Tuesday, 30 December 2008

Impaired Assets Continue to Rise for Aussie Banks

Impaired assets continued to rise in the September quarter for Australian banks according to the RBA's quarterly bulletin. Actually it would be more accurate to say they shot up, rising by approximately $4.4 billion, the largest increase since September 1994.

However it is the percentage of impaired assets to total assets which is of most relevance. They also rose sharply to 0.52% from 0.36% in the June quarter. Despite the sharp increase it is still historically low and due mainly to specific impairments rather than system wide deterioration.

Impaired assets as a percentage of the total could go back close to the 1.0% level and still not be particularly bad. I have little doubt that it will get to those levels, it is only a matter of time.

The more interesting question is when does the normal deterioration in this part of the credit cycle turn into a system wide blowout as has happened in the US? Probably not until unemployment really starts to bite and households and corporates being defaulting on their debt on mass.

It is not clear if we will get to that point in Australia, but it cannot be ruled out as a possibility.


Jason said...

Hi what does the increase in impaired assets mean to the bank?

My understanding of impaired assets are that they are a company's asset that is worth less on the market than the value listed on the balance sheet.

Would it affect their capital ratio indirectly, directly?

The Fundamental Analyst said...

Hi Jason, Obviously for banks their main assets are loans. When a loan becomes delinquent by, for example, someone failing to pay their mortgage, that loan goes through various stages of impairment, 30 days overdue, 60 days, 90 days etc. until they write it off completely.

Another name you may have heard for impaired assets is non-performing loans. As impaired assets rise, banks need to set money aside to cover the expected losses on those assets. That's why, when you look at the profit and loss statements of banks these days, their provisions for bad debts are rising significantly.They are setting aside more money to cover the expected losses from the impaired assets on their balance sheet.

You can also use impaired assets to describe MBS, CDO's or CDS that, as you describe, are trading at less than the value on the balance sheet.

If the losses are big enough they will definitely have a direct effect on capital ratios, just take a look at the major US banks, that without government injections of capital, would be insolvent. It is no coincidence that the major Australian banks have been raising capital because they know losses from impaired assets are going to rise.

Jason said...

Thanks for replying so quickly.

Yeah my interest in finance and related fields have piqued recently.

I noticed the various major banks in Australia has been raising capital in billions recently by issuing of new rights/shares, sovereign guaranteed debt in variety of currencies, cutting dividends but by raising their capital ratio so much to brace for losses from impaired assets, would it affect their normal functions like reducing lending activity to protect their own balance,these functions make money for shareholders.

The Fundamental Analyst said...

Most certainly it does affect their ability to lend. A dollar put aside to cover losses is a dollar the bank can't lend out. That's why bank earnings will continue to come under pressure in an environment of rising bad debts.