Traditionally, one of the first share investments anyone in Australia ever makes is in one of the big four retail banks – ANZ, CBA, NAB, and Westpac. As kids, we were taught that banks ‘look after’ your money, pay you some interest as a thank-you, and then when you are old enough, will lend you a whole lot of money to follow the Great Australian Dream and buy your house.
What wonderful people they are, hey?
When you buy shares in the banks, you get a handsome dividend each six months too, and having seen on the nightly news just how much profit the banks make, what could ever go wrong owning bank shares?
Here’s what you need to know about banks
For a long time, the question of how banks make a profit has been pretty straightforward: they lend you and me money to buy a house at say, 7% interest and pay us about 2-3% interest on our savings. Then keep the difference; it’s a simple formula.
So far you haven’t learnt a thing here today – I get that. However, in a similar vein to Woolworths and their ill-fated foray into home improvements through Masters, many other companies also refuse to stick to their bread and butter, diving instead into other business opportunities. Why, I hear you ask?
They’re striving to constantly grow their earnings because that’s what investors like to see. Just as Masters was an epic fail for Woolworths, some of the banks’ efforts to diversify through building new businesses have cost them dearly. Don’t get me wrong, some have been a spectacular success as well, take CommSec, which CBA set up to conquer the online broking world, for example. What a great business!
Stay at home
There are lots of banks all over the world so why do domestic banks think they can succeed in other people’s backyards? Americans want to borrow from American banks, Londoners want to borrow from UK banks! Simple.
It’s the same with investment banking – why do retail banks think they can out do the deal doers in the investment banks? Let the retail banks look after the debt side of the ledger, and the investment banks look after the equity side. I think it’s quite arrogant to presume that because one’s bank has been successful in domestic mortgage lending, they can muscle their way into Asian or European markets and do the same.
A quick look at the relative performance of the banks over the last ten years proves my point – the banks that have stayed predominantly domestic have done way better than the ones that have ventured overseas.
Oil is a problem for banks
Banks obviously don’t just lend to home buyers, though. They also fund companies. And this is where I think the big problem is still ahead for our beloved banks. A lot has changed in the last few years on the business lending front, and it’s why I think the banks are no longer the safe investments they’ve always been.
If you read my last post on oil, you would remember I wrote about how when the oil price was surging, producers everywhere were getting $130/bbl. The inflated price brought a whole wave of new companies into the market, who set up oil rigs and started drilling for Black Gold. At the time, because the prevailing wisdom was that oil would always fetch $130/bbl, the $100/bbl production cost seemed inconsequential. Neither was it a concern that it might take a few years to start even producing – you see, oil prices were going to stay high forever. Or so the Oracles told us…
Who funded the gamble? Yep, the banks. Just like up until the Global Financial Crisis, they thought house prices would never fall. And so it was with oil… and iron ore, and copper, and so on….
With oil now sitting around $30-35, a lot of these companies are now blatantly uneconomic. And given that I don’t see oil going way back up anytime soon, I see no other path but a wave of company defaults and bankruptcies, which has to hurt the banks. Yes, their shares have already fallen from the lofty levels of 6 months ago, but I’m pretty sure we are still in the first half of the game.
And to my first golden rules of trading and investing:
- Always worry when a company moves away from doing what it does best.
- Don’t just buy and hold shares anymore, expecting them to rise in value each year. Even ‘safe as houses’ bank shares. The investing world has changed forever.
Rory (The Raw).
Disclaimer: you know this is conjecture and opinion don’t you? You won’t be silly enough to buy or sell bank shares or make any other profound investment decisions based on my opinion, will you? If you need specific, personal advice, please find someone who’s paid to give it and has all the right legal disclaimers. Ok?
Or ask me who can help you and I’ll find someone for you.