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04 May 23 Insight Fixed Income Challenger Investment Management

Dividends are not the most important metric this bank earnings season. This is.

Investors have been told repeatedly by regulators that 2023 will not be 2008 all over again. Since 2008, more banking regulations and quicker central bank intervention has made the industry a little tighter. But between the end of the Global Financial Crisis in 2009 and 2023, interest rates never rose above 2.5% in the US and 5% in Australia.

In other words, monetary policy settings were not reset to normal after 2009 and remained that way for the best part of 13 years. 

Now, interest rates are rising but banking competition is still stiff and contagion is as much around now as it was in 2008 (perhaps moreso now thanks to social media).

So why are officials so sure we won't see history repeat itself - and are they too sure of themselves?

In this edition of Expert Insights, I sit down with Pete Robinson of Challenger Investment Management to discuss the investable lessons of the last few weeks.


LW: How are Australian banks more resilient compared to overseas counterparts?

Robinson: I think there's three things, and number one is profitability. For a long period of time, our banks have consistently ranked pretty high when it comes to things like return on equity and net interest margins, so the banks are raging from nine to 14% in terms of ROEs, NIMS in the mid ones, and that's certainly a lot stronger than some of the European banks, broadly in line with the US major banks over there. Yeah, pretty strong profitability.

Number two I think is, we all know Australia is an oligopoly, so all the banks are regulated accordingly, but there's, I guess, two elements to that.

One is that higher level of regulation and the unquestionably strong standard of capital that they have to hold, but two, the fact that the banking system is arguably less competitive here, which allows the banks to be more profitable. I think those are the key things that differentiate our banks from the banks offshore and some of the situations that we've seen of late.

LW: What is the most important implication of the SVB and Credit Suisse crises?

Robinson: I think it's fascinating because they failed for two very different reasons. You had Credit Suisse, which was a bank that really was the poster child for struggling to generate any profitability off its capital base, and ultimately its investors lost confidence with that and that ability to return to profitability.

The SVB situation was completely different. Really that was about the composition of its customer base and also the way it hedged its interest rate risk in a rising rate environment, but underpinning both of those things is the word confidence.

Banks don't fail because of capital reasons. Typically they fail because of liquidity reasons. What we saw in both cases was a crisis of confidence. Deposits left the system and ultimately regulators had to intervene.

To me, the big lesson coming out of that is that deposits can move very quickly. This is a constantly evolving thing.

As the greater the technological advances that are happening within the banking system, deposits are going to be able to move ever faster across the system. We had over 40 billion dollars withdrawn from Silicon Valley Bank in a day. I don't think any bank is immune to those risks, and certainly I think from an Australian perspective, one of the big lessons I hope that we don't forget is that this is not a story of Australian exceptionalism here. Every bank is exposed. May be a different risk, it may be a different reason, but everyone is exposed to a crisis of confidence, and we should bear that in mind.

LW: What is the biggest reason for and against 2023 being a repeat of 2008?

Robinson: 2008 was an emotional rollercoaster for those of us that were involved in markets in those days. I think the epicentre of that was the subprime market where we had, call it US US$350-400 billion worth of losses.

Now, I think in terms of the for argument, why this could be a little bit like the GFC, if you look at commercial real estate, we've got about three and a half trillion dollars of lending outstanding.

Now, it is possible when you look at the underlying fundamentals of that asset class, you've got vacancies in the US in office space over 20%, you've got around 13% in Australia, and both of those are still rising, set against this higher interest rate environment and really a higher credit spread environment, so a tougher financing environment.

You could see significant losses coming out of that sector and those losses in an aggregate sense, and they could get close to what we saw during the subprime crisis.

I think on the against side of things, the reality is we have a much larger financial system as it stands here today.

While it sounds like a large number, it's not the same size as it was in 2008. We've also got a banking system that is much better capitalised, with much stronger regulation across the system.

I think actually the outcome of what we've seen from the SVB and Credit Suisse crisis is, and I hesitate to use the word crisis, but those bank failures, is that the system has absorbed them and the regulators really responded quickly. The playbook this time around is really well written, well-defined in terms of regulators and central banks responses.

LW: What will you be looking out for in the next set of bank earnings?

Robinson: To me, confidence is driven by profitability, so I'm focused on the net interest margin of the banks and that that's really the driver of their profitability. Provisions will eat into NIMs, but it's that balance between deposit pricing and mortgage pricing, I think, that that is driving things.

We've had intense competition on the mortgage side, significantly less competition on the deposit side, which I think can come under some scrutiny given where the pricing is in a relative sense.

Banks have not passed on the rate hikes to depositors and how long they can sustain that without that leading to withdrawal of deposits from households and non-financial corporates is an open question I think.

Access to income and capital stability

Pete's Fund aims to provide clients with capital stability and income on a regular basis accompanied by lower levels of volatility than traditional fixed income strategies.