Banks turn off banks

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The health of the banks is critical to the direction of the Australian market. Two reports are looking closely at earnings and asset quality, and both raise questions. First, Credit Suisse looks at the accounting treatment of earnings.

Since 2010 major banks have adopted increasingly aggressive accounting treatments, with aggregate major bank earnings benefiting cash earnings by 6% in 2H11 from more aggressive accounting practices, rising to 10% in 2H11 and 8% in 1H12 (from a limited range of accounting factors). We see CBA as having been relatively less aggressive in its accounting treatment among the major banks (no usage of significant item restructuring charges, only modestly aggressive expense capitalisation and the least amount of dilution of loan loss provision coverage), with ANZ marginally the most aggressive (largest quantum usage of significant item restructuring charges, the most aggressive capitalisation of expenses, but only modest dilution of loan loss provision coverage).

Credit Suisse suggests that bank earnings are coming under pressure:

■ We recently saw bank earnings quality fraying at the edges, notably with: 1) generally rising balances of capitalised software assets, 2) the return of significant item restructuring charges, and 3) softening collective provision coverage ratios – all of which can be argued tend to “over-state” the industry norm view of profit, namely “cash earnings”.
■ Our major bank order of preference: WBC (OUTPERFORM), ANZ (NEUTRAL), NAB (NEUTRAL) CBA (UNDERPERFORM).

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Macquarie suggests that property values might create problems:

Asset values up until 2007 and 2010 appeared to have peaked in CRE and residential asset prices, respectively. Since then residential asset prices have trended down at the same time as credit growth has reached decade lows. Similarly, with CRE, values have decreased from their peak (although a rebound from its lows has been seen through to 2011) and are currently sitting at ~10% below 2007 levels. Arguably, as credit growth continues to soften, further pressure will be placed on asset values.

The banks may have dodged the GFC effectively, but the risks have not gone away.

Credit Suisse 050912

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