Banks – Is The Worst Over? No.

By Greg Tolpigin | More Articles by Greg Tolpigin

I’ve been bearish the banks for quite some time and in fact my bearishness began well before the recent peak in property prices. I had been warning of the current market circumstances as far back as 2017 – in this column. I will put my hand up and say that the last few months have been difficult sticking with the short banks thematic as they have been grinding higher and from a charting perspective can be argued that they look attractive. Some brokers have started to upgrade their recommendations to “BUY” on the banks and believe that they represent value in and around these levels. I still strongly disagree.

Almost everything that I have warned about in this column over the past 18 months to 2 years have all largely come to fruition. We have had a peak in property construction, we have had a significant draw down in prices and this is all impacted consumer spending and economic activity. The ramification of this has been to be short the banks and avoid consumer-related stocks over the past two years. The question remains is this is the worst over?

I don’t believe it is for several reasons. Firstly a property boom that lasts more than two decades does not correct itself in just a 6-month window. Secondly, most people and I specify, almost every single economist did not believe prices would be going down and we would have an economic slowdown and that the next move by the RBA would be to lower rates. These economists and commentators are now starting to try and pick a low in the property market and suggest that prices will begin to stabilise and begin recovering into 2020. I can’t stress how strongly I disagree with this outlook.

The sheer amount of developments and property still to hit the market that requires settlement and in many cases buyers, is enormous.  An article this week in the Australian Financial Review highlighted that Atlis Property Partners which is the largest privately owned funds management business in the country is buying apartments in bulk at roughly replacement cost. That is, their purchase price is the equivalent of the cost of purchasing the land and building an apartment. Another way to look at this is approximately a 40% drawdown from recent peaks. Market prices are down 20% from the peak, but bulk purchases are occurring at an additional 20% discount! Sure some sales by developers are currently going through at only a 20% dip from the peak but these sales are occurring at 1 per month.  Snail pace.

As I continue to have extensive discussions with some of the most influential and largest players in the local property industry I get a completely different picture to which the banks would lead you to believe in their profit results. Each of the banks reported a severe contraction in Net Interest Margins and an increase in mortgages in arrears, as increasing consumers are stressed, budgets are strained – yet the provisions the banks are making for defaults continues to be very mild.

Everyone seemed to be focusing on the Royal Commission and the fact that most of this now past tense. The worst is over so they say. The Royal Commission was never ever a reason why I was negative the banks and to date all of the risks that cause me to be concerned 18 months ago still firmly remain. In fact, if you look back at the GFC in the USA we witnessed banks blindly refuting any issues with their exposure to the mortgage market – that everything was ok. You even saw during 2008 considerable recoveries in the bank share prices before ultimately all collapsing by mid-2008.

Now, I’m not calling a GFC style collapse here but I do believe there are far better investments and I certainly do not think we have seen the worst of the property fallout. This is why the Australian 10-year bond yield continues to make fresh new record lows. It is why Adelaide Brighton (ABC) issued a profit warning yesterday citing the slowdown in residential activity. Building approvals have plummeted 30%. And despite the 20% pullback in prices, valuations are still at astronomical levels no matter what financial yard stick applied.

Today we have seen infrastructure stocks like Australian Pipeline Trust (APA), AusNet (AST), Sydney Airport (SYD), Transurban (TCL) all have very strong breakouts or resumption of their trends higher. The yield crunch I have flagged since the start of the year is real and I have continued to push readers to be aware that this is the safest place to be – when looking for any meaningful yield. The yield on the banks cannot be trusted. NAB already cut it’s dividend and I do not believe that we can have one of the worst downturns in the Australian residential property market without the other banks cutting their dividend. I certainly do not believe any of the rhetoric about they’re look through of forward-looking statements at all and I find it mildly amusing that it is the actual banking economists and research departments that are out there pushing the worst is over story.

From all my contact in the property industry – the buyers and managers – not the developers or brokers, the banks have massive exposures to Tier 2 property developers (and I personally know which ones). Many of these banks are desperate to reduce their exposure. Much of the current focus is on how Mum and Dad investors are fairing. Very little conversation has been on the property developers and which ones are financially in trouble or will be in the next 12 months. More importantly, little has been done to quantify the bank exposure to property developers who still upwards of $1 billion still under construction. It is a huge and real risk and this is what will create a real earthquake in the industry.

What we have seen in the residential market is now starting to flow through to the industrial market where mum and dad investors have been purchasing off the plan industrial units with the expectation of using equity in their residential property to fund the purchase. Prices in the industrial market have been on a tear. Unfortunately these buyers had not gained prior financing approval and as a result are finding it difficult to settle. My contacts have specifically cited a rise in defaults on settlement on many of these industrial units.

I’m not a Debbie Downer, I’m a realist and specifically, I make my money from being able to predict these thematics correctly. Like I said 18 months ago I hope I am wrong but I am positioned financially in case I am right. II see no reason to deviate from that strategy and following more than two decades of butting heads with economists in investment banks the battle of who will be right still remains.

Greg Tolpigin

About Greg Tolpigin

Greg Tolpigin has over 20 years of experience as a proprietary trader and high-level strategist for the major investment banks including Citigroup, Bankers Trust and Macquarie Bank.

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