The Banks Are Fine.

The Banks Are Fine.
March 30th. 2008 - Australasian Investment Review – (AIR)

Not only are Australian banks weathering the international financial storm better than their peers in many offshore markets, but their basic financial strength hasn’t been hit so far.

That’s a message many investors have ignored, given their lemming like approach to the valuation of banks since late January.

In fact, the market reaction of investors would indicate they see big problems in all banks as share prices have plunged.

And while the banks are very well capitalised, according to the RBA’s Financial Stability Report, none have been downgraded by rating agencies and the nuts and bolts of their financial structure are sound.

They have plenty of liquidity, with individuals and corporates depositing tens of billions of dollars with them since the credit crunch hit last August.

That is an interesting judgment by individuals and companies that is at variance with the stockmarket performance.

That’s also of interest given the quiet disclosure in the report that the country’s financial regulators have proposed a modest deposit insurance system to the Federal Government.

The catalyst was the bailout and nationalisation by the Northern Rock Bank in Britain, a situation and eventuality that the regulators and Government there were not equipped to tackle.

“This experience is consistent with the Council’s previous analysis that arrangements in Australia would be enhanced by the establishment of a scheme to repay depositors in a failed authorised deposit-taking institution (ADI) in a timely fashion.

“Under the existing legislation, depositors rank ahead of other creditors in a failed ADI, although they are likely to have to wait some time before they could be repaid.

“Given this, the Council is working on an Early Access Facility, which would provide early repayment of up to $20 000 per depositor in a failed institution; it is estimated that this cap is sufficient to cover the entire deposits of around 80 per cent of depositors.

“Such a facility was recommended to the previous Government, and is before the current Government, while Council members have continued to investigate a number of technical issues relating to making early repayments to depositors in a closed institution,” The RBA said

Given the RBA’s view that the banks are well capitalised and are ‘weathering’ the storm well, a deposit scheme idea might send the message that all is not well. But it would seem the argument is for a form of insurance and preparedness in the event things get worse in the future.

But the position of the banks is impressive, as detailed by the RBA.

Here are some highlights.

The ratio of banks’ non-performing assets to total assets remains low both by historical and international standards.

As at end December 2007, this ratio stood at 0.4% of banks’ total assets, down slightly on the figure six months earlier.

Of these non-performing assets, just under half are classified as ‘impaired’, in that repayments are in arrears by more than 90 days (or are otherwise doubtful) and the debt is not well covered by the value of collateral.

The remainder while in arrears is considered to be well covered by collateral.

Despite the recent small decline in non-performing assets as a share of total assets, charges for bad and doubtful debts increased by one third over the past year, albeit from a very low base, to be the equivalent of 0.2% of outstanding loans.

The recent decline in the aggregate non-performing loan ratio is evident across each of the main segments of banks’ domestic loan portfolios.

In the business portfolio, the ratio of non-performing loans to total loans stood at 0.9% as at December 2007, compared with 1.3% four years earlier.

Within this aggregate figure, the share of banks’ commercial property lending that is classified as impaired picked up slightly over the year to September 2007 (the latest available data), to 0.3%, although this too remains low by previous standards.

As noted above, some banks have recently announced higher provisions against business exposures, though the increase remains small compared with the size of the aggregate business loan portfolio.

That said, any slowing in the domestic economy would likely be associated with some decline in the average quality of the business loan portfolio.

In the housing portfolio, 0.3% of loans on banks’ domestic balance sheets were non-performing as at December 2007, down from the figure in mid year and about the same as a year ago.

Most non-performing housing loans are considered by banks to be well covered by the value of collateral.

The ratio of non-performing personal loans to outstanding has also fallen slightly over the past six months and, at 0.9%, is around the same level as a year ago.

As at end December 2007, the ratio of the value of non-performing housing loans to total housing loans on banks’ domestic books stood at 0.32%, unchanged from a year earlier.

Of these non-performing loans, most were well covered by collateral.

The 90-day arrears rate for housing loans that have been securitised was also broadly unchanged over 2007, and stood at 0.40% in December. The arrears rate on securitised loans has, on average, been a little higher than that for loans on banks’ balance sheets, partly reflecting the higher share of low-doc loans in the securitisation pool.

For low-doc loans, the 90-day arrears rate was 0.70% in November 2007 more than double that for prime full-doc loans, but broadly around the level of a year ago.

In contrast, the arrears rate on nonconforming loans – which are made to borrowers with poor credit histories – has risen significantly over the past few years to stand at 7.25%. These loans, however, account for less than 1% of outstanding housing loans in Australia.

The low arrears rate on household loans relative to many other countries – and particularly the United States – reflects the ongoing strength of the Australian economy, as well as a number of other inter-related factors.

One of these is that the non-conforming housing loan market in Australia (the closest equivalent to the sub-prime market in the United States) accounts for less than 1% of outstanding mortgages, compared with about 13% in the United States, and Australian banks have been very minor participants in this market.

Another is that the level of interest rates has been quite different in the United States and Australia: in the United States, the Federal funds rate fell to 1% in 2003/04 and then rose only slowly, making it possible for many borrowers with poor credit histories and limited repayment ability to obtain loans.

A third factor is the legal environment. The Australian Uniform Consumer Credit Code (which has been in operation since 1996) means that courts can set aside mortgage agreements where the lender could reasonably have known that the borrower would not be able to repay the loan without substantial hardship.

Further, Australian mortgages are ‘full recourse’, so that unlike in a number of states in the United States, a borrower in distress cannot just hand the keys to the lender, and effectively extinguish the debt.

These legal requirements reduce both the incentive of lenders to provide loans to people that are likely to have difficulty repaying, and the incentive for borrowers to take out loans that cannot be repaid unless house prices increase substantially.

While these various factors have helped promote a more soundly based mortgage market in Australia, there nonetheless had been a general loosening of credit standards over recent years.

For example, the share of low-doc loans among all housing loans extended in 2006 was 10%, compared with 3% in 2002. In addition, the debt-servicing criteria that lenders use in assessing loan applications had been eased, and lenders began making greater use of lower cost electronic and off-site property valuation techniques.

These changes mean that, looking forward, for any given state of the economy and interest rates, housing loan arrears are likely to be higher than in the past.

This article is contributed by Australasian Investment Review – (AIR) You can subscribe for their free newsletter at -->

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