AUSTRALIA Insolvencies Stubborn # of Insolvencies 17, 16, 15, 14, 13, 12, 11, 1, Source: ASIC, Macquarie Research, Dec 212 WA/VIC insolvencies deterioration 2.4 2.2 Jan- 2 1.8 1.6 1.4 1.2 1 Source: ASIC, Macquarie Research, Dec 212 Insolvencies diverging from BDDs 9 7 5 3 1 # of insolvencies yearly rolling (LHS) PcP growth (RHS) Linear (# of insolvencies yearly rolling (LHS)) Source: Bank Data, ASIC, Dec 212 12% 1% 8% 6% 4% 2% 11 December 212 Macquarie Securities (Australia) Limited % Jan-8 May-8 Sep-8 Jan-9 May-9 Sep-9 Jan-1 May-1 Sep-1 NSW VIC QLD SA WA 27 28 29 21 211 212 BDD Write-Offs Insolvencies (RHS) 1 155 15 145 1 135 13 125 1 115 11 Insolent Insolvencies Event Overlaying recent insolvency trends with the diverging BDD/write-off picture indicates that unless there is a substantial improvement in the economic outlook, impairment charges are likely to head up in FY13. Impact Insolvencies still stubbornly high - ASIC s insolvency monthly statistics showed continued weakness in corporate Australia. Whilst the monthly growth in insolvency appointments has not yet reached GFC highs, the sticky elevation and upward trending number of insolvencies is concerning. Driving the national insolvencies uptick were increases from the slowing of the highspeed WA economy, and the further deterioration in VIC economy. This data plays directly into the observations of materially weaker pre-commitment levels of new residential developments in Victoria. Insolvencies, similar to write-offs, are marching to a different beat than impairment charges As raised in our report Cash is King, 23 November, we highlighted the ongoing divergence between write-offs and the banks impairment charge. When overlaying ongoing insolvency trends, an interesting picture begins to emerge. Similar to write-offs, insolvencies increased around 29 and have stayed high, with a possible argument that they have actually increased post 21. This analysis would seem to indicate that unless insolvencies and write-offs take a material step down over the course of the next year, that impairment charges are due for an increase in FY13. Some cracks emerging we expect more to appear in FY13 - Asset quality across the majors showed signs of deterioration with BDD expenses flat to up and corporate credit quality showing some cracks, in November 212 reporting season. A common theme in reporting season was the deterioration of the Business and Institutional divisions, with HoH BDD expenses up 57% A (Business and ex. APEA divisions), CBA +6% (business) and +264%, NAB +4% business and WBC remained flat after large increases in BDD expenses in. We d expect this to continue in to next year, as the impact of the mining slowdown becomes more apparent. Outlook Coming out of Bank reporting season, BDD expenses on average were higher in for the sector. Concerning is the emergence of a corporate BDD cycle, with corporate asset quality deteriorating in (increasing impaired asset, past dues and BDD expenses). It is most likely that the deterioration seen to date will see higher BDD charges in 2H13; there is however a chance this uptick will be seen in 1H13 from banks with poorer quality books such as NAB. Please refer to the important disclosures and analyst certification on inside back cover of this document, or on our website www.macquarie.com/disclosures.
Assessing asset quality further deterioration in sight ASIC s insolvency monthly statistics showed continued weakness in corporate Australia in the latest data, October 212. Insolvencies ticked up MOM. Whilst the monthly growth in insolvency appointments has not yet reached GFC highs, the sticky elevation and upward trending number of insolvencies is concerning. Fig 1 Australian insolvencies, sticky elevated and upward trending insolvency numbers # of Insolvencies 17, 16, 15, 14, 13, 12, 11, 1, Jul-4 Nov-4 Mar-5 Jul-5 Nov-5 Source: ASIC, Macquarie Research, December 212 y = 51.62x - 5413 Mar-6 Jul-6 Nov-6 Mar-7 Jul-7 Nov-7 Mar-8 Jul-8 Nov-8 Mar-9 Jul-9 Nov-9 Mar-1 Jul-1 Nov-1 Mar-11 # of insolvencies yearly rolling (LHS) PcP growth (RHS) Linear (# of insolvencies yearly rolling (LHS)) Jul-11 Nov-11 Mar-12 Jul-12 Driving the national insolvencies uptick were increases from the slowing of the high-speed WA economy, and the further deterioration in VIC economy. This data plays directly into the observations of materially weaker pre-commitment levels of new residential developments in Victoria. 7% 6% 5% 4% 3% 2% 1% % -1% -2% -3% Fig 2 State by State Insolvencies Levels remain high Fig 3 State by State Indexed Insolvencies Some signs of an uptick 7,8 1,2 2.4 6,8 5,8 4,8 3,8 2,8 1,8 Jan-8 May-8 Sep-8 Jan-9 May-9 Sep-9 Jan-1 May-1 Sep-1 NSW VIC QLD SA (RHS) WA (RHS) Source: ASIC, Macquarie Research, December 212 Source: ASIC, Macquarie Research, December 212 1, 8 6 4 2 NSW and QLD also showed signs of deterioration, with October insolvencies ticking up. Whilst by no means peak monthly growth for 212, the states insolvency levels continue to tick up and remain stuck at elevated levels. 2.2 2 1.8 1.6 1.4 1.2 1 Jan-8 May-8 Sep-8 Jan-9 May-9 Sep-9 Jan-1 May-1 Sep-1 NSW VIC QLD SA WA 11 December 212 2
More concerning Impairment bucking write-off/insolvencies trends As raised in our report Cash is King, we highlighted the ongoing divergence between write-offs and the banks impairment charge. When overlaying ongoing insolvency trends an interesting picture begins to emerge. Similar to write-offs, insolvencies increased around 29 and have stayed high, with a possible argument that they have actually increased. Fig 4 BDDs, write-offs and insolvencies trend heading the wrong way 1 1 27 28 29 21 211 212 Impairment Charge Write-Offs Insolvencies (RHS) 1 155 15 145 1 135 13 125 1 115 11 Source: Bank Data, ASIC, Macquarie Research, December 212 This trend is exacerbated further when removing NAB, where the impairment charge has been substantially higher than the other banks due to ongoing issues in the UK. Fig 5 BDDs, write-offs and insolvencies (ex NAB) trend exacerbated 9 7 5 3 1 27 28 29 21 211 212 BDD Write-Offs Insolvencies (RHS) 1 155 15 145 1 135 13 125 1 115 11 Source: ASIC, Company data, Macquarie Research, December 212 This overall analysis would seem to indicate that unless insolvencies and write-offs take a material step down over the course of the next year, that impairment charges are due for an increase. 11 December 212 3
Given asset quality deteriorated in reporting season, the read-through from the Insolvency data suggests further BDD hits are likely in FY13 Asset quality across the majors showed signs of deterioration with BDD expenses flat to up and corporate credit quality showing some cracks, in November 212 reporting season. A common theme in reporting season was the deterioration of the Business and Institutional divisions, with HoH BDD expenses up 57% A (Business and ex. APEA divisions), CBA +6% (business) and +264%, NAB +4% business and WBC remained flat after large increases in BDD expenses in. Given the continued deterioration of business credit quality in October 212 as reflected in ASIC data, we reiterate our sector macro call, where we remain comfortably cautious on asset quality in the sector and confirm our 2H13/1H14 BDD cycle. Fig 6 A BDD expense uptick driven by Business and divisions Fig 7 CBA reduction in retail BDD expense offset by increase in 75 6 7 65 6 55 5 45 63-15 564 549 549 75-2 61 61 4-8 686 681 681 55 5 45 4 35 545-17 7 87 438 438 445 15-15 -12 532 532 531 531 543 4 3 Business Banking APEA ex. APEA Business Banking Bank West Source: Company data, Macquarie Research, December 212 Source: Company data, Macquarie Research, December 212 Fig 8 NAB - reduction in retail BDD expense offset by increase in Business, UK and provision Top-Up 1,7 Fig 9 WBC flat BDD expenses driven by reduction in St. George BDD exp, and increases in other divisions 65 1,5 1,3 1,1 9 7 1,131-96 149 1,35 1,35 17-27 2 24 1,157 1,157 1,159 1,183 193 1,291 1,484 6 55 5 45-7 68 61-47 67-3 -11-3 554 551 54 537 537 64 5 4 3 Business UK & Business St.George Source: Company data, Macquarie Research, December 212 Source: Company data, Macquarie Research, December 212 11 December 212 4
Important disclosures: Recommendation definitions Macquarie - Australia/New Zealand Outperform return >3% in excess of benchmark return Neutral return within 3% of benchmark return Underperform return >3% below benchmark return Benchmark return is determined by long term nominal GDP growth plus 12 month forward market dividend yield Macquarie Asia/Europe Outperform expected return >+1% Neutral expected return from -1% to +1% Underperform expected return <-1% Macquarie First South - South Africa Outperform expected return >+1% Neutral expected return from -1% to +1% Underperform expected return <-1% Macquarie - Canada Outperform return >5% in excess of benchmark return Neutral return within 5% of benchmark return Underperform return >5% below benchmark return Macquarie - USA Outperform (Buy) return >5% in excess of Russell 3 index return Neutral (Hold) return within 5% of Russell 3 index return Underperform (Sell) return >5% below Russell 3 index return Volatility index definition* This is calculated from the volatility of historical price movements. Very high highest risk Stock should be expected to move up or down 6 1% in a year investors should be aware this stock is highly speculative. High stock should be expected to move up or down at least 4 6% in a year investors should be aware this stock could be speculative. Medium stock should be expected to move up or down at least 3 4% in a year. Low medium stock should be expected to move up or down at least 25 3% in a year. Low stock should be expected to move up or down at least 15 25% in a year. * Applicable to Australian//Canada stocks only Recommendations 12 months Note: Quant recommendations may differ from Fundamental Analyst recommendations Financial definitions All "Adjusted" data items have had the following adjustments made: Added back: goodwill amortisation, provision for catastrophe reserves, IFRS derivatives & hedging, IFRS impairments & IFRS interest expense Excluded: non recurring items, asset revals, property revals, appraisal value uplift, preference dividends & minority interests EPS = adjusted net profit / efpowa* ROA = adjusted ebit / average total assets ROA Banks/Insurance = adjusted net profit /average total assets ROE = adjusted net profit / average shareholders funds Gross cashflow = adjusted net profit + depreciation *equivalent fully paid ordinary weighted average number of shares All Reported numbers for Australian/ listed stocks are modelled under IFRS (International Financial Reporting Standards). Recommendation proportions For quarter ending 3 Sept 212 AU/ Asia RSA USA CA EUR Outperform 5.% 56.85% 61.54% 41.38% 63.19% 44.15% (for US coverage by MCUSA, 7.35% of stocks covered are investment banking clients) Neutral 36.62% 25.14% 27.69% 52.13% 3.77% 3.57% (for US coverage by MCUSA, 9.31% of stocks covered are investment banking clients) Underperform 13.38% 18.2% 1.77% 6.49% 6.4% 25.28% (for US coverage by MCUSA,.% of stocks covered are investment banking clients) Company Specific Disclosures: Important disclosure information regarding the subject companies covered in this report is available at www.macquarie.com/disclosures. Analyst Certification: The views expressed in this research reflect the personal views of the analyst(s) about the subject securities or issuers and no part of the compensation of the analyst(s) was, is, or will be directly or indirectly related to the inclusion of specific recommendations or views in this research. The analyst principally responsible for the preparation of this research receives compensation based on overall revenues of Macquarie Group Ltd (ABN 94 122 169 279, AFSL No. 31862) ( MGL ) and its related entities (the Macquarie Group ) and has taken reasonable care to achieve and maintain independence and objectivity in making any recommendations. General Disclosure: This research has been issued by Macquarie Securities (Australia) Limited (ABN 58 2 832 126, AFSL No. 238947) a Participant of the Australian Securities Exchange (ASX) and Chi-X Australia Pty Limited. This research is distributed in Australia by Macquarie Equities Limited (ABN 41 2 574 923, AFSL No. 23754) ("MEL"), a Participant of the ASX, and in New Zealand by Macquarie Equities New Zealand Limited ( ME ) an X Firm. s services in New Zealand are provided by ME. 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We accept no obligation to correct or update the information or opinions in it. Opinions expressed are subject to change without notice. The Macquarie Group accepts no liability whatsoever for any direct, indirect, consequential or other loss arising from any use of this research and/or further communication in relation to this research. The Macquarie Group produces a variety of research products, recommendations contained in one type of research product may differ from recommendations contained in other types of research. The Macquarie Group has established and implemented a conflicts policy at group level, which may be revised and updated from time to time, pursuant to regulatory requirements; which sets out how we must seek to identify and manage all material conflicts of interest. The Macquarie Group, its officers and employees may have conflicting roles in the financial products referred to in this research and, as such, may effect transactions which are not consistent with the recommendations (if any) in this research. The Macquarie Group may receive fees, brokerage or commissions for acting in those capacities and the reader should assume that this is the case. The Macquarie Group s employees or officers may provide oral or written opinions to its clients which are contrary to the opinions expressed in this research. Important disclosure information regarding the subject companies covered in this report is available at www.macquarie.com/disclosures. 11 December 212 5