Graham Harman
Following its recent long-term investing report, in which it urged investors to better diversify their portfolios in current market conditions, Russell Investments has honed in on the four Australian banks and questioned whether they are “worth the risk”.
A paper (view here), written by Graham Harman, senior investment strategist, says that many investors think they are diversified if they have Australian shares and property, but they are, in fact, hitched to the same wagon of mortgage lending because of the 28 per cent of the Australian sharemarket capitalisation accounted for by the banks.
Harman says there are three layers of risk with the banks: share price volatility; bank capital impairment; and risk of another financial crisis.
Bank stock prices have been volatile, with 20 per cent jumps in January and March given back in April and May. However, he says, we are probably at the bottom of the current zig zag.
Investors should realise that banks are geared at 15:1 compared with thye average 2:1 gearing of non-financial bluechip companies. This means that if housing turns down or unemployment gets worse the impact on shareholders’ equity will be 15-fold.
Harman points out that Australia’s banks tend to have a major solvency crisis every 20-25 years and the last one was in 1992. “Our banking system collapses, in 1974 and 1991, were out of sync with the rest of the world, which took its turn in 1982 and 2008,” he says.
The four “increasing areas of vulnerability” Harman’s paper identifies are: the housing market; government bonds; traditional margins; and disruptive technology. Questions about whether housing is in a bubble, especially in Sydney and Melbourne, are well known. The Russell paper adds that expected increasing interest rates in the US will have knock-on effects in Australia, one of which is share market valuations of yield-based securities, such as banks.
The paper says that two sources of more profitable activity for the banks – credit cards and currency exchange charges – are facing headwinds due to increasing customer conservatism and better pricing transparency.
Longer term, fintech developments make retail banking and home mortgage lending ripe for disintermediation. Harman says: “Amazon, PayPal and Google are growing consumer payments, SocietyOne is pioneering peer-to-peer lending, new mortgage providers are taking market share with superior processes and savvy consumers looking for competitive pricing and product choices are cheering from the sidelines. At the same time, cybercrime, scams and hackers are defrauding Australians of millions every year – and the banks are in many cases picking up the tab. In the process, both profits and confidence in bank security are being depleted.”