Australia, beautiful for banking one day but what about the next?

Many lament while that may well have been true once, it fails to recognise the massive structural shifts in the Australian economy in recent decades. Australia of course is essentially a services economy.

"Banks… are a leveraged play on the economy and given the actions and statements by the Reserve Bank in recent days … the growth outlook is getting worse."
Andrew Cornell, Managing Editor

And one of those service industries, which is flourishing, is financial services.

According to the latest Australian Bureau of Statistics data, mining contributes 8 per cent of real gross value added by industry, agriculture and forestry 2.4 per cent, accommodation and food services 2.5 per cent. Financial services chips in 9 per cent.

That tells us financial services, including banking, is a major contributor to national earnings. And part of that story is over the last few years Australia has been one of the best places to be a bank.

Speaking with BlueNotes this morning in the wake of ANZ’s December quarter trading update, chief financial officer Shayne Elliott conceded one of the tough parts of his job was defending the diversification and growth benefits of ANZ’s super regional strategy in the face of the argument more pure Australian (and New Zealand) peers have done better.

Elliott made the case that a like by like comparison would show ANZ’s Australian operations had performed equally as well as peers but indeed Australia is a smaller part of ANZ’s business.

Diversification is obviously one part of the story: with foreign currency earnings coming in, ANZ benefits when those earnings are converted to a weaker Aussie. But the pillar of Elliott’s defence is Asia offers the kind of growth outlook Australia simply doesn’t and shareholder returns depend not just on unit earnings – return on equity – but how fast those units are growing.

Australia has been good to banks in recent years. The challenge though is when the good times will end.

Banks, over the long term, are a leveraged play on the economy and given the actions and statements by the Reserve Bank in recent days (and the forecasts of economists) the growth outlook is getting worse.

Also speaking after ANZ’s trading update, which saw a strong result from ANZ’s Australian business, chief executive Mike Smith warned BlueNotes the big issue he saw globally and also in Australia was confidence.

Exactly the same view came from Ian Narev recently releasing Commonwealth Bank’s half year result. As head of Australia’s largest bank and the one considered the bellwether for sector, Narev said despite what was also a solid result he was very concerned about both consumer and business confidence, roiled by political uncertainty.

Improved confidence would require “implementation of a coherent long-term plan that clearly addresses target government debt levels and time frames, infrastructure priorities, foreign investment, business competitiveness policies and, above all, job creation”, according to Narev.

This was the prevailing theme out of the profit and trading update season, an Australian economy travelling well (commentary on credit quality was very encouraging across the banks) but with animal spirits well into the skittish end of the Keynesian scale.

It is a view confirmed by a recent poll of Australian chief financial officers.

While National Australia Bank is working through some bank specific issues, its trading update was also considered solid or “uneventful” as one broker said.

CBA delivered revenue up 5 per cent in what was described as “subdued market conditions”.

Ditto Mike Hirst at Bendigo and Adelaide Bank delivering his interim numbers: “This is a solid result given the highly competitive, low-growth environment in which the bank is operating".

Recent international assessments of the Australian economy, from institutions such as the International Monetary Fund or the OECD, have emphasised the longer term fiscal and structural problems facing the country.

It seems ironic that for many years around the financial crisis Australians were convinced they were going over a cliff when they weren’t. But now the cliff is approaching – albeit a fair way off – the country seems to lack confidence in the driver.

The most recent assessment, by the OECD, points for the need for tax reform – off the agenda – and micro-economic reform – barely considered.

Some might say this is the usual stuff from international bodies but such views, when coupled with the apparently chronic lack of confidence in the community, would have to suggest Australia as the best bet for your banking chips may be over the odds.

The problem, as discussed in this column last week, is taking your chips off the table too soon can cost money.

Looking at this banking reporting season, there is no obvious reason to sell. There is revenue growth, albeit hard won. Margin pressure is manageable. Cost control is in focus. Bad debts are almost nowhere to be seen.

And nor is there an obvious alternative. New Zealand has been a rock star economy but it is relatively small and may be peaking. Asia is the obvious choice but barriers to entry are high in terms of establishing a meaningful local presence while global liquidity is such that competition is intense in Asia.

It seems the lesson from these results is Australia is still a good place to be a bank. But how much of that is it’s difficult to think of alternatives?