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Bad debt spike is banks' biggest risk    
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Source : The Bull, Australia

A rebound in bad debts is the biggest risk facing Australia's big banks as a divergence emerges in earnings potential between business and retail lenders, Credit Suisse says.

Bank profits jumped to record levels in fiscal 2010 thanks to heavy falls in bad debts that cut profits in 2009 during the global financial crisis.

All four major banks continued their record profit run in the first half of fiscal 2011, last week reporting more modest declines in bad debts - which almost halved on the previous corresponding period at Westpac.

But now Australia's multi-speed economy, characterised by recent natural disasters amid a mining boom, threatens to reverse the fall in bad debts, Credit Suisse bank analysts James Ellis and Jarrod Martin say.

"Bad debt charges are normalising ... but not normalising at the pace which you've been seeing in the last couple of years, (with) the impact of ... a multi-speed economy coming through," Mr Ellis told reporters on Thursday.

Mortgage arrears also ticked up for ANZ Banking Group, Westpac and Commonwealth Bank (CBA) during the first half of fiscal 2011, and could climb higher with rising interest rates, he said.

"The seasonality effect will fade, but then you've got what is a more enduring impact of the higher repayment burden which is not going away."

Cost management, rather than revenue growth, drove banks' interim underlying profits between four and eight per cent higher compared to the September 2010 half.

Underlying profits exclude bad debt provisions, and Credit Suisse expects the growth to continue but only if credit growth tracks higher.

Against that backdrop, the broker sees a divergence in earnings potential between domestically-focused, mortgage lending giants CBA and Westpac and their southern rivals.

Melbourne-based ANZ and National Australia Bank (NAB) are more exposed to business lending and run much smaller home loan books.

"There's a clear demarcation between a corporate-orientated versus a retail-orientated bank," Mr Ellis said. NAB, Australia's biggest business lender, is the broker's preferred stock due to its heavy leverage to business lending growth which stuttered back to life in the last two months to overtake growth in mortgage lending.

But the uptick in business lending would take 12 months before the full impact hits NAB's bottom line, Mr Ellis said.

NAB delivered the best interim result, had stronger balance sheet momentum than its rivals and was yet to see its net interest margin (NIM) suffer from undercutting competitors' mortgages to grab market share, Mr Ellis said.

Its true test would be whether its current NIM was maintained, he added.

ANZ's Asia strategy makes it a high growth-oriented bank, which may produce lower return on equity (ROE), a measure of profitability.

"You're beginning to see that, whereas NAB is just your recovery or self-help story," Credit Suisse's Mr Martin said.

Domestic fund managers who previously saw ANZ's expansion plan as a "graveyard for bank capital in the overseas expansion are now much less resistant", Mr Ellis said.

By contrast, Credit Suisse sees CBA and Westpac as lower growth, higher ROE banks hamstrung by their large exposure to mortgages.

Rising house prices fuelled home lending growth to an average annual growth rate of between 11 and 12 per cent over the past 20 years, and the rate never fell below eight per cent.

It is now running at six per cent, making the business environment tougher for CBA and Westpac, which both lost mortgage market share to NAB over the past six months.

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