Troublesome Loans Rising At CBA

This story features COMMONWEALTH BANK OF AUSTRALIA. For more info SHARE ANALYSIS: CBA

By Greg Peel

The recent full-year result from Commonwealth Bank ((CBA)) and accompanying quarterly updates from the other three majors showed a common theme. Margins, for the most part, remained under pressure but lost earnings were offset by reductions in provisions for bad and doubtful debts (BDD).

When everything went awry in 2008 the big banks all moved to protect their balance sheets by shifting earnings into emergency provisions and reducing distributions. Those provisions took two forms – one specifically against a worst case rise in BDD and the other simply a war chest against general economic uncertainty.

The banks have since raised substantial capital and as the dust has settled, Australia has come out of the GFC relatively unscathed. BDDs have not reached the levels feared and the banks have thus brought some of their provisions back onto the bottom line, as well as once again improving dividend payouts. The uncertainty provisions remain in place nevertheless, (a) because some uncertainty still lingers and (b) because the banks assume regulatory changes, when they come, will likely require greater levels of liquidity.

But a reduction in BDD provisions from the omigod emergency levels of 2008 does not alter the fact that credit quality on bank loan books remains an issue. With regards to CBA, the UBS bank analysts this morning question whether the trouble is really gone or is it indeed still coming.

A “bad” debt is one that is written off and a “doubtful” debt is one that looks like it will have to be written off as well. But as we move up the quality scale, we meet the interim levels of “non-performing” and “troublesome” loans. NPLs are stuck in the limbo of perhaps one day being paid off but currently not being serviced, while one presumes troublesome loans are those with somewhat erratic servicing.

UBS notes CBA loans in these categories grew to $13.2bn in value or 4.3% of total exposures in the second half FY10, up from $11.4bn or 3.7% in the first half.

The largest contributor to “troublesomes” is property loans, which saw a troublesome increase to 8.8% of that portfolio in the 2H up from only 5.9% in the 1H. UBS notes BankWest loans are the major culprit. The largest deterioration was experienced in the agriculture portfolio which saw troublesomes grow to $2.5bn or 14.6% from $1.8bn or 10.9%. UBS notes problems in the New Zealand dairy and wine industries are to blame, rendering agriculture CBA's “lowest quality” book.

Small improvements were nevertheless seen in retail & wholesale trade, energy, transport and, of course, mining, which specifically saw troublesomes fall from 4.4% to 1.8%.

Clearly, UBS sees the growth of troublesomes as somewhat troubling, undermining its belief in a “high quality, well capitalised franchise generating a strong 19% return on equity”. UBS thus maintains a Neutral rating on the stock, as do another eight out of the ten brokers and researchers in the FNArena database. It is only Macquarie, which has long been waving the CBA flag, that offers an Outperform (Buy) rating.

At $54.31, the consensus price target among those brokers offers only 4.7% upside.

UBS expects the outlook for CBA to remain subdued subject to the strength of the economic recovery and any move to reprice loans, meaning in particular increasing mortgage rates despite the RBA staying put. Such a move is still likely as soon as Australia has a government.

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