Week Ending 15.04.2016
Locally, March unemployment registered a slight improvement to 5.7% (26,000 new jobs). The composition was less attractive, with 35,000 new part time positions, offset with a 9,000 fall in full time roles. Hours worked therefore fell by 1.1% in the month. After much comment on the credibility of labour force numbers in the past year, the ABS is at pains to point out the impact of its sampling. In essence, the bureau has a rotating set of eight sampling regions. A new group replaces one every month to reduce the risk the sample becomes biased to a particular population cohort over time. In this rotation, the new group overall has higher part time employment and a lower level of workforce participation. While this is unlikely to be the sole reason for the March numbers, it reinforces that monthly data is far from the overall story.
The data below show the change in composition of the Australian working population over the last three years. Full time employment has risen by 2.3% over this time, while part time has increased by 8.4%. Males have been the primary cause of this trend, with a 14.4% increase in part time employment versus 1.2% for full time. Overall, the number of female workers has risen by nearly double the rate of that for males, and the balance between full and part time has only shifted modestly.
Change in Australian Working Population - Last Three Years
Not wanting to overplay the gender card, some of the details in the ABS release on youth employment are of interest. Of the 15-24 year old population in full time study, 46% of females have employment while only 39% of males take on a job; in both cases the skew is unsurprisingly to part time.
The average part time employee works about 17 hours a week, while full time averages very close to the standard 40 hours. The chart below (data from 2012, but unlikely to have moved substantially) shows the range of hours people say they work (or perhaps more accurately are at work!). Single hours are graphed between 30-40 hours.
Hours Worked Per Week, Proportion of Employed Persons
These trends go a long way to explain the current status of economic momentum. Wage growth is low as part time work is typically paid less per hour. With a higher proportion of part time workers, particularly in males, the perception of income security is lessened. In turn, the saving rate remains relatively high and spending is capped.
Comment on the housing sector is a regular feature in financial circles. In this week’s releases, lending to both owner-occupied and investor lending was up 3.8% month-on-month, reversing the trend of late last year. This would be unwelcome news for the RBA, which had presumably written its Financial Stability Report prior to that data set. The RBA noted the easing in investor lending as a key measure to reduce financial sector risk. APRA and the RBA have coordinated their efforts to slow investor loan growth and the RBA this week clearly stated that it would expect it to fall further.
The charts show the pressure points; high investor lending growth with skinny LVR’s and a large weight in interest only loans.
Housing Loan Characteristics, Share of New Approvals
In the same vein, the RBA expressed some concern on lending to property developers as a source of increased risk, citing the oversupply in apartments in some cities and weak commercial rent trends. It is therefore more than likely banks will ration new property lending, depending on their existing book.
Though short of detail (and many will argue, credibility) China’s first quarter GDP came in at 6.7%, nicely in between the recent central government meeting, where the target had been set as 6.5%-7%. While sceptics abound, there has been a pickup in property activity and in some industrial sectors. Even with a possible improvement in these areas, there will have to be more for it to achieve the goals. The financial sector contributed 1.3% to last year’s 6.9% GDP growth and looks less likely to do so again. Further, the authorities are well aware that private sector debt is a problem. Even the RBA Financial Stability Report included a lengthy comment on the risks in the Chinese banking sector. There is no easy path for China to achieve its high ambitions.
A true test of the accuracy of polling will come with the Brexit (Brittan to exit EU) vote on 23 June. Prior to confirming a voting day, the British presumably found it easy to say they would want to leave, given there was nothing to be lost. Since the referendum has been called, the actual decision has to be made and voters appear less certain. Even then, those that are personally asked (telephonically) seem less keen to express a desire for change than those that are anonymous (online), though that might also reflect on the type of person who does participate in telephone surveys.
Brexit Voting Surveys
The financial sector is clearly in favour of ‘remain’, but some companies have put a blanket ban on comment, stating that they do not want to be seen as taking sides. Others might argue that if financial firms are seen as in the ‘remain’ camp, it works against this outcome given the cynicism on the motivations of large financial organisations.
If Britain does vote to leave, the expectations are that the GBP will sell off further, though more than likely the Euro would be weak too, given political repercussions. The current weakness in investment spending would also likely persist given the uncertainty. Other repercussions will take a longer time to flow though. Perhaps the most damaging will be the potential for even greater instability in the Eurozone, already struggling with the migration issues, monetary policy and bank bad debts. Many use this backdrop to support the contention that the Eurozone will inevitably fail. That could prove to be the case as monetary unions have a poor track record. One could, however, also argue that these issues and others are just as problematic in most countries, not least the US where the current political climate cannot be seen as a positive for the corporate sector.
Fixed Income Update
As an extension to the new Basel III regulatory changes affecting the capital requirements for banks, APRA has proposed that Australian banks reduce their exposure to volatile short term funding from 2018. The new rules are aimed at increasing ‘capital cushions’ of the banks in the event of another financial crisis. To adhere to these rules, the banks would need to issue more longer-term bonds and term deposits.
While these measures are still a while away, pressure on bond margins is expected to continue. Funding costs for banks has increased in the last few months as credit spreads have increased. The average spread over the swap rate for banks and corporates in Australia is at a 2 ½ year high.
In light of the higher funding costs in the wholesale market, banks have stepped up their need for term deposits and are now offering more attractive rates. Spreads over the BBSW rate have increased this year, with margins moving from an average of 40bp over the reference rate to between 60bp and 100bp. Longer dated deposits offer the highest margin, with eight months to one year rates currently being the most attractive. ‘Special’ rate offerings are also coming more often, such as a one year deposit rate of 120bp over BBSW being marketed this week. The chart below illustrates the average current offerings of the major banks for term deposits as a comparison to the BBSW rate.
Term Deposit Rates vs BBSW Rate
Liquidity concerns in global bond markets has been topical for a while. However, in contradiction to this, the last day of trading in the March quarter in the US had the highest turnover of bonds in the last 11 years (since this data has been recorded). What is perhaps of more interest is that the trading is concentrated to a few super-sized bonds, as liquidity is focused on the larger issuers. In a $6.7 trillion investment grade bond market, the top 10 corporate bonds in the US (totaling $116.5 billion) accounted for 1/10th of the trades done in March. Like the US high yield market where a two-tiered market exists (energy and non-energy bonds), the investment grade bond market is showing signs of a dislocation, based on issue size. Below is a list of the most heavily traded corporate bonds.Enlarge
The Australian hybrid market has posted six consecutive days of positive gains to Friday. We noted the value in long dated bank hybrids in our publication two weeks ago, and the market obviously agreed, pushing credit spreads tighter and yields to maturity back below 8% fully franked (except CBAPD’s) on the majors.
Crown’s subordinated debt (CWNHA and CWNHB) have also moved higher over the week following a debt investor presentation last Friday. While the CFO gave no clarity on Packer’s intentions to privatise the company (which has been rumored for months and is responsible for the sell off in Crown’s listed bonds), he did re-iterate that Crown values its investment grade credit rating. This was supportive for both securities, with CWNHA securities rising 4% over the course of the week and CWNHB rising 2%.
Small cap food stocks experienced another bout of share volatility this week, including Blackmores (BKL), Bellamy’s (BAL), a2 Milk (A2M), Murray Goulburn (MGC) and Bega Cheese (BGA). After robust returns in 2015, companies in the sector have faced a more challenged period in the first few months of this year. There are two primary factors, firstly underperformance of high growth, momentum-driven stocks and secondly, increasing concerns over the opportunity available from the Chinese market.
As the table from A2M shows, the regulatory issues from China are broad, with several still to be resolved. The two that have been front of mind for investors this week are the taxation increase on e-commerce sales and a crackdown on what is known as the ‘cross-border’ channel, or grey market. This channel has grown rapidly over the last few years and involves Chinese nationals buying the products of these companies in Australian stores then taking them back to China to sell online for a marked-up price.
China Regulatory Issues Under Review
The impact that this change (which had been foreshadowed late last year) will have on the various stocks is expected to be quite different, although Blackmores would appear to be most at risk. In Blackmores’ half year report, the company estimated total sales to Asia of $170m for the period, with only $61m from direct channels, indicating a large contribution from the grey market. The developments over the last week across the industry are an important reminder of the risks that are often glossed over in individual equities when a particularly strong structural theme (Chinese consumption) is presented to investors.
Bendigo and Adelaide Bank (BEN) held a strategy day along with a trading update for the first quarter of 2016. BEN is looking to differentiate itself from its peers through a more intense focus on its customer relationships. While it may do well on this scorecard, the model typically translates into a higher cost to service, capping the margin outcome for BEN. An increased proportion of customers utilising digital channels also potentially puts BEN at a disadvantage given the lead that the majors have in this area.
Bendigo and Adelaide Bank has a unique product in the market called Homesafe, which is designed as an alternative for older customers to release equity in their home. The product that has traditionally been sold to meet this need has been reverse mortgages, which are essentially a loan against the equity in your home. Instead, Homesafe is an equity-release product whereby the homeowner agrees to sell a percentage of their home to BEN and receive a lump sum payment in return, with BEN then sharing in the capital gain (or loss) from that date until it is sold. While Homesafe has opened up a new market for BEN, it has now exposed the bank to house price movements in its earnings statement (as opposed to losses from bad loans that affect the rest of the banking sector).
Following slight declines in house prices in Sydney in the March quarter, the quarterly contribution from the Homesafe portfolio was a pre-tax loss (as a result of the decline in the mark to market value), and so a source of earnings strength for the bank has turned into a potential headwind heading into FY17.
Other broad banking macro themes will also have an impact, including benign lending growth (and BEN has been growing at below trend, see chart below), elevated cost growth, increasing funding costs and the potential for bad debts to normalise. Improvements in net interest margins have been better than peers following the repricing of mortgages, although the benefits have been marginal. Reflecting the challenges and risks, BEN currently trades on a discount the major banks, and BOQ is typically the preferred exposure of the two regionals among investors.
Bendigo and Adelaide Bank Lending Growth (Rolling 12 Months)
GUD Holdings (GUD) rallied strongly this week after announcing that it had sold the balance of its stake in the Sunbeam appliances business. The sale will generate $35m for GUD after the division reported an operating loss in the first half.
In the current weak corporate earnings environment, restructures such as this are likely to attract market attention given the reliance on this characteristic for respectable earnings generation. GUD has a further ‘problem division’ on its books, Dexion, which manufactures storage solutions for the industrial and commercial market, and so the exit of this business would likely also receive support. For investors, the question should be how the proceeds are going to be deployed in order to create shareholder value. GUD has historically had a mix of strong and weak performers across its portfolio, which puts a cap on the potential multiple that the market is willing to pay for the company as a whole. The appeal for some is in a solid yield, with dividends now growing after being reset across 2012-13.