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[LARGE CAPS] Safe as houses?

Jakov Males is the head of equities, Australia for UBS

Our portfolios' banks underweights are at the high end of recent ranges, with our concentrated strategies over 6% below benchmark weights. This is driven by multiple downside risks to mid cycle normal cash flows due to cyclical, structural and regulatory pressures. For businesses that are near to 30 times geared, this suggests a poor risk adjusted thesis.

While ~$20b in equity capital raisings have been digested, offshore regulatory developments and comments by APRA domestically, suggest ongoing pressure to strengthen balance sheets.

This will continue to threaten returns as will the negative margin momentum of the past five years. The latter (which has fallen from ~2.3% to ~2.0% over this period) has been driven by aggressive competition within the environment created by ultra-loose monetary policies. This together with the sacrificing of earnings due to efforts to rationalise diverse operations, are narrowing the sustainable coverage of the much demanded dividends from the sector. Some payout ratios are now well above 80%.

Although the above is known, even if their individual materiality is debated, where we differ from the market is on credit growth. We believe the indebtedness of the average Australian household (which has continued to grow since the GFC towards global highs of ~200% of disposable income), prices in the residential property market, the focus on investor (including foreign) participation and the lack of enthusiasm of businesses to invest and borrow, create doubt around the demand for credit going forward.

This is will be particularly challenging from the starting base given the massive historic growth rates of multiples of GDP pre-GFC and solidly low to mid-single digits since. For this reason we regularly ask the banks (including NAB's chairman just two weeks ago) whether they expect flat or even negative credit growth at some stage over the next 3 to 5 years.

This relatively bearish scenario does not require a residential property crash (which we believe has bubble characteristics). We believe torturously analysing this probability is a waste of time, just as it was endlessly debating whether China would land hard, all the while resource stocks were being hammered.

The point being that given the above headwinds and the leverage involved, a wholesale collapse in property prices isn't required for the banks to come under severe pressure. What is clear is that the key drivers of bank performance and liquidity are at abnormal levels.

Published on: Friday, April 01, 2016

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