The Great Bank Robbery

The Great Bank Robbery

As the economy tanks,
The states join the federal ranks.
They’ve run out of dough;
They’re desperate, so
They’re legally robbing the banks.

I would like to state at the start of this essay that it is in no way to be construed as financial advice, (see a licensed financial adviser or do your own research when making investment decisions) and to state also, in the spirit of full disclosure, that I do own bank shares, as indeed do millions of Australians either directly or indirectly through superannuation policies – I am not a bank shill and don’t believe the banks should be immune from scrutiny and criticism and, if necessary, punitive action when they err. I believe however, that bank-bashing (the great Australian sport) and bank-robbing are both counterproductive in the long run.

Nothing demonstrates better the true nature of both the Australian government and the opposition then the recent imposition of the bank tax, or as they prefer to call it: “the large bank levy.” The tax is selectively applied to the five major banks, and at this point in time is not applied to the smaller banks or overseas banks, clearly putting the major domestic banks at a competitive disadvantage. The monies raised will no doubt be used to plug a small part of the fiscal hole created by wasteful spending – it is a short-term band aid measure and just kicks the debt can down the road a little further. Of course the opposition supported the move – they are well aware that the general public (also known as the voters) overwhelmingly hate the banks. The Liberal government, under the Prime ministership of the super-wealthy ex-merchant banker and lawyer, Malcolm Turnbull, has demonstrated once again that it is a Social Liberal government and has abandoned completely its ties to its Classical Liberal (almost the polar opposite) roots. It is a left of centre socialist government while the opposition Labor Party is far-left and the Greens (their strange bedfellows) are extreme-left – everything has shifted left over the past couple of decades. Now the state of South Australia has decide to impose a bank tax of their own on the same banks and no doubt other cash-strapped states will do the same. Both the feds and the states are running out of money (actually they ran out of money quite some time ago, but are now running out of credit) and have had to go into the bank-robbing business – they don’t have the courage to cut spending so have to get the money from somewhere – in the tradition of Ned Kelly they have figured out that you can’t rob money from people who don’t have any – the banks are the obvious target.

These are the same banks of course who were widely congratulated (for a short time) some eight or so years ago for saving us from the Global Financial Crisis (GFC). Our majors, unlike so many banks in the US and Europe, had not got embroiled in the sub-prime fiasco – sure the NAB had a relatively small exposure and the ANZ even smaller, but overall the banks had been extremely cautious, even to the point of being criticised by some commentators for not getting in for their share of the pie. Had it been otherwise, then Australia, like the US and Europe, would have been plunged into recession and worse – but that was eight years ago, so is mostly forgotten – the banks once again are the targets of public anger and thus it is politically safe, even advantageous, to rob them.

Ok, you say – so what about the fact that the banks are making super-profits? (I disagree with this term but will use it for the sake of the exercise) In the tradition of banana republics, shouldn’t we take this excess money that they are hoarding (or giving to their greedy shareholders) and give it to the poor. (i.e. the people who don’t own bank shares). Well let us first examine in a simplified but logical and unemotional way whether the banks are making super-profits.

Most sane people would agree that a profit is a good thing – after all, the money you have left on payday after paying your tax and work expenses is your profit. If your expenses exceeded the amount you were paid then that would be a loss and you would be going backwards financially. So profit (unlike what the extreme left say) is good – we have established that fact by logical analysis. It is therefore good that a corporation must make a profit to be viable just as any business large or small must. Let us then examine record profits. Because of inflation, an individual or a business large or small must make a record profit each year or they are going backwards – this is simple grade three (or is it two?) mathematics. An individual will need more money (because of inflation) to meet the costs of living – in simple terms, a corporation will need to grow and also distribute an increased dividend to its shareholders so that they can meet the increased cost of living. Of course with both individuals and businesses it is more complicated than that, as profits may be saved and reinvested – banks also are in the process of increasing reserves due to new banking rules, but let’s keep it simple.

Some individuals, businesses and corporations that are involved in cyclical industries have to make super-profits from time to time. Examples are farmers or miners – a farmer may make no money for two years and then have a bumper harvest when prices for his product are high – he makes a lot of money; (a super-profit) he pays off his debts from the lean years and if lucky has enough to put some away for the future bad times. A mining company will on average enjoy high prices for its commodity about three years out of nine, so must make hay while the sun shines – again its profits must be very high during the good years in order to create a cash buffer.

So we come to the banks and their profits. The banks are cyclical, and from an investor’s point of view relatively risky. (the subject of this essay is an example of an unforeseen risk) They are not usually however (at least not in Australia historically) anywhere near as cyclical as say a miner like BHP, which was making oodles of money a few years ago (when the then Labor government wanted to impose a mining tax) but now struggles through the commodity slump. The banks churn out a reasonable dividend every six months when risk  (investment in shares should deliver a risk premium to help justify the risk) is taken into account, and banks have recovered much of their share price since the GFC, (Commonwealth bank has exceeded it) but the GFC started in 2007 – one would generally hope that a sound capital investment recovered its losses after ten years.

When looking at profits, the size of the profit must be compared to the overall value or market capitalization (simply multiply the share price by the number of shares on issue) of the company. A very large profit in terms of its absolute size in dollars is going to be normal and healthy for a very large corporation. A much smaller company with a much smaller market capitalization will naturally have a much smaller overall profit, but the ratios of both company profits to market capitalization will be similar if the companies are performing in a similar profitable manner. In other words don’t be scared by a very large profit number – it is probably being made by a very large company – like Commonwealth Bank.

The argument that the banks are making super-profits simply does not hold water for one simple reason – the banks are cheap, or at least they are valued cheaply. The dearest bank, the Commonwealth Bank, has a P/E (price to earnings ratio) of only 14.2 at this time, far below many of the large corporations listed and considerably less than the average P/E of the market. The market has no bias one way or another towards the banks and coldly values a company according to its collective analysis (and a fair degree of crystal ball gazing and guesswork). The bank has a return on assets of only 1% and a net margin of not much over 2%, (these are all approx figures – do your own research) i.e. it is effectively lending money at slightly over 2% interest when its costs are taken into account – would you lend money at 2%? It has bad and doubtful debts of approx. 1.3 billion dollars on its books – that’s 1.3 billion dollars it may eventually have to write off. It has an ROE (return on equity) of about 15, which is good but not exceptional – there are many more companies on the ASX with far better ROE’s. I think you may be starting to understand the reason Australian banks don’t trade on high P/E’s – seldom more than 15 – they are indeed risky. As a comparison, real estate in say, Sydney, probably has a P/E of around 40 based on rental income, so Sydney real estate is much dearer than Commonwealth Bank shares at least by the P/E yardstick.

In conclusion I would just like to state once again that I do not claim to be a financial expert, far from it. I have however been heavily involved in stock market trading and investing for twelve years and over that time have become increasingly aware of the general lack of knowledge (even amongst otherwise knowledgeable people) of the stock market and corporations. This is disturbing when one considers that we live in a capitalist society and owe our high standard of living to the businesses, small to large, which create wealth. It also means that immoral governments can more easily make cynical decisions which damage individuals and the economy without a public backlash – in this case, even getting quite a measure of public approval. Governments, it would appear, benefit from keeping their subjects in the dark – they will continue to behave in this manner as long as they can get away with it – you can bank on it.