Are Australian Banks a Good Investment?

By Motley Fool

Joe Magyer, the chief investment officer of Lakehouse Capital in Australia, joins Gaby Lapera to talk about Australian banks and real estate. Property is expensive, banks are highly leveraged, and they have unusually high valuations considering a few potential risk factors. They also chat about how to buy Australian stocks or funds. Watch this segment ofIndustry Focus: Financialsto learn more.

A full transcript follows the video.

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This podcast was recorded on Sept. 15, 2016.

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Joe Magyer: Up until recently, Australian bankswhere the most expensive banks in the world. They're still very expensive. Why are they so expensive? Well, default rates have been incredibly lowin Australia. The country hasn't had arecession in 25 years. Just think about that. To an American, you're like, "What?! 25 years? That's crazy!" It'salmost the longest streak ever. Australians havea lot of confidence as a result of this. Just imaginehow different your life perspective would beif you had not seen a recession. You have professional investorswho are in their early 40s who have not seen a recession. It's a very different worldview.

Gaby Lapera:That's so wild.

Magyer:Yeah. So,I think the banks tend to make loanswith a little bit more of an optimistic view than American banksdo, andinvestors tend to value thema little bit more optimistically. So,I'm actually rather bearishon the Australian banks. It's not because I'm expecting some cataclysmic event. But there are a few things. One,net interest margins are getting squeezed --to get back to that thing I was saying you shouldn't pay too much attention to before. Default rates are near record lows. They won't stay that way. I don't know when exactly they'll pop, but they won't stay that way. The banks are also paying up around 75% of their income as dividends, which does not leave...


Magyer:Yeah. The yields are huge, andeverybody loves that and gets excited about it. But that doesn't leave much room for error, when you're levered 15:1. All you need is a slight down-tipin your profit. When you magnify that,there won't be a lot of gravy left over for dividends.

Lapera:Yeah. If they're smart, they'll cut their dividend instead of trying to hold on. Is the real estate marketsubstantially different than it is here? I realize, at the center of the country...

Magyer:No one is there.

Lapera:No one super-duper lives there. Like some kangaroos. But is it a lot tighter as a result? Is housing super expensive? Is it D.C. levels or Iowa levels? Or is it somewhere in between?

Magyer:It's regional, but overall, it's very expensive. There was some work done by Jonathan Tepper and John Hempton in the past year, a couple of hedge fund managers. They went around and basically pretended to be interested in buying homes, and went to dozens ofdifferent banks to see what they could get lent. One bank was willing to lend them -- they were posing as a couple -- 10 times their income to buy a home. That's lofty.I personally don't think I could afforda mortgage that's 10 times my income, or buy a property that's 10 times my income.I just think, overall, it's not as extreme as the U.S. was in terms of loose lending standards, overall. No doc loans, or NINJA loans -- no income, no job -- those aren't really existing in Australia.

Still, prices are high,just like we saw with the dot-com bubble. Just because assets are freely traded,and there's nothing illegal going ondoesn't mean an asset can't get overvalued. I think there's probably risk in the Australian property market today. If you're buying Australian property with a five- to 10-year residential viewpoint, it'snot something I would stress about. But there's a lot of people -- something like one in seven Australians -- own an investment property. Which is a crazy concept in America.I certainly don't know one in seven people that own aninvestment property. And most of those are what's called negatively geared. Thatbasically means they're losing moneyon a cash flow basis month to monthin anticipation of getting it backin capital gains.(laughs)When I heard that, I was like, whoa! That's apretty foreign concept to Americanproperty investment as well.

Lapera:I mean,the things you're describing, while they're not quite as bad as they were during the financial crisis, are things that were happening during the pre-financial crisis.

Magyer:Yes.I remember, back then, it seemed likea surprising number of my friends were budding real estate moguls. And I was like, "Actually, no ... " It just seemed odd, at the time. Anyway. Overall,I think property is expensive,and there's some risk there to be mindful of. If you're thinking about buying the banks, which are super levered to that and don't have much wiggle room with their payouts, and rich valuations. So,overall, I'm not predicting a crash, I'm just saying thatI think the banks are basically priced as though everything will stay great. But there are many ways to lose. And I try to avoid situations like that.

Lapera:Fair enough.I think our listeners will haveone question after hearing all that. Not that they're going to go out and buy Australian banks, but, is there a way for U.S.investors to buy Australian stocks?

Magyer:Yes. You can do itdirectly. You can alsolook at Australian funds. It should be clear that I'm not actively touting our fund, whichdoesn't even exist yet. I'm just saying, broadly speaking,you can look at active management. You can also look at ETFs. The trouble with ETFs inAustralia, though, is that the market is super top-heavy. There's thebig banks, a couple big retailers, and commodity companies. Something like 10 companiesmake up almost half of the index. There's another 2,000 that make up the other half.

Among those,you've got companies that don't look anything like the big players. There're a lot of small, fast-growing software companies that aredeeply profitable, strong recurring revenue, great balance sheets. Those are the kinds of things I get into. So, you could look for active management,but to be honest,it's kind of difficult, straight up. You could go direct, but active management, you wouldwant to find a fund that's based here in the U.S. so you could make the investment. It's hard to invest in funds that are basedoutside of America, because then you run intowhat's called PFIC rules. That's a long story short.

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