Bendigo & Adelaide Bank BEN S
December 07, 2011 - 5:06pm EST by
miser861
2011 2012
Price: 9.60 EPS $0.90 $0.90
Shares Out. (in M): 372 P/E 10.0x 10.0x
Market Cap (in $M): 3,575 P/FCF 10.0x 10.0x
Net Debt (in $M): 0 EBIT 460 485
TEV ($): 3,575 TEV/EBIT 8.0x 7.0x
Borrow Cost: NA

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Description

I think that Australia is in a housing and credit bubble that is on the verge of breaking, and Bendigo is my favorite Australian bank short.  I believe that Bendigo is poorly-reserved even for current NPLs, doubly so for the deluge of defaults coming.  

 

Why I Think There’s a Bubble

In late 2007 when the US was wringing out the excesses of our mortgage and consumer lenders, Australian homes experienced a 10% price correction, then continued their upward trajectory, reaching new highs as late as December 2010 before correcting 3% to September 2011.  The rapid recovery of commodity prices and continued economic resilience of China is likely responsible for Australia averting a recession and a full housing correction.  Also a perception prevailed that the Australian dollar would be a strong currency due to the economy’s reliance on resources, and Australian housing became a popular store of value for wealthy foreigners, particularly Chinese.  One developer claimed on November 30th that most of his customers were from China.

http://smh.domain.com.au/real-estate-news/crisis-will-force-greeks-back-triguboff-20111130-1o5y3.html

 

In Q1 2011 (the most recent data) the median price of existing homes transacted in Australia was A$495,432 (US$508,660).  This number includes all states and also includes condos.  Perth was 15% of transactions, so it’s not inordinately distorted by mining mania, and you can see that prices are tightly-grouped across the country.

 

                             Median Price     % of BEN’s Branches

Sydney                575,000              6.5%

Melbourne        484,000              45%

Brisbane             450,000              20%

Adelaide             402,000              7%

Perth                   500,000              9%

Hobart                339,000              3.5%

Darwin                510,000              1%

Canberra            538,000              6.5%

 

Price and volume data: http://www.abs.gov.au/AUSSTATS/abs@.nsf/DetailsPage/6416.0Sep%202011?OpenDocument

 

Average full-time wage in August 2011 is on a $71,562 run-rate.  Median price/wage multiple is 6.9x.  At the peak of the US housing bubble median price was $230,300 and average wage was $29,788, a multiple of 7.7x.  Mortgage interest isn’t tax deductible in Australia, so the tax-adjusted multiple is likely much higher in Australia, possibly in the ballpark of 8.7x.  Put another way, at today’s mortgage rate of 7.2%, 50% of pre-tax income would be going to interest for the incremental buyer (40% assuming a 20% down payment), 63% of after-tax (51% assuming a 20% down payment). 

 

                             Avg Wage           Price/Wage Multiple

Sydney                71,916                 7.5

Melbourne        68,094                 7.1

Brisbane             69,857                 6.4

Adelaide             65,291                 6.2

Perth                   84,250                 5.9

Hobart                62,816                 5.4

Darwin                72,602                 7.0

Canberra            71,916                 7.5

 

Wage data:

http://www.abs.gov.au/AUSSTATS/abs@.nsf/ProductsbyReleaseDate/7F76D15354BB25D5CA2575BC001D5866?OpenDocument

 

 

Timing

 

NPLs are on the rise again, despite prices only recently dipping 3%.  Bendigo’s NPLs have steadily increased the last three years from 1% to 2.4% at 6/30/11.  Many of the lower-quality securitizations I’ve looked at are seeing a significant rise in NPLs.  Suncorp Bank’s NPLs were 9.9% of loans at 6/30. 

http://www.rba.gov.au/publications/fsr/boxes/2011/sep/c.pdf

 

Building permits took a nasty dip in October after a steady march toward the ground.

http://www.abs.gov.au/AUSSTATS/abs@.nsf/ProductsbyReleaseDate/0545FFC6A101264DCA25719F007F6F1F?OpenDocument

 

Transaction volumes have recovered from their March lows, in an overall downtrend, having never recovered to their late 2007 highs.  One homebuilder announced on November 15th that sales since June 30th were down over 50% from last year.

http://www.abs.gov.au/AUSSTATS/abs@.nsf/DetailsPage/5609.0Sep%202011?OpenDocument

http://www.asx.com.au/asxpdf/20111115/pdf/422jkcsd6zyc95.pdf

 

Australian and Chinese PMI are on the decline.  The construction materials sector is in severely negative territory in the high 20s. 

http://www.aigroup.com.au/portal/binary/com.epicentric.contentmanagement.servlet.ContentDeliveryServlet/LIVE_CONTENT/Economic%2520Indicators/PMI/2011/PMI_report_Nov_11.pdf

 

 

Why Bendigo?

 

Three primary reasons: 1) loan loss reserves as a % of NPLs is the lowest of the large banks except Suncorp, 2) net interest margins are very low (1.76%) so BEN’s ability to absorb higher loan loss provisions is limited, 3) tangible equity/assets is only 4.3%.

 

Loan Loss Reserves

At 6/30/11 NPLs as a % of loans was 2.38%, and growing.  Allowance for loan losses was .53% of loans.  BEN has reserved 22% of NPLs.  This ratio has declined steadily from 36% in 2008.  NPLs are already higher than average, indicating poor underwriting.  An entertaining Sydney Morning Herald article suggests that the bank’s franchise model fosters bad underwriting.

http://www.smh.com.au/business/franchise-bank-model-turns-sour-20110513-1em6w.html

 

Net Interest Margins

60% of BEN’s branches are operated under a franchise model (described in the SMH article above) wherein BEN shares 50% of revenue with a community company, BEN agrees to shoulder all the loan losses, and the community company bears all the branch operating costs.  This model is very profitable when loan losses are low, but it creates an earnings stream that can be very volatile when loan losses increase.  BEN’s pre-provision EBT is .93% of assets.  Over the last 12 months Wells Fargo has provisioned 1.2% of loans, so if losses go that high at BEN pre-tax profits would turn negative.

 

Tangible Equity

At the highest (today) prime non-agency 90+ day delinquencies+forclosures+REO have reached 19% in the US.  Subprime and Alt-A have both reached 28%.  Since this is a point-in-time figure, cumulative defaults are much higher.  Let’s assume BEN’s NPLs go to 10% of loans and they reserve 60% of NPLs (Wells Fargo has reserved 71% of NPLs), oops equity is wiped out entirely.  BEN is not responsibly capitalized.

 

 The Best Bull Stories I Can Find

Lower Loan to Value Ratios

This is true.  BEN’s average LTV is 60%, whereas the average US bank was probably 80%.

 

Loans >80% LTV are Insured

This was true of the US as well.  I estimate that Australian PMI carriers have A$3.5 billion of capital.  There are A$1.2 trillion of mortgages outstanding in Australia.  There is a .3% capital buffer standing in front of the banks.  55% of BEN’s loans are uninsured.

 

Recourse is Stricter than in the US

After default Australian banks can take some assets and garnish 50% of the borrower’s income above A$61,700 for a family of four ($46,000 for a single person) for three years.  However, I’d point out that many US states were also recourse: Nevada and Florida for instance.  Deficiency judgments were rarely pursued in the US because of cost/benefit assessments.

 

Coastal Bias

In a country almost as big as the US with 1/14th the population, a higher proportion of property is coastal or near-coastal.  I’ve got nothing for this.

  

Valuation

BEN trades for 1.6x tangible book.  Compared to global bank multiples, this is demanding.  BEN’s pre-provision after-tax ROE is 15%, so maybe on Big Rock Candy Mountain where loans never go bad BEN should trade for 1.5x book.

Catalyst

-Rising delinquencies
-Falling prices
    sort by   Expand   New

    Description

    I think that Australia is in a housing and credit bubble that is on the verge of breaking, and Bendigo is my favorite Australian bank short.  I believe that Bendigo is poorly-reserved even for current NPLs, doubly so for the deluge of defaults coming.  

     

    Why I Think There’s a Bubble

    In late 2007 when the US was wringing out the excesses of our mortgage and consumer lenders, Australian homes experienced a 10% price correction, then continued their upward trajectory, reaching new highs as late as December 2010 before correcting 3% to September 2011.  The rapid recovery of commodity prices and continued economic resilience of China is likely responsible for Australia averting a recession and a full housing correction.  Also a perception prevailed that the Australian dollar would be a strong currency due to the economy’s reliance on resources, and Australian housing became a popular store of value for wealthy foreigners, particularly Chinese.  One developer claimed on November 30th that most of his customers were from China.

    http://smh.domain.com.au/real-estate-news/crisis-will-force-greeks-back-triguboff-20111130-1o5y3.html

     

    In Q1 2011 (the most recent data) the median price of existing homes transacted in Australia was A$495,432 (US$508,660).  This number includes all states and also includes condos.  Perth was 15% of transactions, so it’s not inordinately distorted by mining mania, and you can see that prices are tightly-grouped across the country.

     

                                 Median Price     % of BEN’s Branches

    Sydney                575,000              6.5%

    Melbourne        484,000              45%

    Brisbane             450,000              20%

    Adelaide             402,000              7%

    Perth                   500,000              9%

    Hobart                339,000              3.5%

    Darwin                510,000              1%

    Canberra            538,000              6.5%

     

    Price and volume data: http://www.abs.gov.au/AUSSTATS/abs@.nsf/DetailsPage/6416.0Sep%202011?OpenDocument

     

    Average full-time wage in August 2011 is on a $71,562 run-rate.  Median price/wage multiple is 6.9x.  At the peak of the US housing bubble median price was $230,300 and average wage was $29,788, a multiple of 7.7x.  Mortgage interest isn’t tax deductible in Australia, so the tax-adjusted multiple is likely much higher in Australia, possibly in the ballpark of 8.7x.  Put another way, at today’s mortgage rate of 7.2%, 50% of pre-tax income would be going to interest for the incremental buyer (40% assuming a 20% down payment), 63% of after-tax (51% assuming a 20% down payment). 

     

                                 Avg Wage           Price/Wage Multiple

    Sydney                71,916                 7.5

    Melbourne        68,094                 7.1

    Brisbane             69,857                 6.4

    Adelaide             65,291                 6.2

    Perth                   84,250                 5.9

    Hobart                62,816                 5.4

    Darwin                72,602                 7.0

    Canberra            71,916                 7.5

     

    Wage data:

    http://www.abs.gov.au/AUSSTATS/abs@.nsf/ProductsbyReleaseDate/7F76D15354BB25D5CA2575BC001D5866?OpenDocument

     

     

    Timing

     

    NPLs are on the rise again, despite prices only recently dipping 3%.  Bendigo’s NPLs have steadily increased the last three years from 1% to 2.4% at 6/30/11.  Many of the lower-quality securitizations I’ve looked at are seeing a significant rise in NPLs.  Suncorp Bank’s NPLs were 9.9% of loans at 6/30. 

    http://www.rba.gov.au/publications/fsr/boxes/2011/sep/c.pdf

     

    Building permits took a nasty dip in October after a steady march toward the ground.

    http://www.abs.gov.au/AUSSTATS/abs@.nsf/ProductsbyReleaseDate/0545FFC6A101264DCA25719F007F6F1F?OpenDocument

     

    Transaction volumes have recovered from their March lows, in an overall downtrend, having never recovered to their late 2007 highs.  One homebuilder announced on November 15th that sales since June 30th were down over 50% from last year.

    http://www.abs.gov.au/AUSSTATS/abs@.nsf/DetailsPage/5609.0Sep%202011?OpenDocument

    http://www.asx.com.au/asxpdf/20111115/pdf/422jkcsd6zyc95.pdf

     

    Australian and Chinese PMI are on the decline.  The construction materials sector is in severely negative territory in the high 20s. 

    http://www.aigroup.com.au/portal/binary/com.epicentric.contentmanagement.servlet.ContentDeliveryServlet/LIVE_CONTENT/Economic%2520Indicators/PMI/2011/PMI_report_Nov_11.pdf

     

     

    Why Bendigo?

     

    Three primary reasons: 1) loan loss reserves as a % of NPLs is the lowest of the large banks except Suncorp, 2) net interest margins are very low (1.76%) so BEN’s ability to absorb higher loan loss provisions is limited, 3) tangible equity/assets is only 4.3%.

     

    Loan Loss Reserves

    At 6/30/11 NPLs as a % of loans was 2.38%, and growing.  Allowance for loan losses was .53% of loans.  BEN has reserved 22% of NPLs.  This ratio has declined steadily from 36% in 2008.  NPLs are already higher than average, indicating poor underwriting.  An entertaining Sydney Morning Herald article suggests that the bank’s franchise model fosters bad underwriting.

    http://www.smh.com.au/business/franchise-bank-model-turns-sour-20110513-1em6w.html

     

    Net Interest Margins

    60% of BEN’s branches are operated under a franchise model (described in the SMH article above) wherein BEN shares 50% of revenue with a community company, BEN agrees to shoulder all the loan losses, and the community company bears all the branch operating costs.  This model is very profitable when loan losses are low, but it creates an earnings stream that can be very volatile when loan losses increase.  BEN’s pre-provision EBT is .93% of assets.  Over the last 12 months Wells Fargo has provisioned 1.2% of loans, so if losses go that high at BEN pre-tax profits would turn negative.

     

    Tangible Equity

    At the highest (today) prime non-agency 90+ day delinquencies+forclosures+REO have reached 19% in the US.  Subprime and Alt-A have both reached 28%.  Since this is a point-in-time figure, cumulative defaults are much higher.  Let’s assume BEN’s NPLs go to 10% of loans and they reserve 60% of NPLs (Wells Fargo has reserved 71% of NPLs), oops equity is wiped out entirely.  BEN is not responsibly capitalized.

     

     The Best Bull Stories I Can Find

    Lower Loan to Value Ratios

    This is true.  BEN’s average LTV is 60%, whereas the average US bank was probably 80%.

     

    Loans >80% LTV are Insured

    This was true of the US as well.  I estimate that Australian PMI carriers have A$3.5 billion of capital.  There are A$1.2 trillion of mortgages outstanding in Australia.  There is a .3% capital buffer standing in front of the banks.  55% of BEN’s loans are uninsured.

     

    Recourse is Stricter than in the US

    After default Australian banks can take some assets and garnish 50% of the borrower’s income above A$61,700 for a family of four ($46,000 for a single person) for three years.  However, I’d point out that many US states were also recourse: Nevada and Florida for instance.  Deficiency judgments were rarely pursued in the US because of cost/benefit assessments.

     

    Coastal Bias

    In a country almost as big as the US with 1/14th the population, a higher proportion of property is coastal or near-coastal.  I’ve got nothing for this.

      

    Valuation

    BEN trades for 1.6x tangible book.  Compared to global bank multiples, this is demanding.  BEN’s pre-provision after-tax ROE is 15%, so maybe on Big Rock Candy Mountain where loans never go bad BEN should trade for 1.5x book.

    Catalyst

    -Rising delinquencies
    -Falling prices

    Messages


    SubjectRE: Couple of questions
    Entry12/21/2011 07:18 PM
    Membermiser861
    Genworth I'm afraid to short.  Main reason being that the annuities business I think does $800m of EBT, and I'm assuming it's bankruptcy remote.  QBE LMI is an insignificant piece of the parent.  Genworth is going to try IPOing the Australian business in Q2.
     
    I think it makes no sense to default as long as prices are increasing.  So if prices continue to decline I think delinquencies will rise.  They're rising already, and have been consistently for BEN and other banks.  I think China would act as an accelerant for a fire that's already burning.
     
    As far as I can tell there's not a way to buy CDS on, or short MBS.
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