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 30^th 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/[email protected]/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/[email protected]/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/[email protected]/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 15^th that sales since June 30^th were down over 50% from last year.

http://www.abs.gov.au/AUSSTATS/[email protected]/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 1/14^th 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.