It’s Only Getting Worse For The Banks

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This story features COMMONWEALTH BANK OF AUSTRALIA, and other companies.
For more info SHARE ANALYSIS: CBA
The company is included in ASX20, ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

By Greg Peel

Late on Friday Commonwealth Bank ((CBA)) announced yet another independent increase of it’s standard variable (mortgage) rate (SVR) of 12 basis points to 9.44%.  Suncorp-Metway ((SUN)) was also moved to add 5 more points to 9.37%. Since August the RBA has added 100 basis points of interest rate while the banks, on average, have added a further 33 points. The increase in banks’ funding costs over that period, as identified by the 90-day bank bill swap (BBSW) rate over cash, is 35 points.

Thus on that basis, the banks are still coming up short.

The score card in term of increases over RBA now reads St George ((SGB)) +40, CBA +35, Westpac ((WBC)) +30, ANZ ((ANZ)) +30 and National ((NAB)) +29. These numbers indicate (a) Westpac, ANZ and NAB still have scope to rise, with CBA having broken ranks, and (b) St George’s previous reliance on securitisation markets is rendering it less competitive. But while CBA has matched the increase in BBSW, JP Morgan suggests the bank is not yet fully recovering its increased cost of funding posed by a steeper yield curve and increasing wholesale funding costs.

UBS suggests banks are probably now ahead on mortgages specifically, but the lag lies in recouping incremental costs in corporate and institutional divisions. “This, ” says UBS, “is a big part of our caution on margins”. The analysts hope the February credit growth numbers, which showed a slowing in business credit growth, are a reflection of a fall in demand only and not that banks have already begun to ration credit.

If banks are forced to ration credit due to their straining capital bases and higher funding costs, any benefit the big banks may achieve from winning back prodigal borrowers from the securitisation markets will be tempered. It is such a win that analysts have been putting faith in ever since this credit crunch began – a trade-off against increased costs and bad loans. GSJB Were is staking it’s whole argument on this basis – an argument which sees Weres as the last bank bull left in the paddock.

But the number of analysts fearing a bad-loan blow-out is growing. Last week Macquarie decided bad loan levels could indeed exceed the last peak of FY01-02, while Deutsche Bank moved to assume they would reach the previous peak. JP Morgan has consistently warned that FY92’s significantly higher peak cannot be ignored.

Today ANZ Bank issued an ASX announcement informing that its “credit provisions for the first half will exceed the consensus of market expectations primarily due to a higher collective provision charge”. ANZ’s move comes hot on the heels of the Opes Prime imbroglio, in which the question of legal shareholder ownership rights is still up in the air. Little wonder ANZ is now assuming bad loans (including those involved in margin lending) might escalate. In FY07 ANZ provided $567m against bad loans. For FY08 the bank has now put aside $975m – a 72% increase. Sector bad loan provisions in FY02 were roughly 60% higher than in FY07. They were about 800% higher in FY92.

ABN Amro reports the Bank of England as noting local financial institutions plan to cut mortgage and corporate lending, which will only serve to intensify the credit squeeze. One presumes a similar situation exists in England as in Australia, where prodigal borrowers are fleeing from securitisation markets and wobbly Northern Rocks and returning to old faithfuls such as Barclays and co. If the big banks intend to cut (ration?) lending, where does that leave the Australian banks in a similar scenario?

ABN suggests NAB’s decision to take a provision not just against specific loans, but against “current uncertain global environment” is tacit acknowledgement Australia’s banks are going to see things get worse before they get better.

The big banks (with the exception of CBA) will be reporting their first half ’08 results shortly. We get a precursor with Bank of Queensland ((BOQ)) this Thursday, before we hear from ANZ on April 23, Westpac on May 1, St George on May 6, and NAB on May 9. Macquarie Group ((MQG)) will reveal its FY08 full year result on May 20.

Before the locals get a run, US banks will begin releasing their official first quarter 2008 results this week. In the next month, all US listed companies will post first quarter results. The investment banks have already pre-released some details, but further provisions or write-downs may occur. These first quarter results across the broad market are arguably the first “recession” results, so it will be interesting to see just how the average fairs. Banks will be watching keenly as well, given weak profit results do not bode well for bad loan increases.

Of course, a lot of the tension could be removed if credit spreads begin to meaningfully return to less-stretched levels, and wholesale funding costs fall for banks and thus for other corporates. But despite everything central banks have thrown at the market, credit spreads remain high. It will take a long time yet before the credit squeeze eases, suspicion dies down and spreads move back to some sort of “normal” level. It will possibly be a generation before they return to pre-credit crunch levels.

In the meantime banks are rushing to try to balance out their cost of funds. While increasing their lending rates effectively bolsters their earnings potential on mortgages and other loans, demand will surely drop off more rapidly the higher rates go. It’s a rock and a hard place. And The Australian’s Michael West reported this morning:

“Senior banking figures at board level tell this columnist that their 24-hour turnover data on large retailers already showed consumer demand ‘going over the cliff’ at least three weeks ago. The point being that an interest rate slowing – the point of Reserve Bank policy – is not the same as the bottom falling out of consumer confidence.

“These same figures point to the lag in the Reserve Bank’s data, which is sometimes up to a month old, compared with their real-time economic figures. The bank may have failed to get off the interest rate bus a few stops back, where it ought to have alighted.”

History suggests central banks always overreact. In Australia’s case it could mean the difference between the banks bungling through, and bad loans across the whole business/consumer spectrum ballooning with disastrous results.

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