Australian Banks exposure to bad debts

Hello,
A question for those that follow banks - do oz banks have any exposure to bad loans that could upset the balance sheet, for example as in the US sub-primes and British markets? Are the banks bad and/or dodgy loans portfolio published anywhere. If so, which bank is the most exposed?

I posted this a couple of weeks ago now;

Banks possess an interesting spot in the global economy. They are the funnel in the capital formation process and the engine that keeps the liqudity flowing throughout the system.

Banks earn their money traditionally from the spread, the difference between their cost of borrowing, and the rate that they lend it out. In the early days, the depositors cash was the primary source of capital for the banks. As such, a certain percentage had to be kept as liquid reserves, to satisfy day-to-day needs of depositors.

Banks were rated as to their safety in times of trouble. If there was a liquidity crunch, could you still get your money back? This was the underlying cause of many a bank run from the 1700’s through to the 1930’s.

The FDIC pretty much ended this risk for depositors within the US, while concurrently emboldening the bankers to over-reach with their lending and credit risk management. It directly precipitated the S&L crisis of the 1980’s.

Banks overleveraged their Balance Sheets, placing their equity capital under ever increasing risks. What is considered a prudent level of leverage? The more conservative start to say anything over six times equity capital is starting to place excessive risk of failure in the picture should there be an untoward event.

Barings Bank, bank to the Queen, a history of hundreds of years, blew up due to poor risk management and one rogue trader. [Nick Leeson] The lesson being, the bank is only as big as it’s equity capital, and the ability to refinance illiquid assets in time of crisis.

With that provisio, National Australia Bank [NAB] one of the stallwart blue chips of the Australian bourse, a couple of years ago, was subject to it’s own group of rogue traders, slack risk management, and generally shoddy business practices.

Australia as an economy is booming on the back of a strong commodities bullmarket, with the bulls citing ever present and increasing demand from China et al. Real estate markets, like most real estate markets world-wide have also seen steady growth.

We would expect NAB to be a major participant within both of these developments. Certainly the NAB shareprice has appreciated with the All Ords, and is at I believe all time highs.

After running an analysis on NAB, I was left rather concerned; all the following are compounded returns over five years.

Revenues +7.14%
Interest income +9.17%
Interest expense +12.75%
Non-interest income +3.43%
Non-interest expense +0.75%
Loan Loss provisions [-2.75%]
Non-permorming loans +22.7% *[YOY]
Deposits +1.44%
Total loans +4.17%
Equity +3.70%

There is a very nasty trend of information developing here; NPL’s increasing by 22%, Loan loss provisions shrinking by 2.75%, the Equity growing only by 3.7%, total loans increasing by 4.17%. The equity is coming under ever increasing leverage and risk; first by reducing loan loss provisions, reserves are depleted [rather than built] for the trend in increasing NPL’s, thus placing the equity under higher risk.

The leverage has increased by 11% from an aggregate of 9.89 times, to, 10.20 times [6.0 times is considered aggressive] again placing the equity under greater risk. [When your equity = $0.00 you are bankrupt]

This 11% increase in leverage resulted in;
3% increase in Interest income
1.4% increase in Net Profit Margin
[-0.1%] loss on returns to total capital

The end, does not justify the means.

There are some serious discrepancies within reported earnings, and actual earnings. Declared earnings from Income totaled $10.84 over five years. I could only find actual evidence of $8.47 of earnings [including dividends] for the same five years. That means $2.37/share have gone missing somewhere. [I will try to track them down]

Equity to Assets, the golden ratio for banks. This is their ability to absorb short or longer term, adverse economic conditions, as banks are highly correlated to the economy. We want to see a large number. As a minimum, 7.5 is the cut-off, 6.0 is the average, and below 5.0, trouble ahead. NAB is average at 6.0 thus fails the safety test.

Cash-flow is another major area of concern, and ties directly into the missing earnings.
Cash-flow from Operations has been on aggregate running losses of [-$2761] this figure blew out hugely in 2006 to [-$11514]

Thus, after banking business, NAB lost a ton of money. They sold shares, and dramatically increased their bonded debt. This accounts for the disconnect between Interest income, and Interest expenses. The low cost source of capital, viz. deposits, has not been pursued, or customer satisfaction is low, whatever the cause, it is hurting their earning power.

Where are the losses in operations concentrated?

Three entries caught my attention and this is where we came in; trading losses. A loss of $3803 resulting from transactions in trading securities, a loss of $1507 from trading derivatives, a loss of $2638 of securities marked to market.

With their chequered history in regards to risk management, and the sad history of trading blow-ups; Barings, LTCM, et al, this is an area that when carried out by a commercial bank, as opposed to an Investment Bank, are you really buying their stock for their commercial banking skill set, or their capital markets accumen?

All-in-all, I wouldn’t be holding this stock under the current market conditions. Strong bullmarkets in any number of geographic regions, asset classes and these guys manage to lose a bundle of money. If their stock was cheap, possibly I might think on it, but the stock is overpriced into the bargain.


jog on
d998

Competition from the industry superfunds bank Members Equity is hurting them in the home lending market and GE is hurting them in the personal loan market.

Westpac's latest advertising campaign about them being a "good" bank is also interesting. They were known as the "Bastard Bank" through loans they did with farmers tied to a foreign exchange rate that sent the farmers broke when the $A fell. Trying to claw back customers by taking over BOM didn't help and in fact made them more unpopular with Melbournians, many who switched banks after the takeover.

The only thing I have been able to find regarding Aussie Banks exposure to slowing mortgage/defaulting loans has been a Huntley Analysis regarding the ANZ on the 18/12/2006

Mortgage Lending Slowing

"ANZ has provided a timely warning about substantially rising loan loss provisions in the coming year. Recent interest rate increases are affecting overall lending with a slowing in the rate sensitive mortgage lending segment. From heady growth above 20% two years ago the growth rate in mortgage lending is currently around 12% and slowing."

Increasing Loan Loss Provision

"In FY06 ANZ’s loan loss provision was $407m comprising an individual provision of $338m and a collective provision of $69m. This compared with FY05’s total provision of $565m comprising an individual provision of $357m and a collective provision of $139m. In the current year it is likely the total provision could increase by around 50% to near $600m – individual $450m and collective $150m."

No one seems to have connected the dots yet in Australia regarding the Mortgage foreclosures and the Banks exposure.

All good points!
I can add, being a Mortgage Broker (independant) The percentage of home loans I did last year for my clients, only 10% were with the Big4 (ANZ,CBA,NAB,WBC) .

They are not competetive against all 20 other (bank and non bank lenders on our panel). They do have the branches though, commonwealth has the most, but they look at these as expenses! These banks still follow the UK system of banking.

ING,CitiBank,RAMS and Superfunds - Don't have any branches (expenses) but are getting more market share! They follow the US system of banking. They use Brokers and F/Planners 100% - no branches or bank employees.

I which lot I would invest in. Banks (and brokers like me) do get royalty income from each loan on their books- monthly! This is why this space is so competetive. Ultimately those with the best service (and products) will attract more loans!

Oh and all my clients personal loans I direct to 2 or 3 credit unions.

When I started the Big 4 probably had about 70% of the loan market. That is probably 40% now and declining. Yet they still make record profits! Through increased fees, investments, financial planning and insurance. Can they keep it up? I'm not so sure!

I was doing some research on Mortgage Choice (MOC) and noticed the two co-founders have sold off substantial portions of their holdings in MOC over the past two years.

They sold of 12%($19 Mil) of issued capital on the 9/9/2005. One the co-founders then sold off another 8.5%($25 mil) of issued capital on the 6/4/2006.

I found this somewhat interesting after reading on what's happening in US Subprime.

Uncle Festivus said:

Hello,
A question for those that follow banks - do oz banks have any exposure to bad loans that could upset the balance sheet, for example as in the US sub-primes and British markets? Are the banks bad and/or dodgy loans portfolio published anywhere. If so, which bank is the most exposed?

Click to expand...

Uncle Festivus,

Yes Australian banks do have exposure to loans that may go bad. Its part of business that's why they make provisions for doubtful debts, the last few years has seen abnormally low provisioning levels so it is not surprising to see them rising at this point in the cycle. ANZ gave the market a heads up on this at their FY06 result back in November.

The last time we were at a similar point in the economic cycle in 2001 I was an assistant banking analyst. At its height there would be couple of major loans falling over every week and we wouldn't find out about it until it hit the news. They would range from a few million to a several hundred million in size. Quite often 2 or 3 of the major banks would be lenders with differing amounts of exposure. We would call the bank and they would tell us what their exposure was say $20m and that they were writing 90% it off. But they would never divulge the composition of their loan portfolio. The most they would ever say was something like - we have our eye on a few loans we think will become impaired in the next couple of months and give a rough estimate of the amount.

Back then we wrote a 100 page document saying that the banks were well provisioned to see through a round of bad debts and we were right. They absorbed it well. The question is how far have they extended themselves this time and are they as well prepared? Have they been chasing loans at the risky end of the market? No doubt there is more debt out there this time round just how exposed are the major banks?

Ducati brings up the important point of Capital ratios, traditionally NAB has operated on the thinnest capital ratios of the major banks. However that was 5-6 years ago. I haven't been following the banking sector. ANZ got themselves into a bit of trouble in asia a decade ago but then slowly reduced their exposure and became the star of the banking sector. I don't know what they've been up to in the last five years but I know they were always keen to get back into asia once they thought the time looked right.

Don't know if any of that helps.

A major risk for all banks are Credit Revolvers

Credit Revolvers are contractual agreements with Corporate customers for a line of credit to support Working Capital.

The major risk for analysts are that they are Off Balance Sheet
This is perfectly legal as of course they are not current liabilities, just a contractual possible future liability.

Drawdowns on credit revolvers tend to occur during tough business conditions. Fee grabbing by the banks for credit revolver facilities can place the balance sheet in trouble if overleveraged

jog on
d998

The reason I asked this question was that I have a friend who is a property valuer, & he's been telling me that there has been an extraordinary increase in mortgagee in possession sales that he's had to value. Whereas only 2 years ago he would get probably 3 a month, now he's getting about 4 a week. People are hurting out there in mortgage & rental land; just wondering when this will have an effect on the economy, and trading strategies eg shorting banks after they go ex div?.

Ducati, it sounds like NAB may be one to stay clear of?.

Must be about time for an Aussie Subprime Mortgage meltdown...

Kimosabi said:

Must be about time for an Aussie Subprime Mortgage meltdown...

Click to expand...

well if them i-mer-i-cans we like to mimic are any indication,

and from the bowels of the christian science monitor,

and yes you must be a believer to read this,

"from the March 2, 2007 edition

Foreclosures rising among high-risk US mortgages

Loans made to people with weak credit during the housing boom have pushed more than 20 companies into bankruptcy.

...

At issue is a class of mortgages that lenders call "subprime" because they do not qualify for the lowest or prime interest rate. These are designed for high-risk borrowers, those with fixed incomes, or those who have had credit problems in the past. Since 1998, more than 6 million Americans have borrowed in this way, according to the Center for Responsible Lending (CRL). The majority of these loans are adjustable-rate mortgages (ARM) that are tied to changes in interest rates.

One in five loans subprime

That's a dramatic increase in only a decade. In 1995, subprime mortgages represented a niche market: less than 5 percent of mortgages originated. Today, Wall Street analysts estimate they make up from 18 percent to 24 percent.

..."

http://www.csmonitor.com/2007/0302/p01s02-usec.html

cheers

Skipping over to the evil empire for a moment, but on the same vein, an interesting article about Goldman Sachs/Merryl Lynch.

Goldman, Merrill Almost `Junk,' Their Own Traders Say (Update1)

http://www.bloomberg.com/apps/news?pid=20601087&sid=a0j4oiYE3Bfw&refer=home

By Shannon D. Harrington

March 2 (Bloomberg) -- Goldman Sachs Group Inc., Merrill Lynch & Co. and Morgan Stanley, which earned a record $24.5 billion in 2006, suddenly have become so speculative that their own traders are valuing the three biggest securities firms as barely more creditworthy than junk bonds.

Prices for credit-default swaps linked to the bonds of the New York investment banks this week traded at levels that equate to debt ratings of Baa2, according to Moody's Investors Service. For Goldman, Morgan Stanley and Merrill Lynch & Co., that's five levels below the actual Aa3 rating on their senior unsecured notes and two steps above non-investment grade, or junk.

Click to expand...

Is that a horse I see bolting off in the distance?

~~~~~~~~~~~~~~
WASHINGTON (MarketWatch) -- Federal bank regulators demanded tougher standards for subprime loans Friday, saying they're worried that borrowers of adjustable-rate mortgages may not understand the risks associated with them.

http://www.marketwatch.com/news/sto...x?guid={13649CAD-C0A3-446D-8CC1-A46A6DAB468B}

Buffett weighs in
Subprime loans have attracted wide attention, and Thursday, Warren Buffett, chairman of Berkshire Hathaway, told shareholders in his annual letter that the slowdown in residential real-estate markets partly stems from weakened lending practices in recent years.
"The 'optional' contracts and 'teaser' rates that have been popular have allowed borrowers to make payments in the early years of their mortgages that fall far short of covering normal interest costs," he said. "But payments not made add to principal, and borrowers who can't afford normal monthly payments early on are hit later with above-normal monthly obligations."
"This is the Scarlett O'Hara scenario: 'I'll think about that tomorrow.' For many home owners, 'tomorrow' has now arrived," Buffett wrote.

I have an analysis of Lehmans under "Where's all the Yen" on the blog pg3 for any interested

jog on
d998

This is probably the best place for a comprehensive ongoing round-up on the US Sub-prime market debacle ==> http://ml-implode.com/

This site is currently sitting at 30 Sub-Prime(was 26 at the beginning of the week) lenders that have disappeared into their own puff of stupidity.

I personally think the US administration lowered interest rates and lending standards in the US to placate the populace while they went off and had their dirty, illegal war in Iraq.

****, I just read this:

Wall Street Journal reports alt-A mortgage defaults double

News Digest, 1 March 2007

Today’s Wall Street Journal reports that the pain in the US mortgage market is spreading upward. The article points out that a record $400 billion of ‘Alt-A’ mortgages were originated last year, up from $85 billion in 2003, citing Inside Mortgage Finance. The category includes mortgages to those with little, if any, documentation of income or assets, and option adjustable-rate mortgages.

Now a rising number of borrowers who took out these loans are running into trouble, according to the Wall Street Journal. The article quotes UBS data as showing that the default rate for Alt-A mortgages has doubled in the past 14 months.

Click to expand...

NEW YORK (MarketWatch) -- Several analysts agreed Monday that New Century Financial Corp., one of the nation's largest subprime mortgage lenders, likely faces liquidation or bankruptcy following revelations that it's under criminal investigation and in violation of debt covenants with several lenders.
"New Century is more likely to enter the death spiral we had feared, as filing delays, financial difficulties, likely restricted liquidity and regulatory/criminal investigations could conspire to limit its options outside of bankruptcy," Merrill Lynch analysts wrote early Monday.
As troubles continue to roil the market for subprime mortgages, New Century disclosed late Friday that it's technically in default with several lenders and that federal regulators have begun an investigation.

Kimosabi said:

This is probably the best place for a comprehensive ongoing round-up on the US Sub-prime market debacle ==> http://ml-implode.com/

This site is currently sitting at 30 Sub-Prime(was 26 at the beginning of the week) lenders that have disappeared into their own puff of stupidity.

Click to expand...

It's ticking up another one practically every business day now so this seems to be gathering momentum. It's at 32 now, up again today.

Dr Doom said:

NEW YORK (MarketWatch) -- Several analysts agreed Monday that New Century Financial Corp., one of the nation's largest subprime mortgage lenders, likely faces liquidation or bankruptcy following revelations that it's under criminal investigation and in violation of debt covenants with several lenders.
"New Century is more likely to enter the death spiral we had feared, as filing delays, financial difficulties, likely restricted liquidity and regulatory/criminal investigations could conspire to limit its options outside of bankruptcy," Merrill Lynch analysts wrote early Monday.
As troubles continue to roil the market for subprime mortgages, New Century disclosed late Friday that it's technically in default with several lenders and that federal regulators have begun an investigation.

Click to expand...

NEW closed at $4.56 last night... and these were >$40 less than a year ago. lol

...of particular interest to me

Rates 'biting into mortgage payments'

March 8, 2007 - 3:14PM

A growing number of Australian households are falling behind in their mortgage payments as record indebtedness, rising interest rates and high petrol prices continue to bite.

Moody's Investors Services has found that 30-day delinquency levels in the fourth quarter of 2006 were on the rise, particularly in December, when seasonal factors such as Christmas spending depleted borrowers' pockets.........

http://www.smh.com.au/articles/2007/03/08/1173166869633.html?sssdmh=dm16.250112

The Credit cycle is starting to turn, and it will bite the market in the ass.
Add in a recession, the end of a *cyclical* bull, and the secular bear is starting to stir.

Watch out goldilock's.
Better start jogging.
d998