By Michael West
There are four key threats to the profits of Australia's banks: bad debt write-downs from imploding corporates, the well-documented rise in the cost of wholesale funding, losses from structured-finance holdings and the potential for mortgage defaults.
Unlike banks in the US - the smaller ones are dropping like flies - Australia's banks are relatively well managed and well capitalised. With every new problem exposure however, the prospect of the banks moving to improve their capital buffers and cost of funding via large equity issues increases.
The potential for mass mortgage defaults is the most remote of the challenges facing the banks at the moment. Home loan defaults have been rising but still comprise a negligible hit to profits. Australian households are as safe a bet as any asset class there is.
Moreover, falling interest rates are reducing the likelihood of red ink flowing in the big banks' mortgage books.
The danger is unemployment. If, for instance, the commodity super-cycle were to end and Australia were to find itself in the grip of a global recession, this country's highly indebted households would begin to default in numbers. That would pose a real threat to bank profitability.
At this point the crisis on Wall Street is yet to spill over into the Australian economy.
The rise in the cost of wholesale funding has already wreaked damage on bank profit margins. In the case of the Big Four however - NAB, CBA, Westpac and ANZ - their large depositor bases and a $10 billion per annum fee clip serve as decent protection against the rise in wholesale funding costs.
Bancassurance group Suncorp and the second-tier players are not finding the going quite so easy, and non-bank lenders ... well look at Rams.
To the next threat: structured finance. Over the past three months ANZ and NAB have both taken large write-downs on their collateralised debt obligations (CDOs) and other fancy structured products. Banking analysts are increasingly tweaking their forecasts and their modelling for the prospect of further red ink from these investments.
CBA and Westpac have both admitted to exposures as well, but these are widely regarded as less of a problem than for ANZ and NAB. UBS recently raised the spectre of $150 million to $1.6 billion in further structured finance write-downs for NAB.
For its part, ANZ has a large CDS (credit default swap) exposure and has also been hit hard by its exposure to stock lenders Opes Prime, Chimaera and Tricom. This week came another bout of bad news with a $US120 million exposure to the bankrupt Lehman Brothers. They can't take a trick.
Which brings us to the "Bad Boys''. The Bad Boys are the leveraged former heroes of the boom - the Smartest Guys in the Boom you might say - who borrowed too much and whose share prices have been slaughtered.
The figures on the accompanying table are estimates of the bank exposures to the Bad Boys - and to the latest and greatest of the Bad Boys, Babcock & Brown. These estimates are gleaned from public admissions, corporate advisory and institutional sources and should be regarded as a guide.
It is a worrying guide, particularly for ANZ and Suncorp - the former because of its large exposure to B&B and the latter because it is smaller than the Big Four banks and can less afford the losses.
It should be noted that most of the Bad Boys are not insolvent and still have the chance of trading out of their positions.
Sadly, the rise in counterparty risk from the woes on Wall Street and the increasing prospect of damage to the real economy does not help the prospects of the Bad Boys. Most, if not all, are now in de-facto "work-out'' with their creditors and likely to fail.
The table does not include many other corporate casualties such as Commander Communications, which have gone under this year.
It does, however, include Raptis, the Queensland property developer which had receivers appointed to one of its entities last week.
Suncorp has declined to specify its exposure, however BusinessDay believes that it is close to $200 million. Given Suncorp's budget for bad debts is $96 million this year and given that its non-performing loans are now believed to be $659 million, excluding Raptis, a blow-out for Suncorp chief John Mulcahy and his team would appear to be in the works.
As an interesting diversion, the greatest mystery in modern-day Australian banking remains unsolved. That is the relationship between stockbroker Tricom, Babcock & Brown and ANZ.
You have to hand it to Tricom chief Lance Rosenberg, whose survival efforts make Lazarus look like a quitter. But why is it that - and ANZ still had nothing to say on this matter yesterday, having claimed to have cleaned up its stock lending mess last month - Tricom is still alive?
Tricom had assisted B&B in numerous ways during the halcyon days, including providing B&B executives and staff margin loans against their various B&B stable holdings.
It also provided substantial assistance to B&B in its takeover of Alinta by offering clients margin loans (believed to be non-recourse) on their Alinta stock provided they accepted the B&B terms.
These terms are part of the reason that Tricom margin lending ended up with so much of the B&B satellites in the margin lending account
While B&B flirts with death, ANZ has apparently funded former executive and head of B&B Capital, Rob Topfer, into a recapitalisation of Tricom. The irony is that B&B had closed down its corporate finance business as part of its recent restructuring but now appears to have set up Tricom as a corporate finance shop, thanks to Topfer and ANZ.
It seems B&B, Babcock Communities and Babcock Capital may pay Tricom to unwind the Babcock deals for which Topfer was originally responsible. Why didn't they just keep him on?
Will there be a fee rebate for savaged shareholders of B&B, BCM and BBC for unwinding these deals?
Nice work by Rosenberg and Topfer. There is still $80 million in the Tricom margin lending book that needs to be unwound.
But the big question remains, what is ANZ hiding? Does it relate to the failure to deliver Allco stock in January when Tricom blew up? The claw-back of stock from the dying Opes Prime perhaps? A deal arising from the shift of part of Tricom's loan book to Opes in February?
Who knows, apart from Rosenberg and ANZ? Still, Lehman might be gone but Tricom still lives!
mwest@fairfax.com.au
BusinessDay