Australian Major Banks’ Bad Debts Hit 16 Year High

11 May 2009

Australian Major Banks’ Bad Debts Hit 16 Year High

Australia’s major four banks (the majors) have delivered a very creditable set of half-year earnings amidst deteriorating economic conditions, scarcity of capital and rising unemployment. According to PricewaterhouseCoopers’ ‘Banking Perspectives’, the majors achieved underlying cash earnings of $8.4 billion – a six per cent reduction over the prior corresponding period.

Mike Codling, PricewaterhouseCoopers Australia Banking and Capital Markets Leader said, “The majors have delivered a strong result and proven their resilience in the wake of a softening domestic economy and global banking crisis. Compared to the extraordinary losses experienced by banks across the UK, US and Europe, Australia’s majors have fared extremely well.”

The banks’ results were, however, significantly impacted by a near-trebling of bad debt expenses to $6.5 billion – a 16 year high – up 178% per cent over the prior corresponding period. Over the same period total bad debt provisions doubled to $16.3 billion. The average provision coverage ratio (total provisions to gross loans and acceptances) now stands at 95 basis points, up from 60 basis points a year ago.

“The significant rise in bad debt expenses has not been surprising. We’ve seen the collapse of some large highly-geared corporate borrowers and now we’re starting to see the broader impacts of the economic recession, with some pain coming through the small to medium size business exposures. Clearly the level of write offs is going to increase considerably. But given the level of balance sheet provisioning now in place, it remains an open question as to whether the level of expenses will rise again. Over the new few periods a key determinant will be the extent to which unemployment, and underemployment, will continue to rise,” he said.

New Zealand based Financial Services Partner Paul Skillender says the results from Australia bode well for the New Zealand banking market. “In the US and the UK the losses incurred by banks have lead to an overall decline in capital, which has forced many to the brink and beyond. However the good news for Australian banks, which in turn impacts New Zealand banks with Australian parents, is that we are seeing a reduction in profit, as opposed to a decline in capital. Although this is a clear sign that the global downturn is having an impact on banks in Australia, it is less severe than what we’ve seen in other markets.”

Net interest margins expand
Net interest margins (NIM) widened for the second successive half, mainly as a result of loan re-pricing measures. The rise came despite strong competition for retail deposits and greater wholesale funding costs. The average net interest margin of 2.14 per cent represents a 6 basis points rise during the first half of 2009.

Mr Codling said, “Increases in net interest margins are expected during the first phases of a recession. It enables the majors to repair stressed balance sheets, assist growth and continue lending. Higher costs for customers are inevitable, but it is a preferable outcome to having financial institutions in distress that would have far-reaching economic consequences.”

“Whether and how long the margins will continue to increase is hard to predict this time around. It depends not only on the ability of the banks to continue repricing upwards their loans, but on their funding structure. The clamour for deposits is highly competitive, and could be more expensive than the old wholesale debt rolling off,” he said.

Loans and deposits
Net interest income grew sharply overall by 19 per cent to $20.9 billion, partly because of the flight to quality by depositors. Household deposits with banks rose by 24 per cent over the year to March 2009.

“Prior to September 2008, household deposits have never grown more than 16 per cent in a twelve-month period,” Mr Codling added.

However, lending growth rates have tailed off significantly in the half. The housing lending system growth rate of 7.2% for the year to March 2009 is the lowest over-the-year growth rate recorded since the deregulation of the Australian financial system. And business lending actually fell in the March quarter by 0.8%.

“A combination of recessionary factors and repricing of business risk margins indicate that business borrowings will continue to decline for a period. During the 1992 recession, business loans fell by 8 per cent as economic conditions deteriorated,” Mr Codling said.

“On the positive side for the majors, they have increased their market share, particularly in housing lending, which positions them well for when the market turns,” Mr Codling added.

Cost efficiencies
Mr Codling said, “Each of the majors registered improved efficiency ratios during the half-year as a result of their revenue growth and disciplined expense management. The primary driver of cost management was the banks immediate reduction in discretionary spend items.”

“Costs reduction will continue as a profit growth driver in this challenging operating environment. Having said that, the banks seem determined to avoid a slash and burn approach, and instead are focusing on process improvement to achieve sustainable cost reductions and maintenance of prudent risk management,” he said.

Full Perspectives 2009 May (pdf)

ENDS

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