Oils Aint Oils and NAB's Departure from the Pack

Traditionally when we think of Australia's big banks our initial reaction is: four peas in a pod. They are all in the same business and are impacted by the same forces. But allow me to use another old saying that may be more accurate in describing banks in 2021. Remember the classic Castrol advertisement and the mechanic Sol which helped make Castrol a household name with his characteristic saying – “oils ain’t oils”? In today’s stock market, just as oils were different, so are banks.

There are important differences emerging. Three of our major banks have ridden the housing boom. In the second half of 2021, using figures from Evans and Partners Research, 55 per cent of the core profit of CBA came from the retail business dominated by mortgages. Westpac is not far behind with 49 per cent while ANZ got 43 per cent of its core profits from retail.

But then there is NAB, where only 25 per cent of its profits come from retail. The market sees this as NAB underperforming but NAB sees this as its great advantage. And in this instance, I am on NAB’s side.

NAB gains 42 per cent of its profit from its business lending. The NAB business profits are dominated by its strong position in agriculture where NAB towers over the other three big banks. Indeed, the Number 2 ranking in agriculture is Dutch-based Rabobank rather than another big four bank.

You wouldn’t know it by listening to the National Party, but agriculture is set to be transformed in Australia. Farmers are discovering that by using modern technology they can accurately assess water and minerals in the soil and manage their crop, water, fertiliser harvesting and grazing using artificial intelligence to increase productivity dramatically.

And the current prosperity in many rural areas is providing farmers with the cashflow plus bank loans to invest in the technology and buy the neighbour's farm to improve the economics of its application. Not surprisingly NAB’s agricultural loans rose 14 per cent in the last year.

But this technology also enables carbon to be stored in the soil which will further increase productivity and, once it is measured correctly, that carbon storage is akin to carbon credit which can be sold on world markets.

NAB in conjunction with a number of other world banks is going to become involved in carbon trading and is working on tailoring some of its loans to farmers whereby interest payments will be lowered if they store carbon. 

We are looking at a new era in agriculture and agricultural lending. And NAB is in a different position to the other banks. This is not something the share market takes much interest in. The total business lending arena is also starting to stir, and business loan enquiries and applications are set to rise substantially in 2022.

NAB is developing technology to enable it to greatly increase its lending to smaller business on a cashflow basis which the bank can now monitor. 

One of the ironies of the banking world in Australia is the fact that five years ago NAB’s business banking operation was struggling to prosper in the bureaucracy of the bank. It lost key executives who in frustration went off to form Judo Bank. 

The Commonwealth looked at the NAB mess and thought the leading business banker of Australia was ripe for the picking. But in the turmoil that came out of the Royal Commission, NAB appointed Ross McEwan as CEO and suddenly there is a new sense of direction in the business arena. 

The Commonwealth Bank remains our second largest business banker with an impressive 31 per cent of its profits coming from business banking. But it would have been a lot greater but for the changes at the NAB.

ANZ and Westpac have slipped. Westpac in the latest half year gained only 19 per cent of its profits from business banking and it has merged the business sector with consumer banking. To stay with our Castrol analogy that is oil and water. The convulsions that come with intercompany mergers like that can set an operation back a long way. The CBA will be able to pick off key Westpac executives and take market share.

ANZ decades ago was Australia’s leading business bank but could only manage 16 per cent of its profit from business in the latest half year. And when its CEO set out the growth opportunities of the ANZ bank, business did not make it to the top five. 

This is clearly a very big divergence in banking strategies and I think the NAB has called it correctly. The mortgage business is increasingly being commoditised. 

We have substantially increased the size of loans for housing and those that have borrowed large sums are vulnerable to interest rate rises. The increase in US bond interest rates is already boosting the cost of housing finance in Australia. In normal times banks would be increasing their interest rates in the next few months irrespective of the Reserve Bank due to higher foreign borrowing costs. 

We have an election coming up where interest rates are going to be a very important issue in marginal seats in outer suburbia. It will be fascinating to see whether the banks hold back rather than be linked to a key election issue. But once the election is out of the way, if overseas rates stay high the banks will seek to increase interest rates irrespective of what the Reserve Bank might do.

The Reserve Bank is saying inflation will not break out driven via higher wage rises as distinct from price rises that they think are transitory. The Reserve Bank can’t see interest rate rises in the near term. That will keep the lid on rates, but Morgan Research is saying that the real increase in CPI is now at 4.8 per cent. If Morgan Research is correct, then the Reserve Bank will have to eventually cave in. It is going to be a very tense election period where the share and bond markets will be very much part of the action.

But this is more bad news for bank deposit savers. With the consumer price index rising by between 3 and 5 per cent and bank term deposits at token levels we are looking at negative interest rates of between 3 and 5 per cent a year.

No saver can afford that terrible drain on their savings. The Reserve Bank stand is probably linked to trying to get the recent excess borrowing under control in the housing market by depressing interest rates while the cost of housing is rising rapidly.

Longer term, this is not good news for the CBA and its high share price.

In the US, the same attitude is being embraced by the Federal Reserve. But Americans understand what is happening in their country and the bad vibes are extending to the US president. That hasn’t happened yet in Australia.