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