CONTRIBUTED ARTICLE by Sean Fenton*
Revelations at the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry have impacted many stocks, but the focus on responsible lending across the banking sector has the potential to drive wider ranging economic impacts.
The Australian housing market has already been softening following moves by APRA to limit interest only lending in an effort to contain runaway house prices. The tightening in credit availability and repricing of mortgages by the banks has seen a decline in auction clearance rates and house prices in nearly all capital cities. This dynamic is likely to be exacerbated by a tighter focus on responsible lending standards driven by the Royal Commission, particularly with actual expenses being scrutinised as opposed to unrealistically low expenditure benchmarks and more documentation around income. The likely reduction in loan sizes will further tighten credit availability and should lead to further weakness in house prices. This has obvious implications for the banks which are currently enjoying a record low level of bad debts but will also impact the economy more broadly.
The banking sector looks to be attractive on a superficial valuation basis as it’s trading at a material discount to its historical averages, but it could well be a value trap. Even without dire forecasts of a housing collapse, there will be headwinds from slower and maybe negative credit growth, an increase from historically low bad debt provisions, increasing compliance costs, increasing technology costs and increasing competition from FinTech. It is difficult to identify a catalyst for significant outperformance by the banks and the attractive dividend yields may come under pressure.
The Australian economy has been robust in recent years as low interest rates have boosted house prices and driven a construction boom. A recovery in commodity prices and increased government spending on public infrastructure have also helped to boost activity. At least part of this strength will be challenged by a tightening in bank lending standards. The price and availability of credit is probably the most important driver of house prices and there is also a strong correlation between house prices and building construction. Combined with mounting evidence of an oversupply of apartments in Brisbane, Sydney and Melbourne, particularly as overseas investors have stepped away from the market, the outlook for housing construction is looking decidedly soggy. This leaves us cautious on companies with direct exposure to construction such as property developers, real estate, building materials, hardware, whitegoods and furniture sales. A slowdown in housing also has implications for the broader economy as there are strong multipliers across employment and consumption. Negative wealth effects from lower house prices are a further headwind for consumption. We are wary on companies with exposure to employment, advertising and general retailing.
Of course, based on past form the RBA is likely to ride to the rescue and cut interest rates at some stage if things get too hairy. This would be particularly negative for the $A as the rest of world is in a rate tightening cycle. As such, companies with offshore operations are a good way to benefit from any $A weakness.
* Sean Fenton is director and portfolio manager at Tribeca Investment Partners
ARTICLE FIRST PUBLISHED IN THE AUSTRALIAN FINANCIAL REVIEW: https://www.afr.com/markets/sean-fenton-beware-the-royal-commission-effect-20180611-h117nx