The bad debt spanner in a rate cut rationale

Australia's credit growth and non-resource investment remain weak, but sharp falls in the banks' bad debt provisions suggest a Reserve Bank snip may not come yet.


Don’t be too confident about a Reserve Bank rate cut tomorrow or, for that matter, in June. Why? Ask the banks.

On the weekend, market sages (Westpac's chief economist Bill Evans and AMP's Shane Oliver) told readers of their weekly missives that the softer news from the overseas and local economy meant the Reserve Bank had room to cut rates again. But both believed it wouldn't move until June, after next week’s budget and with the benefit of more data on first-quarter economic performance – the April jobless data this week and the business investment figures for the March quarter later in the month.

Does the economy need (another) cut? While we’re travelling at just under trend (GDP growing around 2.5 per cent), inflation is low and unemployment low, though it may be edging up. But housing has yet to really respond to repeated Reserve Bank cuts, credit growth is still slow and so is non-resource investment.

That said, two key parts of the economy continue to do well.

Friday’s car industry sales figures for April show we’re still buying cars in record numbers – sales are now running more than 5 per cent ahead of 2012, which was itself a bumper year. And leading retailer JB Hi-Fi surprised with a profit upgrade for the 2013 financial year - with two months to go. The 11 per cent rise in earnings predicted by the company adds to the better news on retail sales we saw in January and March. That better news continued today with the ABS' retails sales data for March. Sales grew 0.4 per cent in trend terms in March, following 0.4 per cent rises in trend terms in January and February. And while turnover at current prices was down in seasonally adjusted terms (-0.4 per cent) it was up 2.2 per cent in volume terms. That is, consumers are buying more, but retailers are still discounting.

If two sectors as heavily skewed to consumer confidence as car purchases and consumer electricals are doing well, and retail generally is performing solidly, is a rate cut really needed while 1.75 percentage points of cuts since late 2011 are still working their way through the economy?

And then there are there are the latest reports of our biggest banks, led by ANZ and Westpac last week (the NAB reports this week). Record results, dividends and rising share prices tell us investors are not nervous about the outlook for the banks. And the banks, their managements and boards are so confident of the future that their bad debt provisions all fell in the six months to March, according to their reports to the ASX.

For example, Westpac said on Friday that it had cut its provision for bad debts by a massive 28 per cent to just $438 million, as souring loans fell in its key business, its Australian domestic retail unit. That's the one that sells home loans, credit cards etc. Westpac is the country's second-biggest home lender.

ANZ's provision for bad and doubtful debts fell 13 per cent to $599 million in the six months to March 31. Gross impaired assets dropped 10 per cent and new impaired assets fell 15 per cent, half on half (i.e. first half of the year vs second half of the year) with the ANZ saying all its divisions saw falls in the level of newly impaired assets. And Bank of Queensland's provision plunged to just under $60 million from more than $268 million (a clean-out of bad debts after new management took over). More important, the Bank of Queensland said its impaired assets fell to 1.8 per cent of loans, from 2 per cent.

Back at the end of December, the Commonwealth Bank, the country's largest, revealed it had lifted bad debt provision by 13 per cent because of a small number of loans in its business banking group soured. But the bad loan provision in its biggest business, Australian retail (home loans etc) fell 31 per cent to $246 million at the end of December 2012, from $356 million at the end of 2011.

If the banks were really worried about the outlook for the economy, they would not be as aggressive in cutting their provisions, nor would the level of impaired loans be falling. The banks all add what's called an "economic overlay" to their provisions and estimates of bad loans to take account of their view of the economic outlook.

Now, yes, the banks could be wrong, with boards and managements searching for ways to boost earnings at a time when investors want more. And they’ve erred in the past – 2007 and 2008 come to mind, when they missed the emergence of the GFC and failed to start putting more away for bad debts. They got caught and had to slash dividends, boost bad debt provisions and ask the market for more than $20 billion in fresh capital, and they also had to get emergency funding from the Reserve Bank in late 2008 when wholesale funding markets offshore dried up.

But on the basis that there isn’t an industry-wide error about the state of the housing loan market, the sluggish nature of domestic demand doesn't seem to be ringing alarm bells at the banks. The Reserve Bank has already pointed out the falling trend in bad debts in the February edition of its statement on monetary policy. The May edition is due out this Friday and will contain up-to-date forecasts for the economy and no doubt remark again on the latest fall in bank bad debts.

This story first appeared on on May 6. Republished with permission.

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