Bank Earnings Forecasts Still Falling

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            [0] => ((WBC))
            [1] => ((CBA))
            [2] => ((NAB))
            [3] => ((ANZ))
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            [0] => WBC
            [1] => CBA
            [2] => NAB
            [3] => ANZ
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This story features WESTPAC BANKING CORPORATION, and other companies.
For more info SHARE ANALYSIS: WBC
The company is included in ASX20, ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

By Greg Peel

Credit Suisse suggested yesterday that FY08 is shaping up as “the year for re-stocking loan loss provisions”, noting that for nine consecutive years Australian banks have been reducing their loan loss coverage. But for leading bank bear JP Morgan the real downside to bank earnings lies in the years FY09 and 10.

JPM made note yesterday that Australian banks continue to underperform in the credit crunched environment, weighed down by declining earnings prospects, rising loan losses and declining funds under management (FUM). But the analysts feel there is still a focus in the market on margin pressure for the banks, rather than the more ominous danger of the re-emergence of the loan loss cycle.

Margin pressure is only likely to create a 5-10% earnings headwind for the banks they say, whereas a reinvigorated loan loss cycle could constitute more like 25-35%. JPM is now assuming 12 months of zero FUM growth, the default rate of non-housing loans rising to 2%, and flat dividends for an extended period with dividend reinvestment plans underwritten.

To put that default rate into context, it is still only in line with the levels of 2001-02. While the JPM analysts have constantly been warning that investors should pay heed to the high default levels of 1991-92 they are not expecting a return to quite such drama. In 1992 Westpac ((WBC)) saw 16% defaults, Commonwealth ((CBA)) 10% and National ((NAB)) 8%.

In the lead up to the 1992 recession, when the likes of Bond, Skase, Connell and Holmes-a-Court were kings, there was an excessive amount of “dumb lending” to businesses, they note. But while this lasted from 1984 to 1989 this time the dumb lending has only really spanned the shorter time frame of 2004 to 2007 and has been less business concentrated. Back then commercial property collapsed due to a glut whereas this time commercial property weakness is due to overvaluations and excessive gearing.

But while the comparisons might prove comforting, the caveat is that JP Morgan’s numbers do not include potential increased losses on home lending, despite indications of declining underwriting standards, and nor do they assume any potential escalation in the current credit crunch.

The analysts expect the banks to fair far worse in FY09 than they will in FY08, as the effect of the credit crunch rolls on. For most FY09 doesn’t even begin until October. Yesterday JPM took ANZ’s ((ANZ)) earnings forecast down 7% in FY09, CBA 10%, NAB 25% (including another 9% in FY08), Westpac 18% (including another 9% in FY08) and St George 16%.

Credit Suisse is expecting sectoral earnings growth of minus 2% in FY08, with slower revenue growth (offset by slower cost growth) and “much higher” bad debt charges.

JP Morgan has also noted (notwithstanding the supposed Bear Stearns bottom) that bank cost of funds is still on the rise, not the ebb as one might hope. The banks have shied away recently from borrowing on 4-5 year terms – where the concentration of mortgage risk lies – to borrowing on 1-2 year terms due simply to the cost. If the banks are right, and the 4-5 year rates do subside, then the maturity mismatch risk they are currently creating should not be too dangerous. However, if they’re wrong…

The analysts note two banks have put their toes in the water this week, and the news is not good. ANZ issued $1.35bn of five year bonds at 128bps over 90-day bank bill. Last September a similar issue required only 42bps. The secondary market in 5-year debt had blown out to as much as 150bps over in March, only to retreat to 100bps recently. The analysts believe ANZ’s issue suggests the secondary market will move back up from 100bps once more.

Westpac had a go with a small issue ($160m) of tier-2 ten-year floating rate notes, and copped 200bps over. This compares to 30bps achieved before the credit crunch, and a NAB issue at 120bps in mid-January.

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