Bank earnings and provisions
The market has become increasingly concerned about the risk of asset impairments for the major banks. Whether it be from exposure to Asia, mining and energy assets, agriculture assets, or the housing market in Sydney and Melbourne. Banks have effectively sold a put option to consumers and businesses over their assets or income streams and as a result they have a leveraged exposure to significant falls in asset prices. The major banks’ earnings growth rates have benefited from falling bad and doubtful debt provisioning over the last 4 years. As a result, the provision charges in the FY15 results were significantly lower than the long term averages for the industry. Of course if there is a significant reduction in asset prices, provisions can rise quickly, putting pressure on the balance sheet and a bank’s capital adequacy. In valuing banks, it is important to look at the sustainable earnings base and return generation of the business. Consequently, extrapolating lower than normal level of provisioning in a valuation is likely to result in an overestimation of the bank’s worth. (VIEW LINK)
Roger Montgomery founded Montgomery Investment Management, www.montinvest.com in 2010. Roger brings more than two decades of investment, financial market experience and knowledge. Roger also authored the best-selling investment book, Value.able.