How exposed are Japanese banks to Antipodean asset values?

Yvan Berthoux - 13 September 2018

Japanese bank shares often appear attractive in valuation terms, such as price-to-book, but currently there is the added possibility that the Bank of Japan will relax its yield curve control (YCC) policy this year, leading to a surge in the 10-year JGB yield and in bank profitability. However, there has been an interesting co-movement of Japanese and Australian bank return indexes in recent years, suggesting a closer connection between their fortunes than is commonly imagined. Over the past 18 months, Japanese bank performance has been more closely aligned to that of Australian banks than to the slope of the Japanese yield curve. While the fate of the Australian and New Zealand residential property markets might be considered a remote concern for Japanese banks, hidden dangers may be lurking in the shadows.

The stratospheric appreciation of housing assets in certain Australian and NZ cities in recent years is legendary: economists and commentators have warned that these valuations are untenable for many years. According to the Australian Bureau of Statistics (ABS) estimates, the property market in Australia is worth US$7tr, by far its largest asset. House prices in the main cities have seen an incredible rise over the past 5 years (figure 2, left frame), with the top two winners up 75 per cent (Sydney) and 60 per cent (Melbourne). Sydney has one of the highest median house-price-to-income ratios in the world, currently standing at a multiple 12.5 according to some estimates. With the housing market on the rise for more than 40 years, the loan to income ratios are currently close to double their long-term average, leaving the household debt to disposable income at roughly 200 per cent in Australia, up by 40 percentage points in the last decade.

Our leading economic indicator, formed from a variety of price data and surveys as inputs, shows a significant divergence from the real economy, painting a more challenging picture for the 6 to 9-month outlook in Australia (figure 2, right frame). A sharp slowdown in the economy would definitely cap property performance in the medium term and raise doubts on the property outlook for the coming year. Many have questioned the sustainability of this market, and therefore investors have looked at different ways of speculating or hedging against a sudden reversal in the Australian housing market. However, it has not been an easy process such as in the US in 2007, when sell-side institutions offered different sort of products to their clients or investors could also short homebuilders (i.e. Toll Brothers, Lennar Corp.) The question now relies on which is the asset that will suffer the most in case of a property market slowdown (a process known as shorting the second derivative).
 

The two main ways of shorting the housing market are to short the Australian Dollar or to short the Australian banks. With house prices at extremely high levels, analysts have been speculating that the documentation on the standards by which the mortgages are issued has been either poor or fraudulent. Hence, the establishment of the banking royal commission last December, whose goal was to investigate whether any of Australian’s banks and financial services entities have engaged in misconduct or criminal proceedings, could accelerate a reversal.

With banks’ mortgages equivalent to roughly 80 per cent of GDP (figure 3, left frame) with no loan loss provisioning as default rates have been close to zero, investors have considered that shorting the banks offered an interesting asymmetric payoff even though Aussie banks are known to pay interesting dividends. In addition, tighter lending standards combined with the recent imposition of taxes on foreign buyers of real estate are deigned to trigger a deceleration in the property prices.

We have seen that in most of the developed countries, decelerating or contracting excess liquidity is usually followed by a poor performance in the equity market, especially for the financial sector that tends to act as the barometer of the country’s economy. Is it time to join the dots from Australia to Japan?


Figure 1: documents these co-movements. 

Data source: Eikon Reuters

Figure 2

Data source: ABS, Eikon Reuters, Economic Perspectives 

Figure 3


Data source: Eikon Reuters, Economic Perspectives



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