Short the Big Four Banks? Why One Hedge Fund is Doing Just That

The Big Four banks are long time darlings of Aussie investors. That won’t come as much of a surprise to you. Not least because the banking sector makes up 49% of the ASX index.

Banks haven’t escaped the stock market rout of recent months unharmed. But all told, things could have been worse. Commonwealth Bank [ASX:CBA] is the only big bank whose share price has fallen by more than $5 since August.

Yet the bears haven’t finished with the banks.

Today we learned that one Hong Kong hedge fund is taking short positions on Aussie banks. Kima Capital is betting on banking stock prices falling further in the coming months.

This gloomy outlook forms part of a broader picture of the Aussie economy. Alex Wallis, an analyst at Kima, shares concern that the Aussie property market faces a downturn. He says that, as this sector weakens, the Aussie economy may find itself in recession.

Australia is destined for a difficult recession at worst or a prolonged period of well-below-trend growth at best.

Neither turn of event would bode well for the big banks. Banks live and die by lending, much of which sits in home loans. Thrown in a property bust and recession, and you have a recipe for disaster. Arrears would rise as people struggle to make repayments. Bad loans and debts could sow the seeds of our very own 2008–style mortgage crisis.

If you’ve been following Markets and Money, you’ll know none of this is news to us. Our editor Greg Canavan wrote a report on the coming recession at the start of this year. I urge you to check it out here.

The evidence for a recession is building too.

Wallis listed many of the factors you’re probably familiar with by now. The commodity price bust. China’s slowdown and currency devaluation. Tighter global liquidity resulting from emerging market currency outflows.

All these factors are weighing on the economy and banks in equal measure. But banks have survived even bigger selloffs because of the property market. How? The boom in construction and lending growth has lessened the blows across big banks.

In any other circumstance, a banking sector crisis was a serious likelihood. Just look at Australia’s terms of trade (TOT) for instance.

The TOT is down 30% from peaks in 2011. This kind of collapse is a bad omen at the best of times. And it usually triggers banking crises, according to Wallis. But that hasn’t happened. At least not yet.

Yet Wallis thinks it’s on the way:

In the case of the former it is APRA in what I believe is a not-so-subtle attempt to prepare the Australian banking sector for a very challenging downturn, whilst the latter has been suppressed by capital controls.’

In other words, new regulations are cooling investor lending growth. As Wallis sees it, this will drag on total credit growth in the property market in the long run.

As far as investor lending goes, early evidence is positive.

The latest data shows investor lending growth slowed to 10.8% in the year to August. That’s still above APRA’s 10% imposed limit. But at least it’s moving in the right direction. As early as June, lending growth peaked at 11.1%.

But investors are only one side of the coin.

Lending to owner occupiers is on the rise. Loans to this segment grew at 0.6% in August, up 5.6% for the year.

This left total lending growth at 7.5% for the year to August. That’s the highest level it’s been since 2010.

So even as regulators and banks crack down on investors, they’re loosening the purse with owner occupiers. Which doesn’t suggest the housing market is on the edge of collapse just yet.

That might mean that Kima is acting premature by shorting the banks. Then again, as we’ve seen, stock markets change on a whim. What looks sure one day, seems less so the next.

What is clear however is that bad loans across banks are on the up.

Big banks and bad debts

You need good reasons to short the big banks. Investors stick with them because they bring stability to proceedings. From earnings, to profits and dividends, you know what you’re getting.

But it’s possible some investors have given banks too much credit. Take for instance the issue of bad loans across the sector.

ANZ [ASX:ANZ] is particularly exposed to lending in resource states. That’s worrying because WA, SA and Queensland are seeing rising arrears and bad debts. Wallis notes:

This inflection point in the banking cycle coincides with the transition — to nothing — from the resources boom which left Australia fighting all the legacy issues synonymous with Dutch disease.

In other words, we’re fighting against the legacy of the commodity boom. The one which heaped investment into mining alone. Which led to the dollar’s sharp appreciation. And which we’re now trying to fix by weakening the dollar.

And it’s why Kima Capital retains such a downbeat outlook on the banking sector. So much so that it expects shares will plunge further.

Selloffs may pick up as mortgage arrears increase, and once investors realise that credit growth has peaked.

ANZ has already faced the wrath of investors this year. Selloffs in ANZ shares picked up once the bank revealed a 32% rise in provisions for bad debts, to $366 million.

Commonwealth Bank is another that Kima Capital is keeping an eye on.

CBA has 18% of its $69 billion worth of loans in mortgages tied up in Western Australia. It also has $29 billion tied up in resource loans, making up 3% of its total credit exposure. Yet, as Wallis points out, this has gone unnoticed by most investors.

Whether you agree with Wallis probably depends on where you see the economy heading. At Markets and Money, many of our editors take a bearish position on the economy. But we also have different opinions on where the property market is heading.

Kima’s shorting the major banks because it sees a slowdown in home loan lending. One that could trigger a recession too. In such an event, banks would take a hammering.

Yet we need more clarity on where the housing market is heading.

Yes, investor lending is slowing, however slowly. But banks are making up for this by increasing lending to owner occupiers.

For that reason, the jury remains out on this one.

Mat Spasic,

Contributor, Markets and Money

PS: The Aussie share market had its worst month since 2008 in August. The ASX lost 9% of its value, shedding more than $70 billion.

Markets and Money’s Vern Gowdie saw this coming. He predicted the current market correction at the beginning of the year. But Vern says we haven’t seen the worst of it yet.

He’s convinced the ASX will lose as much as 90% of its market cap in the coming months. As China’s economic slowdown picks up pace, volatility will follow.

Vern is the award-winning Founder of the Gowdie Family Wealth and The Gowdie Letter advisory services. He’s ranked as one of Australia’s Top 50 financial planners.

Vern wants to help you avoid this coming wealth destruction. That’s why he’s written this free report ‘Five Fatal Stocks You Must Sell Now’. As a bonus, Vern will show you which five blue chip Aussie companies could destroy your portfolio.  You’ll be surprised to learn which banks make Vern’s list…

To find out how to download the report, click here.

Markets and Money offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, Markets and Money delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors.

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