Australian banks, like their global counterparts, have had a good run since the US presidential election. Australian banks however face a number of headwinds and in response to these challenges have repriced mortgage books but their risks remain inexorably linked to the Australian housing market and their significant exposure to household leverage/indebtedness. This poses a risk for Australian equity investors as the big 4 banks comprise 29% of the S&P/ASX 200.

Australian banks, like their global counterparts, have had a good run since the US presidential election. The term “Trump Trade” has been used to describe the gains markets have made since Trump’s election.  These have included rises in US sectors such as energy, materials, industrials and financials.  In Australia, banks have benefited since 11th November 2016 and they came through the recent reporting season relatively unscathed despite warnings of slowing credit growth, higher funding costs, reduced net interest margin and warnings about bad debts.

However with these recent rises there is reduced valuation support with current P/Es trading above their long term average. 

Performance MVW resized CHART 1 UPDATED

LHS: Morningstar Direct as at 5 April 2017.  Results are calculated daily and assume immediate reinvestment of all dividends. Results are net of management costs but do not include brokerage costs of investing in MVB. Past performance is nots a reliable indicator of future performance.

RHS: Factset

Bank Headwinds: Regulatory changes

Currently, interest-only lending represents ~40% of total residential loans. APRA’s recent move to limit interest-only lending flow to 30% of total new residential lending will impact future credit growth.   Furthermore, there are Loan to Value Ratio (LVR) restrictions on interest-only lending being introduced with APRA opting to keep the 10% investor lending growth cap.  A sizeable proportion of new housing lending in recent years has been done at initial LVRs greater than 80% (~30%) and even more alarmingly ~10% is still done at LVRs greater than 90%.

Performance of MVB since US election v2

In an environment where interest rates are at record lows and housing debt to income is at record highs, Australian banks are exposed to any shocks in the housing market.  According to the most recent banking statistics released by the RBA, loans to domestic housing investors make up between 40% and 60% total loans by Australian banks, with approximately 85% of these held by the big four banks so any fall in house prices and the ability of borrowers to service debt could impact banks.  This fear of defaults is highlighted by Australian household debt which looks high relative to history and similar developed markets.  In contrast, the US and UK household debt to GDP has been falling since 2010 but in Australia household debt has surged.

Performance MVW broker note - CHART 3 (resized)

The RBA and the Federal Government have expressed concerns that growth in household borrowing is outpacing growth in income and that standards needs to be enforced. RBA governor Philip Lowe has also criticised the banks for lending to borrowers who have “the skinniest of income buffers after interest”. Aware of these risks, banks have repriced mortgages and deposit rates however they remain exposed.

Most Australian equity portfolios have a significant exposure to the big four banks which represent 29% of the S&P/ASX 200 Accumulation Index. If there is a derating of the banks, such as there was in September 2015 as the banks raised capital to increase capital buffers this would see the S&P/ASX 200 dragged down as it was in 2015.

Performance MVW note - chart 4

You can avoid concentration risk in the big four banks while maintaining marginal exposure using VanEck’s Australian Equal Weight ETF (ASX: MVW).  MVW equally weights Australia’s largest and most liquid securities and is underweight Australian banks by ~23% compared to the S&P/ASX 200. MVW recently had its third anniversary and has outperformed the S&P/ASX 200 Accumulation Index by an average 3.86% p.a. over three years to 31 March 2017 returning 11.39% p.a. compared to 7.53% p.a.

Performance of MVW - chart 5

IMPORTANT NOTICE: This information is issued by VanEck Investments Limited ABN 22 146 596 116 AFSL 416755 (‘VanEck’) as responsible entity and issuer of the VanEck Vectors Australian Equal Weight ETF (‘Fund’). This is general information only and not financial advice. It does not take into account any person’s individual objectives, financial situation or needs. Before making an investment decision in relation to the Fund, you should read the PDS and with the assistance of a financial adviser consider if it is appropriate for your circumstances. The PDS is available at or by calling 1300 68 38 37. The Fund is subject to investment risk, including possible loss of capital invested. Past performance is not a reliable indicator of future performance. No member of the VanEck group of companies gives any guarantee or assurance as to the repayment of capital, the payment of income, the performance, or any particular rate of return from the Fund.

MVIS Australia Equal Weight Index (‘MVIS Index’) is the exclusive property of MV Index Solutions GmbH based in Frankfurt, Germany (‘MVIS’). MVIS makes no representation regarding the advisability of investing in the Fund. MVIS has contracted with Solactive AG to maintain and calculate the MVIS Index. Solactive uses its best efforts to ensure that the MVIS Index is calculated correctly. Irrespective of its obligations towards MVIS, Solactive has no obligation to point out errors in the MVIS Index to third parties.

Published: 09 August 2018