‘More insolvencies’, more provisioning

Ian Rogers

Suncorp Bank and Commonwealth Bank this week kick off a complicated reporting season for the Australian banking industry, amid contested narratives between those who see durability in national income and growth, versus those foreseeing a domestic recession such as those now certain to engulf the likes of the US and the UK in 2023.

On Friday, in its quarterly Statement on Monetary Policy, the Reserve Bank of Australia dampened down forecasts for GDP growth and ramped up forecasts for inflation. 

Inflation, the RBA projects, will reach 7.75 per cent by the end of calendar 2022 and take another 18 months to notably subside. A little heroically, the RBA believes the inflation rate will sneak back within the target band by the end of 2024.

Australian financial conditions have of course tightened markedly since the round of half-year results for banks six months ago, though growth in total credit “has remained high in recent months, at around its fastest pace in more than a decade,” the RBA said.

Housing credit growth remains around 7.75 per cent on a six-month annualised basis. Commitments for housing loans declined in the June quarter, “consistent with slowing activity in the housing market, decreases in housing prices in a number of markets and the prospect of further rate rises,” the RBA said. 

“Commitments to owner-occupiers and investors have eased but remain close to their highest levels on record.”

Growth in lending to businesses “has picked up further in recent months … business lending has increased to the fastest pace in more than a decade,” the RBA said. 

Growth has been driven by lending to medium-sized and large businesses.

“Businesses’ demand for debt finance has been strong, and liaison suggests banks are meeting this demand, especially for larger businesses.”

Strangely, the SOMP almost cynically downplays one of the most pressing themes in the Australian banking industry, the failover in credit conditions across the construction sector. This is a classic leading indicator of a more widespread collapse in business confidence and fast-rising loan losses likely to afflict all banks.

“Some firms [are] expecting more insolvencies in the industry,” was the curt comment on this hot topic from the Reserve Bank, with no context or background on the worsening sequence of builders big and small failing this year.

National media are beginning to revel in the steady flow of news on the demise, administration and liquidation of residential builders, mostly.

One prominent high-density developer in Melbourne – Caydon – last week appointed liquidators to a series of subsidiaries, blaming exploding industry costs and languid (pandemic-constrained) sales, among other factors. There has also been a dribble of news around cuts and redundancies at Metricon, an icon of the sector.

The latest ASIC data on companies entering external administration, released in July, shows insolvencies in construction began to take off during the final quarter of 2021, with 328 recorded.   There were 401 insolvencies in the sector over the three months to May 2022, the most recent available.

“Driven by a spike in the last week of July, monthly insolvencies matched pre-COVID numbers for the first time,” Alares Monthly Credit Risk Insights, published on Friday shows.

And things seem set to darken from here.

Actions by the Australian Taxation Office to begin windups “have restarted in the last couple of days. Not a big number, but they are happening,” John Winter CEO of the Australian Restructuring Insolvency & Turnaround Association pointed out over the weekend.

“Construction is definitely the influential industry,” Kirk Cheesman, managing director of NCI Trade Credit Solutions said yesterday.

“Our biggest indicator is early overdue numbers. They have jumped since February this year.”

The boards of Commonwealth, Bendigo and Adelaide and the dozens of mutual banks now deliberating on appropriate risk settings and provisioning levels in the context of the market’s embrace of a near certain recession (and thus escalating arrears, impairments and write-offs) will be hard-headed.

The sector’s most respected advisers on these hot debates will guide them there.

Banking Day is hearing that the most candid versions of the outlooks prepared by the economics impresarios at the biggest banks are way more dour and pessimistic than those presented for public consumption so far. 

So the sell-side and buy-side analysts might want to trim their estimates on bank dividends, and brace for a surprise or two.

Lending provisions that built up in a rush amid the all too real stress of the GFC (now 14 years in the past) took the best part of a decade for the industry to work through, until the recent panic in the form of the Covid-19 pandemic produced an upswing in provisions in 2020.

It did not take long for the industry to begin to whittle these away for the stated reason: “reflecting an improvement in the economic outlook” (to quote CBA’s December 2021 half year results), and the perennially unstated reason: to maximise dividends and share buybacks.

The level of impaired loans around the Australian banking industry peaked at A$15 billion in June 2020, and declined to $12.8 billion at the end of 2021, APRA’s quarterly ADI statistics show.

Non-performing loans were $34 billion at March 2022. Expect these to explode as Australia sprints for a slowdown, at best, and most probably a hard landing.

So surely the boards of Commonwealth and Bendigo banks and others will be clear-headed on write-offs and take a little insurance around smoothing profits in the difficult reporting periods ahead.