Ken Henry – on the money

Treasury head honcho Ken Henry raised a bunch of interesting points in his talk to the Australasian Finance and Banking Conference yesterday.  A transcript is available here and is well worth a look.

On the currently vexed issue of bank lending margins Henry does what relatively few commentators have done and simply ties the matter back to the overarching issue of what return on equity they need to be driving.  This seems pretty reasonable – given that the banks have good cost control (and they do) and are getting their funding on the cheapest terms they can find (and they do, within the confines of their debt maturity and duration requirements) the single biggest factor driving their loan rates is how much return they need to get.

Henry makes the point that banks have averaged around 15% ROE since 1992, and poses the following question:

Is a 15 per cent post-tax rate of return on equity too high or too low?

It’s a good question, and one I’ve mulled over many times (here and here and here).  However, I’m not so sure about Henry’s follow-up:

One way of answering that question is to say that it cannot be regarded as too high if the industry is sufficiently competitive; if the provision of banking services is sufficiently contestable. And that is one reason why there is so much focus on banking competition.

The reason I’m not sure about this relates to the 8 year period between 2000 and 2007 – surely a time of unprecedented competition in the finance and banking sector as credit markets eased sufficiently to allow the non-bank lenders to run amok and the banks to cut both margins and lending standards, in the process piling on huge lending volumes.  The big four banks managed averaged a whopping 18.7% ROE (after tax) over these years, while 10 year Govt. bonds averaged just 5.7% (pre-tax).

If returns of nearly 19% were reasonable back then, surely 15% is very reasonable now.  Trouble is, I don’t think either of those statements is correct.

So, while Henry hasn’t provided any answers to this difficult question, he’s doing more than most by asking the question in the first place.

Low Doc Loans? Ship ‘em in!

Given that the AOFM’s RMBS purchase program seems to be a growing in importance, I thought it might be useful to see what sort of mortgage backed securities they are able to buy.  I found this in a September 2010 investor presentation:

Low doc loans?  10 year I/O loans?  Once upon a time the AAA rating requirement would have dispelled any concerns about these types of instruments, but I thought those days were long gone.

The AFR–size does matter

I see David Llewellyn-Smith over at the “Houses and Holes” blog is having a good spray about the quality of AFR journalism.  On a related topic, some years ago I attempted to find another country whose major financial newspaper appeared in tabloid format.  WSJ? No.  FT? No.  Nikkei? No.  Luxemburger Wort? No.  The wonderful Svenska Dagbladet? No!

Is this still the case?  Have those wacky Luxemburgers gone tabloid on us?

There’s clearly more to tabloid journalism than the shape of the paper, and I for one felt that the mighty organ that is the AFR took a turn for the worse as soon as it changed from a broadsheet orientation.

November rate moves – almost an even money bet

Amidst all the shock and horror concerning the RBA’s surprise rate increase on Melbourne Cup day (and the attendant hysteria when CBA subsequently chimed in with a 0.45% increase in its home loan rate), it’s worth reflecting that over the last 20 years the RBA has changed rates in November almost as many times as they’ve left them alone.  In nine years out of the 21 they’ve changed rates in November (six of these have been rate hikes), including the last 5 consecutive years.  In fact, the last time the RBA left rates alone on Melbourne Cup day Makybe Diva was still showing the competition a clean pair of heels (2005).

Looking at the data, it’s fairly clear that November and December are the prime season for rate changes, presumably owing to the proximity of Christmas and the immediate impact on spending.  Contrast June – one rate move in the last 21 years (a hike to 4.75% in June ‘02).  What’s that all about?  Do they hibernate in winter?  There’s been more activity in January, and the RBA stopped meeting in January donkey’s years ago.

Rates-defiant CBA boss Ralph Norris takes swing at populism

Sir Ralph has come out swinging to defend CBA’s decision to follow the RBA’s Melbourne Cup Day 0.25% rate hike with a 0.45% rate hike of their own.  Not exactly surprising given that they’ve been banging on about their cost of funds rising 2bp every month, but the hostility to the reaction has certainly been surprising.  The other lenders all appear to be ducking for cover, letting the CBA wear all the flak, as normally the majors would have all announced their rate move by the Friday following the RBA meeting.

Ralph’s position is covered in the Oz here.  He also gets some help from former CBA head-honcho and current Future Fund chairman David Murray, who went on to make the following observation:

As to the suggestion that major bank profits - about $22 billion for the 2010 financial year - were too big, the Future Fund chairman said the banks needed to make a 15 per cent return on equity to fund the expansion of the economy.

One of the things I’ve never been able to figure out about banking is why they need to make a 15% post-tax ROE (or in the good old days, 20% plus) when the risk free rate was 5% or 6% (and that’s pre-tax).  I’ve pondered this before (see Keynes Mark II and Banks’ ROE), and I’d have to say that Murray’s comments don’t really shed much light in the matter.

Bank ROE – back to 20%?

Stephen Bartholomeusz in today’s Business Spectator:

Like NAB, ANZ has lifted its overall return on equity, to 13.9 per cent versus NAB’s 13.2 per cent, although ANZ achieved an ROE of 15.5 per cent in the second half. To put that in perspective, before the financial crisis ANZ was generating ROEs slightly above 20 per cent.

…

The big difference between ANZ’s metrics in 2007 and its metrics today, however, is that big discrepancy in the returns on equity they yield. That’s because pre-crisis ANZ’s tier one capital ratio was 6.7 per cent and today it is 10.1 per cent.

It is the pressure to return to ROEs in the high teens that does pose some threat of oligopolistic behaviour. While there isn’t any strong evidence of that in the three full-year banks results tabled so far, the level of concentration in the system means it remains a risk.

That’s why the focus of any debate about the intensity of competition in the system ought to be forward-looking and structural – it needs to focus on how to make the remaining regional banks more competitive and how to bring the non-banks back into the market – rather than populist bashing of the banks for highlighting the reality of the margin pressures they are experiencing today.

Once again I pose the question – why should banks be targeting ROEs in the high teens?  This has never made sense to me, and makes even less sense now, when the banks are more highly capitalised than they used to be, more stringently regulated, and have just demonstrated their “too big to fail” tag by getting the benefit of a government guarantee the moment they started to look a bit wobbly.

How can this massive margin to the risk free investment be justified?

Bendigo Bank, Suncorp and the Snout/Trough Index

Just to prove size is no impediment in the snout/trough world, Bendigo Bank’s 2010 annual report reveals an impressive 25 page remuneration report (making up 74% of the total Directors’ report).  Suncorp not quite as impressive at 22 pages (69%) but still well ahead of CBA’s lamentable 19 page effort.

Suxteen mullion reasons to smile

CBA supremo and expatriate kiwi Sir Ralph Norris is reportedly “enthusiastic” about CBA’s prospects.   Given that this revelation has come just a few days after details of his 75% pay rise (to $16m) were made public, I would have hoped for something a bit more expansive.  In fact, as a CBA shareholder* I demand it. Surely something like Tom-Cruise-on-Oprah wouldn’t be amiss.

I can’t help thinking that this may change the Snout/Trough picture next year.  Believe it or not, CBA’s recently released 2010 annual report shows a decrease in the size of its remuneration report – a meagre 19 pages (down from 21 last year) which constituted just 67% of the total directors’ report (2009: 75%).  Any bets on how many pages the 2011 remuneration report will have?  They have a long way to go to catch Macquarie (60 pages!) but you have to start somewhere.  See the other 2009 Snout/Trough numbers here.

 

* Disclaimer: the Weatherman owns CBA stock and (in contrast to much of his portfolio) is not too embarrassed to admit to it. 

2009 Snout/Trough Award

No surprises regarding which bank has again strolled off with the prestigious Snout/Trough Award, recognising both excellence and verbosity in the preparation of remuneration reports.  Yes, it’s Macquarie Bank, which again mustered an incredible 60 page remuneration report to dazzle investors.  This year their Directors’ Report totalled 73 pages, so remuneration only made up 82% of what they wanted to say (2008: 90%).

Although it’s a thumping win (the next best was just 30 pages) it’s pleasing to see a couple of the majors starting to get onto the spirit of the thing.  NAB upped their quota from a meagre 19 pages to 28 pages, while ANZ went from 22 to 30 pages.

Unbelievably, CBA have added a mere 1 page to its 2008 remuneration report, and now rightly find themselves in the cellar.

Results for 2009 were as follows:

	Remuneration Report (# pages)	Remun. Report as % of Directors’ Report
MBL	60	82
ANZ	30	88
NAB	28	74
WBC	23	62
CBA	21	75

Results for 2008 can be found here.

ANZ – the curse of the Bambino?

ANZ’s spectacular fall down the tipsters’ league table continues apace.

Bear in mind that ANZ were leading this competition less than two years ago, neck and neck with my own erstwhile team, with daylight back to the others:

Contrast that with today’s chart:

So what’s the reason for the dramatic fall from grace?  Could it be “the curse of Saul Eslake”, in the same way that “the curse of the Bambino” plagued Boston after Babe Ruth was traded to the Yankees?  

Looking at the data, in September 2008 everyone got it spectacularly wrong, as the severity of the GFC and the scale and speed of the monetary policy response took everyone by surprise:

Sep ‘08 Forecasts	Dec ‘08	Mar ‘09	Jun ‘09	Sep ‘09
ANZ	6.75	6.75	6.50	6.25
Citibank	6.75	6.50	6.50	6.50
Actual Cash Rate	4.25	3.25	3.00	3.00

Variances of 3.5% between forecasts and actuals are obviously going to knock the stuffing out of the results (compare the scale of the 9/08 table with that of 6/10) but don’t explain the relative difference between ANZ and Citi.  For that we need to look at the mid-‘09 forecasts.

Jul ‘09 Forecasts	Sep ‘09	Dec ‘09	Mar ‘10	Jun ‘10
ANZ	3.00	2.50	2.50	2.50
Citibank	3.00	3.25	3.75	4.25
Actual Cash Rate	3.00	3.75	4.00	4.50

It’s here that we find the answer – ANZ’s dyspeptic view of the world persisted longer than others, leaving it exposed to 1.50 – 2.00% variances.  Given the “squared error” approach to variances that the Weatherman prefers, this has had some fairly dramatic consequences for the overall score.  Oh, and as Saul wasn’t traded until August 2009 it’s fair to say that the rot had already well and truly set in, so forget about the curse!

Stagnating House Prices

The price of something rises 0.5% in a single month, and this is thought to be stagnant?  Is it possible that our expectations for house prices are now such that anything less than double figures p.a. is disappointing?

Macquarie GSM – Climb when Ready!

In recent times the mysterious world of marketing has embraced rock climbing as a means for projecting aspirational things.  They get it wrong a fair bit of the time, but the effort from Macquarie Graduate School of Management in today’s AFR was really noteworthy.  I particularly liked the top rope – so much for leadership!  As for the jumar dangling from his harness, I guess all good execs have an escape strategy.  As for the pile of choss he appears to be climbing, the less said the better.

Tipsters’ table – updated

Westpac’s Bill Evans has finally been tipped out of the top spot in the cash rate forecasters table, after 12 months at the top. Citi have now grabbed the mantle while ANZ continue their post-Eslake slide. 

Also of note is the continued improvement in the DIX index, which measures the standard deviation of cash rate forecasts amongst different forecasters.  It’s starting to trend back towards its long-term average, which indicates that the economists are once again starting to sing from the same hymn sheet.

解百姓住房难必先除权力自肥

The Chinese have the right idea!

That roughly translates as:

 To Solve The Populace's Housing Difficulties We Must Root Out Self-Enrichment By The Powerful

Read all about it here.

Gordon Gekko meets Jake & Elwood Blues

See how “greed is good”      

 

Evolved into “greed is God”

 

As Jake and Elwood would say, they’re on a mission from God!

Whack-a-banker

The new Space Invaders….

Olá Portugal

Latest sovereign risk credit default prices show a massive spike in Greek risk, which is hardly surprising, but what did surprise me was the extent to which Portuguese risk dipped below the price for sovereign US risk back in early 2009.  I know things were pretty rough back then, but under what circumstances could this possibly make sense?