 2% of major bank loans.
Let’s be very clear. The actual bad and doubtful debt numbers do not in any way reflect or even support these theories. All of them are forecasts of disaster, without any direct evidence.
There are reasons to fear the longer term threats of technology. Whether in the form of threats to bank operations as long standing IT systems creak under the weight of ever increasing business, or competitive threats from new forms of finance such as crowdsourcing, banks are not immune. However, so far the harbour of incumbency has kept the big four safe. A threat for the longer term perhaps.
ANZ specific threats
Adding to recent pressure on ANZ shares is the disappointing results from its Asian operations. While each of the big four have different customer footprints domestically, it is their international operations (or lack thereof) that distinguish them. Once perceived as ANZ’s strength, its engagement with the higher growth economies of Asia failed at the tactical level. ANZ targeted the high volume, low margin areas of finance, effectively wiping away the benefits of a significant slide in the AUD.
Caught between value and implosion
The chart shows just how far ANZ shares fell after breaking the three year up trend. At current prices, ANZ has a price to earnings ratio around 9.5x, well below the ten year average closer to 12x. The dividend yield (including tax credits) is at 11%, based on the last two dividends. Earnings and dividends can change, but even a halving of ANZ dividends would put the dividend yield at 5.5%
Both of these measures indicate value in my opinion. The caveat is that an explosion of bad debt would change both measures considerably. Those who are forecasting disaster in Australian debt markets should avoid ANZ shares – but anyone else should have ANZ shares on their radar right now.