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7 Sep 2011 - Standard
& Poor's decision to review the credit ratings
of Australia's major banks has clearly ruffled
a few feathers. Local bankers have questioned
S&P's methodology, declaring it to be fundamentally
flawed, and also the rationale for the ratings
re-assessment.
Having come through the 2008 global financial
crisis relatively unscathed, the conventional
wisdom is that Australia's banking system is in
tip-top shape and that the challenges facing banks
in Europe, Japan and the U.S. have nothing much
to do with us.
While that's partly right, Australian banks are
not as shielded from risk as you might imagine.
One measure that highlights this is the leverage
ratio. The ratio can be calculated a number of
ways but the most common approach is to divide
total assets by shareholders equity. In broad
terms, this tells you how much they have geared
up their capital base.
Banks are in the business of borrowing and lending
money so their leverage ratios are nearly always
many times greater than non-financial companies.
Although leverage ratios have
some well-known shortcomings - notably that they
don't always accurately reflect asset quality
- they do provide a gauge of how exposed a financial
institution is to bad loans and writedowns.
If a bank has a leverage ratio
of 10 and 10% of its loans / assets go bad, it
will wipe out the bank's shareholders funds (or
require a massive injection of new capital). If
a bank has a leverage ratio of 20, it only takes
problems in 5% of its total assets to wipe out
its equity. In short, the higher the ratio,
the more you need economic and financial conditions
to stay calm.
As you can see from the table below, there is
a wide variation in leverage ratios around the
globe. Some of these numbers are truly alarming,
especially those for the big European and Japanese
banks, while most of the U.S. banks are remarkably
low - with the exception of the Federal Reserve!
Australia's banks are by no means conservatively
geared and you can understand S&P's interest
in making sure that they are on top of the situation.
While leverage is just one of the many factors
that need to be considered when buying bank stocks,
it is important that investors are aware of the
potential risks. If the Australian economy weakens
in a severe way, bank share prices could fall
sharply.
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|
Leverage
Ratios of Selected Major Banks
(total assets / shareholders equity)
|
|
|
Bank
|
Leverage
ratio
|
|
|
| U.S.
Federal Reserve |
110.1
|
| Mizuho
Financial |
37.2
|
| Deutsche
Bank |
37.0
|
| Credit
Agricole |
33.8
|
| Credit
Suisse |
31.3
|
| Barclays |
28.9
|
| UBS |
27.7
|
| Mitsubishi
UFJ |
25.7
|
| BNP
Paribas |
25.3
|
| Sumitomo
Mitsui |
24.8
|
| Societe
Generale |
22.2
|
| Lloyds
Bank |
21.8
|
| Royal
Bank of Scotland |
19.1
|
| Commonwealth
Bank of Australia |
18.4
|
| National
Australia Bank |
17.3
|
| HSBC
Holdings |
16.8
|
| ANZ
Banking Group |
15.3
|
| Westpac
Banking Corporation |
14.8
|
| Bendigo
& Adelaide Bank |
13.9
|
| UniCredit |
13.7
|
| Goldman
Sachs |
13.5
|
| Macquarie
Group |
13.2
|
| JP
Morgan Chase |
12.8
|
| Intesa
Sanpaolo |
12.1
|
| Reserve
Bank of Australia |
12.1
|
| Citigroup |
11.1
|
| Bank
of America |
11.0
|
| Wells
Fargo |
10.1
|
Sources: Forbes, WSJ, Bloomberg, Wren Research,
Sep-2011
|
Warning: While all care has been
taken in the preparation of this document (using
sources believed to be reliable and accurate),
we do not accept responsibility for any loss suffered
by any person arising from reliance on this information.
This document is not financial product advice
and does not take into account any individual's
objectives, financial situation or needs.
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