Dream Run Over For The Banks As Bad Debts Bite

Dream Run Over For The Banks As Bad Debts Bite

Newcastle Herald
28 February 2008
By BARBARA DRURY - SMH

RISING inflation, the Reserve Bank on the warpath, tighter credit and the prospect of a sharp increase in loan defaults are bad news for banks and their share prices.

In fact, the Crowded House swansong, Don't Dream It's Over, could be the anthem of the Australian banking sector in 2008.

There is no doubt that the five big banks Commonwealth Bank, National Australia Bank, Westpac, ANZ and St George Bank are fundamentally healthy. There is also little doubt that the dream run of the past 15 years is over.

Earlier this month the Commonwealth Bank revealed the prospect of a sharp rise in bad debts and a 39 per cent lift in bad debt provisions, along with a disappointing 4 per cent increase in first-half net cash profit to $2.38 billion, in what chief executive Ralph Norris referred to as a "difficult environment".

As if that weren't bad enough, higher funding costs from global credit markets shaved $100 million off pre-tax profits.

The market was spooked, immediately wiping 6 per cent off the Commonwealth's share price and savaging the rest of the bank sector in expectation of further bad news.

The other major banks have a September financial year, so won't be reporting their first-half profits for about another two months. Analysts had forecast earnings per share growth this financial year of more than 10 per cent for all but St George, which is more exposed to global finance markets. These estimates may be revised downwards after Commonwealth Bank's measly 2 per cent increase in first-half earnings per share.

Steve Johnson of The Intelligent Investor recently reminded clients that banking is a cyclical industry.

"After 16 years of mostly consistent profit growth, it's easy to believe otherwise, but banking remains a cyclical industry," he wrote.

"While it's impossible to know where the top is, we're not at the bottom."

Johnson argues that as credit growth slows, bank revenue growth slows and loan defaults increase. As consumers begin to feel the pain of higher interest rates for their mortgages, credit cards and personal loans, loan defaults are bound to escalate.

"We've been recommending that the big banks make no more than 15 per cent of your portfolio for a number of years now and, if anything, that argument is strengthening," Johnson says. "We won't be revising it until we see the cycle turn."

This is easier said than done when many long-term investors have a portfolio heavy with bank stocks that have served them well for years and when the Australian sharemarket is heavily weighted towards financial stocks. The big five banks alone make up 21 per cent of the ASX 300 Index.

There are signs that the market is re-evaluating the banks' starring role. The overall market fell 11 per cent in January but the financial sector (excluding property) fell 12.7 per cent. Of the big banks, Commonwealth Bank was the worst performer, down 16.4 per cent, while ANZ Banking was the best, down only 5.3 per cent.

Tyndall portfolio manager Brad Potter agrees that the headwinds facing the banks have increased. "Everyone expects bad and doubtful debts to increase, they expect credit growth to slow and they expect margins to reduce," he says.

Potter says margins the difference between the banks' cost of funding and the rates they receive for lending have been declining by five to 10 basis points a year.

The fall in margins has been offset by cost reductions but this strategy can only go so far.

Despite the banks' recent weakness, Matt Williams, Perpetual Investments portfolio manager, stresses that they are well placed to ride out the global credit crisis.

SMH

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