During the lead up to the GFC we had a long held negative view on the banks and consumer discretionary sectors. This was borne from the credit bubble that developed primarily from Greenspan’s excessively loose post 9/11 monetary policy.
Corporate and personal debt levels were becoming too cumbersome and the banks were simply failing to account for these risks in their lending practices.
While our negative view on the banks was subsequently justified, there was no opportunity for backslapping as the crisis eventually engulfed practically all areas of the market.
Now though, as we look ahead to the prospect of economic recovery we view the long-term outlook for the banks as considerably more favourable. We are therefore moving to upgrade our previous Traffic Light status on ANZ Banking Group (ASX: ANZ), the terrier of the big four, to a buy.
At this point in the bad debt cycle, a decent capital buffer is one of the more important considerations for the banks.
Fresh from gorging to the fullest extent possible on retail investors’ applications for its share purchase plan, ANZ certainly isn’t wanting for capital.
The question is of course, does their hunger for extra cash imply worse than expected future bad debt write-offs, additional acquisitions or simply prudent management? In reality, all three are likely to have factored in the decision.
As we discussed in our last review (FAT427), ANZ raised $2.5 billion from institutional investors back in May. Management stated at that time that they would limit the retail component of the capital raising to a maximum of $350 million. In the event, the flood of retail investors’ dollars proved too much to resist and the bank opted instead to take the lot.
This added a further $2.2 billion to ANZ’s war chest and took its tier 1 capital ratio to a mighty 9.5%.
Management of course isn’t raising capital simply to sit on it. Rather, ANZ is set to deploy upwards of $1 billion to acquire certain of Royal Bank of Scotland’s Asian assets. Even after doing so though, the bank’s tier 1 capital will remain in comfortable territory at probably more than 8%.
Given the poor performance of the bank’s loan book relative to the sector so far, however, the capital buffer will almost certainly face some erosion in the year ahead.
Australia’s banks have suffered from exposure to a considerable volume of large-scale corporate failures since the credit crisis began in mid-2007. ANZ however has absorbed a disproportionately large share of the losses. The bank has the dubious honour of holding the largest exposure of the big four to many of the most high profile collapses.
These include the likes of Opes Prime, ABC Learning, Babcock and Brown, Lehman Brothers, Timbercorp and Great Southern.
The big name failures are probably complete with the bad debt cycle now moving through the small to medium sized businesses (SMEs). Even so, extrapolating ANZ’s comparatively poor lending practices to the SME sector would suggest that the bank is in for further pain as the loan-loss cycle climbs to its peak.
The extent of the loan loss cycle and further write-offs for the banks is contingent on one’s view of the depth of recession. As we have discussed in the past, our view is that Australia will suffer only a shallow recession.
Unemployment will find a lower peak than many suggest, potentially less than 8%, and Australian property will avoid a US/UK style meltdown.
If we’re correct on this, then the banks and specifically ANZ may in fact be adequately capitalised. Furthermore, the blame for ANZ’s poor corporate lending track record rests with Mike Smith’s predecessor, John McFarlane. We therefore do not view the performance of the bank’s previous lending as indicative of their likely future performance.
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