On Bank Provisions, The Housing Market And Media Companies

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By Greg Peel

In 2008 as the global credit crisis was accelerating even before the fall of Lehman, Australian banks were forced to shift earnings into provisions against loan losses rather than booking profits. Already there had been some big-ticket failures, such as ABC Learning for example, but banks feared the next phase of small businesses going to the wall in number.

From this phase would flow job losses (peak levels of 8% were forecast) and thus mortgage foreclosures. Housing demand collapsed. Job advertising collapsed. All advertising collapsed. Australia, it was assumed, was heading into the worst recession since at least 1992, if not since 1932.

But it wasn't to be.

There are several reasons why Australia did not suffer the sort of recession levels experienced by the US and UK, for example. Firstly, our minimal level of “subprime” mortgages were not even very “sub”, our own banks were in more robust positions in terms of leverage, or lack thereof, and had little exposure to offshore toxic debt instruments. Employers reacted by cutting working hours rather than jobs per se (although this occurred elsewhere as well) and China began buying up our raw material exports in record numbers at 2008's lingering high prices when analysts had expected the opposite.

And of course the RBA slashed interest rates very aggressively and the government guaranteed bank deposits and poured in fiscal stimulus very quickly, in line with global policy.

The result is that not only has Australia avoided a recession (by technical definition) it has apparently returned very swiftly to trend growth, to the point where the government suggests we may return to surplus by 2011 instead of the 2015 estimate first made.

Crisis? What crisis?

So now we have the big banks in particular sitting on mountains of cash as provisions against bad debts that don't look like happening. Unemployment seems to have peaked having not even reached 6%, let alone 8%. Australian house prices are back on their upward price trajectory and newspapers and media networks are reporting a bounce-back in advertising. Everything looks hunky-dory.

Bank analysts had expected Australia's economic rebound, and thus a subsequent rebound in bank earnings, to occur in FY11. The beginning of FY11 is now only three months off, but already interim bank earnings reports have forced analysts to pull their timing forward to include the beginnings of the rebound in FY10 expectations as well as lowering the expected peak of bad debts. Bank earnings have positively surprised the market and the next step might naturally be assumed to be even more profits being booked as banks decide they no longer need such hefty provisions against loan losses. The return of provisions to the P&L could make for some very handsome FY10 final results for the banking sector.

But there is one small problem.

The RBS banking analysts point out that come 2014 a new international banking standard will come into force. The finer details of the standard are still up for discussion until the end of 2010 but the spirit of the law is clear, and banks have the option to adopt the new standard ahead of time to allow for smooth transition. To date most regulatory reform discussion has centred around capital and liquidity levels, and changes are yet to be legislated, but IFRS 9 deals specifically with loss provisions.

It is proposed that loss provisions shift in basis from “incurred loss” to “expected loss”. In short, this would mean banks must retain greater provisioning as a natural course of business than those levels in place before the crisis. Banks spent 2008 topping up provisions for what they feared or “expected” rather than just what they had “incurred”. The implication is banks may look ahead to new rules and decide compliance could mean hanging on to a lot of the provisions they have now.

Thus RBS is warning the market not to necessarily expect a large and “profitable” rush of provision monies hitting bank bottom lines soon. Investors may be disappointed.

A year is a long time in banking, but RBS has crunched its numbers out to FY13 and decided ANZ Bank ((ANZ) appears worst off among the Big Four with a potential 29% shortfall on expected loss provisions come that time. Westpac ((WBC)) is at the other end of the scale with only a 6% shortfall.

While RBS has been pondering bad debts, JP Morgan has been chatting to home builders. First up JPM has attempted to gauge recent sales activity and home builder confidence in Australia's most populous state, New South Wales.

As noted above, one reason Australia didn't fall heavily into recession was that the RBA slashed interest rates and the government provided swift fiscal stimulus, most notably in the form of first home-buyer grants. The result was Australian house prices dipped only marginally and briefly despite record levels of household debt. But the surprising economic rebound has meant four interest rates hikes since, and the unwinding of the home-buyer stimulus.

How is the housing market looking now?

JPM noted from its survey that none of those polled in the NSW home builder industry described the market as “poor” at present. However, the analysts qualify this result as part of cycling back from crisis levels a year ago. Anything looks good. But nor did any respondents suggest things were “very good” in sales, only 10% suggested traffic (inquiries) were “very good” (down from 40% previously) and 80% noted tightened lending conditions (on top of rate rises) and 75% loss of sales as a result.

The big banks may have sucked up a wealth of new, government-stimulated mortgages but they've learned a lesson on giving money away too readily.

The results have led JP Morgan to conclude the NSW housing market is “flat” at best. While home builders were still prepared to be confident near-term, the analysts suggest longer term problems will rear as affordability continues to decline in the face of higher rates and a lack of stimulus.

In the meantime, ANZ's job ad series has rebounded with a vengeance as unemployment peaks. Along with improvement in classifieds, media networks are reporting a solid return to advertising bookings following the near-death experience of 2008-09 when corporate cost-cutting meant ad-spend was the first to go.

GSJB Were reports a new independent survey of agency ad bookings has commenced, providing analysts with greater visibility than previously. Bookings through agencies represent 50% of the ad market, and they are up 10% over January-February on the same period last year.

With the economy clearly improving, and business confidence surveys trending upward, Weres has elected to upgrade its earnings forecasts for the media sector. The result is an upgrade for West Australian Newspapers ((WAN)) from Hold to Buy, although curiously Austereo ((AEO)) has been downgraded to Hold from Buy, possibly on recent share price performance.

Weres now has three media companies on its “Conviction List” of Buy recommendations – News Corp ((NWS)), Seek ((SEK)) and the Ten Network ((TEN)). The analysts also have Austar ((AUN)) and now West Oz as Buys, but not on the “List”

Many observers find this a curious system, myself included, given the implication is the West Oz rating is now Buy (But We're Not Convinced).

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