At their current prices, are Bank Shares a good income investment?

Welcome to Finance and Fury, The Say What Wednesday edition

This week the question from Jayden – Are CBA and other bank shares a good investment for dividends at the moment?

Based around current price and un-updated yields – Based around prices and assuming dividends will continue to be the same – might say yes – end of the episode – thanks for listening – but wait – is there something else going on?

Start with

Some Banks are close to their post GFC prices – ex CBA – does this mean they are a good time to buy?

Few things happening – The Council of Financial Regulation – (the Council) is the coordinating body for Australia’s main financial regulatory agencies.

1. There are four members: the Australian Prudential Regulation Authority (APRA), the Australian Securities and Investments Commission (ASIC), the Australian Treasury and the Reserve Bank of Australia (RBA)
   1. RBA – Governor chairs the Council and the RBA provides secretariat support. It is a non-statutory body, without regulatory or policy decision-making powers
   2. Objectives are to promote stability of the Australian financial system and support effective and efficient regulation by Australia’s financial regulatory agencies.
   3. But they all have their part to play in controlling the financial system – in particular, APRA, RBA, and Treasury
2. Recent developments –
   1. QE – RBA is ready to purchase Aus Government bonds in the secondary market
      1. Between three entities – Super funds controlled by APRA, RBA who is doing the buying, and Treasury who is doing the selling of the bonds to the super funds on the primary markets
   2. Repo Market – RBA also conducting one month and three month repo operations in the daily market – until further notice
   3. Additional Repo market – conduct repo operations of six-months maturity or longer at least weekly, as long as market conditions warrant
   4. Statement – APRA is ensuring banking institutions pre-position themselves to take advantage of the RBA’s supportive measures
      1. Forcing banks to enter the repo agreements of exchanging their treasury notes for the injection of liquidity
3. Why? They say they are wanting to support the smooth functioning of that market, which is a key pricing benchmark for the Australian financial system.
   1. The Reserve Bank and the AOFM – The Australian Office of Financial Management is a part of the Department of the Treasury. It manages the Australian Government’s net debt portfolio – are in close liaison in monitoring market conditions and supporting the continued functioning of the market.
   2. Statements – Australia’s financial system is resilient and it is well placed to deal with the effects of COVID-19. The banking system is well capitalised and is in a strong liquidity position. Substantial financial buffers are available to be drawn down if required to support the economy.
   3. The RBA is trying to support the liquidity of the system – this is where repos come into it – giving the banks and financial system enough cash to survive
   4. As part of this support it will be conducting one-month and three-month repurchase (repo) operations until further notice. In addition, it will. The Australian Prudential Regulation Authority.
4. But the Government are the ones creating disruption to the whole economy –
   1. When they shut everything down and nothing happens – they will turn around and pat themselves on the back saying ‘good job’ we saved lives – whilst destroying livelihoods and further enshrining an autocratic financial system
   2. Interesting statements – “APRA and ASIC will take account of the circumstances in which lenders, acting reasonably, are currently operating during the prevailing circumstances when administering their respective laws and regulations. Both agencies also stand ready to deal with problems firms may encounter in complying with the law due to the impact of COVID-19 through a facilitative and constructive approach. In particular, each agency will, where warranted, provide relief or waivers from regulatory requirements. This includes requirements on listed companies associated with secondary capital raisings, annual general meetings, and audits. ASIC will also work with financial institutions to further accelerate the payment of outstanding remediation to customers as soon as possible.
5. Second Capital Raisings – The ability of companies to raise equity capital in the virtual absence of alternative debt issuance or bank funding
   1. Is seen as an important safety valve that enables companies to reduce debt exposure and shore up balance sheets
6. Something deeper is going on – A shortage of Dollars and funding mechanisms for the financial system – requiring the liquidity injections – all because the World has been hit with Margin Calls – $12 trillion – banking system is fragile
   1. Go back to 2009 – Fed’s emergency response during the GFC – which included credit facilities backed by corporate bonds and even shares – all the way to unlimited FX swap lines with foreign central banks – all of this was in response to a massive margin call that resulted in the aftermath of the Lehman and AIG collapse – as the conventional cross-border funding pathways froze up
   2. Therefore – this forced Central banks like the Fed to step in and flood the world with dollars to avoid a catastrophic surge in the dollar as the entire world scrambled to obtain the world’s reserve currency.
7. Post GFC – the BIS published a paper titled “The US dollar shortage in global banking and the international policy response” – explains how the then Chair Ben Bernanke bailed out the entire developed world’s financial system – due to facing the dollar shortage crisis due to the sudden deflationary shockwave unleashed by the GFC –
   1. At the same time – ground the global economy, and conventional dollar funding pathways to a halt
   2. While at the same time reached all-time highs in the counterparty risk after Lehman’s collapse and liquidity concerns compromised short-term interbank funding – short term loans to each of the banks – as banks didn’t trust each other – no longer would provide the contracts – why the repo market is so fragile at the moment – needing central banks to provide the funding instead of other commercial banks
   3. Wasn’t just USA – Aus and EU as well – the major European banks’ US dollar funding gap had reached $1.0–1.2 trillion by mid-2007 – but all liabilities to non-banks were estimated to be $6.5 trillion
   4. Essentially – an unprecedented crisis as a result of a global dollar margin call
   5. Had the Fed not stepped in with a barrage of liquidity-providing instruments and facilities, the rest of the world would have simply collapsed as the $6.5 trillion dollar funding gap closed in on itself – this triggered the first-ever launch of virtually unlimited dollar swap lines between the Fed and all other central banks – therefore the severity of the US dollar shortage among banks outside the United States, like Aus banks, called for an international policy response.
   6. Remember – central banks can provide their own currency – but they could not provide sufficient US dollar liquidity – which acts as the global currency reserve
   7. Requires reciprocal currency arrangements (swap lines) with the Federal Reserve in order to channel US dollars to banks in their respective jurisdictions – therefore as the funding disruptions spread to banks around the world, swap arrangements were extended across continents to central banks in Australia and New Zealand, Scandinavia, and several countries in Asia and Latin America, forming a global network
   8. The swap lines between the US Fed and RBA are there – along with the Reserve bank of NZ and every other major banks
8. Remember – ever since the financial crisis nothing has been actually fixed in the structural issues of the financial system – instead, the Fed and now other central banks inject more liquidity every time the system gets stressed – like now
   1. But all done through the issuance of even more debt, and kicking the can down the road whilst masking the symptoms of the crisis
   2. This liquidity upon liquidity has only made the system much more reliant on the Fed’s constant bailouts and liquidity injections.
   3. This can be seen by the events over the last few week – the dollar shortage is back with a vengeance, as confirmed by last week’s concurrent surge in both the Bloomberg Dollar index and the FRA/OIS spread – used as an indicator of interbank dollar funding availability.
9. As it stands – there is now – in JPMorgan’s calculations – a global dollar short that has doubled since the financial crisis and was $12 trillion as of this moment, some 60% of US GDP
10. Enter the Government responses to the novel coronavirus and subsequent oil crisis – has led to a historic run on the dollar – so the supply chains is a payment chain in reverse – an abrupt halt in production and economic output created by Governments extreme overreaction can quickly lead to missed payments elsewhere – multiplier effect – this is why we are seeing the combine rate cuts with open liquidity lines through Repo and QE and a pledge to use the swap lines

11. So the financial system is fragile – and the flow on effects from Governments are unknown at this stage – so Looking directly at Big 4 ASX listed banks–
12. Fundamentals at this stage and Capital raisings – shares listed

1. Looking at the bank shares – their prices and Shares issued –

1. Revenues – Might be further rate cuts – Banks businesses rely on lending – and as lending rates drop – so does their ability to generate a return
   1. Though many in the markets spent much of last year focusing on how lower interest rates would impact bank profitability, that problem seems somewhat less pronounced in the current environment of panic and future default potentials
   2. The Net interest margins – (interest income to interest paid out, as there isn’t anything paid out) – therefore this pressure may be overstated – the real threat to banks comes from the asset quality (loans) from a slowing global economy – bad debt charge forecasts for each of the major banks have been increased by $300M p.a.
2. Real issues comes from bad debts
   1. For example- WBC – increased their bad debt charge forecasts to $1,200 million – across FY20 and FY21.
   2. ANZ – increased by $300M to be $1150M for FY20 and $1200M for FY21
   3. Why you are seeing the Banks with Hold ratings on NAB, WBC and ANZ – CBA has Buy across a few brokers
      1. CBA is better positioned than the other big four to mitigate the impact of lower interest rates (even if its impact is overstated), a fact that potentially explains why the biggest of the big four has traded at a premium to the other banks in the last 14 months

Summary – Assumptions around buying

1. Long term – If the central banks can provide enough liquidity and that defaults on loans don’t become prevalent – yes – banks should recover in prices
2. Dividends – may have to cut from here – but still technically a good dividend payment even if a 30% drop – down to 7% FF in a lot of cases
3. I view bank shares as good-paying Term Deposits with Franking credits – don’t view them as good long term growth companies – competitive markets
4. But the prices from here – depending on the central banks kicking the can down the road – do have the ability to drop in further panic

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