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Fear & Greed, Fear and Greed

The Commonwealth Bank has had a great run lately – it’s closing in on being a $200 billion company.

But how far can it go? And what happens to CBA – and the other big banks – if interest rates do start to fall this year?

Carlos Cacho, Banks Analyst and Chief Economist at Jarden Australia, talks to Sean Aylmer about why the Commonwealth Bank’s share price has been rising, and what it all means for investors.

Remember this is general information only, and you should seek professional advice before making investment decisions.

Find out more: https://fearandgreed.com.au

See omnystudio.com/listener for privacy information.

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Sean Aylmer: Welcome to the Fear and Greed Business interview. I’m Sean

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Sean Aylmer: Aylmer. The Commonwealth Bank has had an incredible run lately.

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Sean Aylmer: It’s closing in on becoming a $ 200 billion company, and

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Sean Aylmer: a recent surge in it’s share price means it’s now

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Sean Aylmer: more than twice the size of National Australia Bank and

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Sean Aylmer: Westpac combined. Mind you, the other big three of the

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Sean Aylmer: big four have done pretty well also. So how far

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Sean Aylmer: can the banks go? What happens to CBA if interest

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Sean Aylmer: rates do start to fall this year? What about the

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Sean Aylmer: other banks? Remember, this is general information only and you

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Sean Aylmer: should seek professional advice before making investment decisions. Carlos Cacho

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Sean Aylmer: is the Bank Analyst at Jarden Australia. He’s also Jarden’s

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Sean Aylmer: Chief Economist, A very, very busy man. Carlos, welcome back

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Sean Aylmer: to Fear and Greed.

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Carlos Cacho: Thanks for having me, Sean. Always a pleasure.

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Sean Aylmer: So we’ll get to the Commonwealth Bank in a moment,

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Sean Aylmer: but more broadly, what is it about the banks at

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Sean Aylmer: the moment that investors like. They certainly have outperformed in

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Sean Aylmer: the past a little bit?

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Carlos Cacho: Yeah, look, they’ve had a good run in the year

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Carlos Cacho: to date, and really since late October when we saw

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Carlos Cacho: the peak in bond yields globally. I think the key

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Carlos Cacho: driver of that has been rising expectations of a soft

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Carlos Cacho: landing both in the US and Australia. And what that

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Carlos Cacho: means for banks is that probably credit losses or effectively the losses

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Carlos Cacho: they bear for loans going bad as people can’t pay

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Carlos Cacho: them, are likely to be smaller than people feared because

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Carlos Cacho: the economy is holding up better. And we’re now kind of at

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Carlos Cacho: the point where we can see the light at the end of the

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Carlos Cacho: tunnel in terms of the central banks probably cutting rates

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Carlos Cacho: later this year by and large. So generally, while banks

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Carlos Cacho: do benefit from higher rates, it obviously creates risks for

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Carlos Cacho: them as well. Creates a risk of slowing down the

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Carlos Cacho: economy, higher unemployment. So they seem to be in the

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Carlos Cacho: sweet spot at the moment of earning more on their

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Carlos Cacho: mortgages or on their loans, but not taking losses on

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Carlos Cacho: the credit because the economy’s holding up better than feared.

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Sean Aylmer: Okay. Just on that credit, we talked about the mortgage

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Sean Aylmer: cliff last year and the idea that people were shifting

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Sean Aylmer: from low fixed rate to higher variable rates. Is it

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Sean Aylmer: that didn’t happen? Or is it much more than that?

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Sean Aylmer: Is it that the economy hasn’t tanked therefore businesses can

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Sean Aylmer: repay their loans, people can pay their credit cards? So

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Sean Aylmer: it’s broader than mortgages, I presume.

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Carlos Cacho: Yeah, look, it is definitely broader than mortgages and generally

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Carlos Cacho: what we see with the banks is that even though

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Carlos Cacho: mortgages represent the majority of their loan books, the losses

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Carlos Cacho: are more likely to come from the business side. Generally

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Carlos Cacho: a mortgage is secured against the property, and even if

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Carlos Cacho: someone falls into arrears, they can’t make payments, there’s still

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Carlos Cacho: value there in the property. And so it’s quite rare

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Carlos Cacho: that we actually see, at least in Australia’s case, where

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Carlos Cacho: the banks take material losses on the mortgages. At the

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Carlos Cacho: moment, the most recent estimates from the RBA have negative

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Carlos Cacho: equity. So the instances where the loan is higher than

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Carlos Cacho: the value of the property are less than 2% across

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Carlos Cacho: Australia, which is the lowest it’s been in a long

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Carlos Cacho: time. And that makes sense given that the housing market

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Carlos Cacho: has made record highs. So it’s really about the business

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Carlos Cacho: side.
And what’s happened over the last year is the

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Carlos Cacho: economy has just held up a lot better than people

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Carlos Cacho: feel. Unemployment is still sub 4% while per capita GDP

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Carlos Cacho: is going backwards. That population growth that brings it down

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Carlos Cacho: is actually a big positive for businesses, and we do

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Carlos Cacho: expect that’s going to continue. And so even though there’s

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Carlos Cacho: a lot of pessimism out there, in aggregate, things are

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Carlos Cacho: actually holding up a lot better than people would’ve expected.

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Carlos Cacho: If you told an economist or a bank’s analyst two

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Carlos Cacho: years ago that the cash rate would be over 4% and

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Carlos Cacho: the unemployment rate would still be less than four, I don’t

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Carlos Cacho: think many people would’ve believed you.

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Sean Aylmer: Okay. Now, you mentioned also about interest rates and what

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Sean Aylmer: that means for the banks. So I remember being a

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Sean Aylmer: banking writer for the Financial Review, and the idea was

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Sean Aylmer: that when rates rose, good for the banks, so it

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Sean Aylmer: can increase their net interest margins, effectively their profit margins.

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Sean Aylmer: When they fall, bad for the banks. Is that not

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Sean Aylmer: the case?

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Carlos Cacho: That is the case, and we have seen net interest

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Carlos Cacho: margins rise, but it’s only to an extent. And initially

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Carlos Cacho: during the hiking cycle, it was very positive for banks.

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Carlos Cacho: Deposit rates rise slower than mortgage rates have, but over

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Carlos Cacho: time what we’ve seen is the banks have competed really

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Carlos Cacho: aggressively on mortgages. We’ve actually seen a materially smaller increase

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Carlos Cacho: in the average mortgage rate compared to the cash rate

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Carlos Cacho: because of that competition. We saw about a 50 basis point,

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Carlos Cacho: a half percent decrease in new mortgage variable rates relative

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Carlos Cacho: to the cash rate since the RBA started hiking. And at

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Carlos Cacho: the same time, they’ve had to pay up more for

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Carlos Cacho: deposits as households and businesses have been shopping around. It

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Carlos Cacho: is still positive from an earnings or a revenue perspective,

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Carlos Cacho: but as I said, it does create risks and that

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Carlos Cacho: as people are paying more in their interest, there is a

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Carlos Cacho: higher chance that some of them may not be able

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Carlos Cacho: to repay their loans and you can see bad debts

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Carlos Cacho: rise.
At the moment, we haven’t seen that. Bad debts

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Carlos Cacho: still remain very benign. What I’d say is normalizing, but

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Carlos Cacho: they don’t look like they’re going to elevated levels. And

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Carlos Cacho: the key things we’re watching there for risks are things

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Carlos Cacho: like unemployment, insolvencies, et cetera. And while there has been

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Carlos Cacho: some stress, it’s mostly been concentrated in areas of the

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Carlos Cacho: economy that don’t have too much debt, like the construction

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Carlos Cacho: sector where, yes, it’s been a very challenging environment, but

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Carlos Cacho: generally speaking, the banks have been making out okay in

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Carlos Cacho: those situations. And unfortunately, it’s the suppliers, it’s the subcontractors

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Carlos Cacho: and it’s the home buyers who’ve been wearing the losses

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Carlos Cacho: from these companies going under.

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Sean Aylmer: Stay with me, Carlos. We’ll be back in a minute.

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Sean Aylmer: I’m speaking to Carlos Cacho, Chief Economist and Bank Analyst

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Sean Aylmer: at Jarden Australia, and I’m just reminding listeners that this

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Sean Aylmer: isn’t an investment podcast. You should always seek professional advice.

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Sean Aylmer: Now, with that in mind, Commonwealth Bank, that has certainly

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Sean Aylmer: been the strongest of the big four. Is there any

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Sean Aylmer: particular reason, and I suppose what’s thrown me a bit

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Sean Aylmer: with the Commonwealth, they haven’t been competing as aggressively as

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Sean Aylmer: ANZ, for example, in the mortgage market. Why are they

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Sean Aylmer: doing so well? Valuation’s everything, so maybe now they’re a

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Sean Aylmer: bit overvalued, I don’t know. But the last couple of

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Sean Aylmer: months, why have they outperformed?

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Carlos Cacho: Look, I think there’s probably a few factors. You’re right.

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Carlos Cacho: CBA has stepped back from mortgage competition for a while.

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Carlos Cacho: We saw in June they were the first bank to

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Carlos Cacho: announce an end to their cashback. They’ve increased their front book

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Carlos Cacho: mortgage rates, those are the rates for new customers, quite

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Carlos Cacho: materially. Since then, we’ve tracked an over half percentage point

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Carlos Cacho: increase across a lot of their rates. In comparison, ANZ is still offering a $2,

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Carlos Cacho: 000 cashback. So CBA is not looking to grow shares

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Carlos Cacho: aggressively. CBA’s focus has been more on maintaining their proprietary

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Carlos Cacho: channels. So that’s the direct customers that come to the bank,

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Carlos Cacho: as opposed to growing through more aggressive expansion in the

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Carlos Cacho: broker channel like most of their peers have done. The

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Carlos Cacho: view there is that perhaps that might be better for

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Carlos Cacho: margins, but it does come at the expense of your

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Carlos Cacho: mortgage book.
In terms of why CBA has been performing so well, I

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Carlos Cacho: think part of it comes down to timing. They’re the

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Carlos Cacho: only one of the big four banks that actually has

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Carlos Cacho: a result in February and pays a dividend in February.

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Carlos Cacho: So for anyone who is looking to receive the benefit

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Carlos Cacho: of that dividend, you’re going to want to own CBA now

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Carlos Cacho: and then you’ve got time to sell CBA and own the other

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Carlos Cacho: three banks before it comes time for them to pay

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Carlos Cacho: a dividend in May. So that’s part of it, particularly

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Carlos Cacho: for some retail investors or some income focused investors. The

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Carlos Cacho: other factor is that globally, we’ve seen a rally in

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Carlos Cacho: banks. US banks have risen over 20% since October. The

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Carlos Cacho: Aussie banks haven’t risen quite as much. They’ve risen about

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Carlos Cacho: 15% last time I looked. And so I think there’s

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Carlos Cacho: probably a bit of a trend where some global investors

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Carlos Cacho: are buying the banks and often they might just buy

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Carlos Cacho: the largest bank, which is CBA, seen as high quality,

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Carlos Cacho: safe, and there’s not too much risk there.
And then

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Carlos Cacho: finally, look, CBA, it’s expensive. There’s no doubt about that.

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Carlos Cacho: It’s been expensive for a long time though. I think

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Carlos Cacho: if you look back at the history of analyst ratings

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Carlos Cacho: and price targets on CBA, it’s been an underweight or

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Carlos Cacho: sell rating for most analysts for the last couple of

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Carlos Cacho: years, with a target price that’s probably averaging it out in the

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Carlos Cacho: nineties. And it’s been trading, before this latest rally, it

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Carlos Cacho: was kind of range bound between 95 and 105, and now it’s up

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Carlos Cacho: to, I think it peaked around 115 or so. So

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Carlos Cacho: it is expensive. It’s still expensive. It’s probably still going

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Carlos Cacho: to be expensive in a couple of months time. That

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Carlos Cacho: high valuation does create risks, but we don’t necessarily see

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Carlos Cacho: a clear catalyst that’s going to change that near term,

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Carlos Cacho: unless we see a bigger concern about an economic slowdown,

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Carlos Cacho: higher unemployment and bad debts coming back to the fore

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Carlos Cacho: for the banks.

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Sean Aylmer: Just more broadly, investing in banks, so you’ve got the

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Sean Aylmer: big four, but there could be a lot of change

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Sean Aylmer: this year, particularly if we have the ANZ Suncorp Bank decision

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Sean Aylmer: to come down later on. ANZ is trying to buy

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Sean Aylmer: Suncorp Bank. It’s been knocked back by the Competition Regulator. They’ve

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Sean Aylmer: appealed that. We’ll see what happens there. We have plenty

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Sean Aylmer: of neo banks always telling us that they’re using AI

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Sean Aylmer: and all sorts of things to create stiffer competition. Yet

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Sean Aylmer: the big four, they just keep going. They just seem

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Sean Aylmer: to be able to have this dominant market position, and

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Sean Aylmer: no matter what’s thrown at them, they just still are

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Sean Aylmer: part, 25% of the market.

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Carlos Cacho: Well, the thing with the banking is we all think

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Carlos Cacho: about loans, we all think about mortgages. And actually a

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Carlos Cacho: lot of the time what’s more important is the other

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Carlos Cacho: side of the balance sheet, the liability side, which is

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Carlos Cacho: your deposits and your funding. And that’s where big banks

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Carlos Cacho: get their big advantage. If you are a big major bank, not

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Carlos Cacho: only do you have bonds that you issue into the

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Carlos Cacho: market, term deposits that you get from customers, but you

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Carlos Cacho: are also probably the main financial institution for a lot

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Carlos Cacho: of households and businesses. CBA likes to talk about, they

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Carlos Cacho: call the MFI share, and it’s into the thirties, I believe.

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Sean Aylmer: So what is MFI?

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Carlos Cacho: Main Financial institution. So basically if someone asked you who’s

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Carlos Cacho: your bank, it’s the one you’d point to. It’s the

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Carlos Cacho: one you have your everyday banking account with, the one

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Carlos Cacho: that you leave the money in. If you’re a business

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Carlos Cacho: where you leave the float that you’re going to pay your employees salaries

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Carlos Cacho: and pay your expenses out of. And that’s really valuable

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Carlos Cacho: because that is usually a pretty low rate deposit product

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Carlos Cacho: that people use. And so that gives a big tailwind

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Carlos Cacho: for the big banks because they get cheap deposits, they

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Carlos Cacho: get cheap funding, and what we saw at the bottom

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Carlos Cacho: of the rate cycle, in the midst of COVID when interest rates were

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Carlos Cacho: at zero, there was a huge amount of competition from

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Carlos Cacho: all of these neobanks, all these non- bank lenders, the smaller

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Carlos Cacho: lenders, because money was effectively free, funding was very cheap,

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Carlos Cacho: and so it was easy for everyone to compete.
Now

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Carlos Cacho: that funding costs have gone up significantly, those big low

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Carlos Cacho: cost deposit bases the major banks have access to, are

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Carlos Cacho: worth their weight in gold, quite frankly. And it’s now

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Carlos Cacho: much harder for some of the smaller lenders to compete.

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Carlos Cacho: We’ve seen some of the likes of, I think it’s called Nano

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Carlos Cacho: Home Loans. They sold their book to AMP because they

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Carlos Cacho: just struggled in that higher funding cost environment. And we

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Carlos Cacho: know that some of the non- bank lenders are also

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Carlos Cacho: finding it more difficult to compete with the banks. If

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Carlos Cacho: you go back two, three years, they were writing mortgages

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Carlos Cacho: at more or less the same rate as a major

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Carlos Cacho: bank would. Now they’re having to charge rates that are

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Carlos Cacho: 1 to 2% higher because they just can’t make things

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Carlos Cacho: stack up if they compete that aggressively.

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Sean Aylmer: Carlos, thank you for talking to Fear and Greed.

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Carlos Cacho: Thanks for having me, Sean.

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Sean Aylmer: That was Carlos Cacho, Chief Economist and Bank Analyst at

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Sean Aylmer: Jarden Australia. This is the Fear and Greed Business Interview.

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Sean Aylmer: Join us every morning for the full episode of Fear

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Sean Aylmer: and Greed, Australia’s best business podcast. I’m Sean Aylmer. Enjoy

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Sean Aylmer: your day.