“We have a situation here where if interest rates move, as the theory says, to keep up with inflation, you have a huge problem in the household sector which will trickle down to the SME economy,” warns Healy.
The comments come after 10 unpleasant days for bank investors. During that period, Commonwealth Bank fell 16% to $87.66 on Friday, its lowest level since April last year. The ABC is down 7% this week, including more than 3% on Friday. Westpac has done even worse, falling 21% in the past 10 days, since the Reserve Bank did better than expected by raising the cash rate by 50 basis points.
Healy says a lot of the problems are down to the RBA. “If you’re going to pump the system with excess liquidity, you’re going to create inflationary problems,” he told financial reporters on Friday. “The fundamentals of economics transcend geographies, and the idea that we can behave like the rest of the world and be exempt from the consequences doesn’t hold water.”
It’s not the average borrower that drives the market down, it’s the marginal borrower.
— Healy, Friday
The judo house’s view of the rate trajectory is similar to that of the big banks: it sees the cash rate rising to 2.5% this year, and possibly pushing to 3%. But Healy says there is a real risk he will have to go higher than that.
“I’m nervous about the psyche saying, ‘she’ll be right, don’t worry about it’. It’s better to be prepared for the worst and hope it doesn’t happen, than to say ‘we don’t. don’t wait for problems to arise and everything will be fine”.
There are reasons to be relatively optimistic. Although the global recession outlook is very high, he says Australia is better off because of its natural resources and agriculture, products the world needs.
Unemployment also remains very low, which Dr Lowe said this week will help support consumption. The RBA governor also pointed to the additional $250 billion in savings during the pandemic as a hedge against rising rates.
Still, Healy says wage inflation will eventually bite into small businesses and force layoffs, driving up unemployment.
With the Fair Work Commission minimum wage increase of 5.2% this week the biggest increase in 16 years, “the psychology of inflation is locked in the minds of employees and people are expecting 5-8% pay increases, and companies are going to have to deal with it – and you deal with it in a world of very low unemployment where it’s hard to retain talent,” he says.
“At what stage [given] rising prices through wages and other influences, are employers saying “I’m going to start cutting because I can’t afford it because my margins are tight”? That’s what the theory says will happen, so I’m not very reassured by the low unemployment rate as being sustainable.
He also says that Dr. Lowe’s emphasis on overall savings presents “a fallacy” in looking at averages rather than risks in borrowers’ queues. “It’s a bit like saying to a non-swimmer: ‘It’s safe to cross the river because it’s on average one meter deep’, only to find that it’s three meters deep between.”
“It’s not the average borrower that drives the market down, it’s the marginal borrower. It’s the highly indebted households borrowing at 6-7 times net income who have bought two or three properties as investments…that’s the Achilles’ heel.”
After the Exceptional 75 basis point hike in the US Federal Reserve rate this weekHealy says the United States generally takes its drugs quickly, but he fears Australia is reacting too slowly to soaring inflation.
“The risk if you don’t accept short-term pain if you have long-term pain,” he says. “But in Australia, the issue is complex because the level of household debt makes people cry. And although the central bank is independent, there comes a time when politicians will find the pain to be inflicted politically intolerable.
Although the outlook for the banking sector is bearish, Healy says Judo Bank will meet all of its prospectus forecasts, made a year ago. Its loan portfolio is expected to reach $20 billion by 2026, making it the largest SME bank after the Big Four.
“We are very confident that we will meet at least, if not exceed, the key indicators that we have outlined in the prospectus,” he said on Friday. These include a net interest margin of over 3%, a cost/income ratio of almost 30% and a return on equity between the low and mid-teens. Judo has 450 employees and plans to hire another 100 over the next 12 months.
With the stock price depressed, Healy says the market may not understand that rising rates provide a tailwind for profitability – if it can keep credit risk under control. Its business loans can be reassessed every 30 days; 91 percent of its loans are variable rate linked to BBSW. But most deposits are blocked for nine months. This means “a rising interest rate environment is a blow to us,” he says.
A 50 basis point increase in the cash rate will increase Judo’s net interest margin by 25 to 30 basis points. “Rising rates aren’t good for our customers or the economy, but because of the way our assets and liabilities are matched, they’re good for us,” he says.
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