WBC - Westpac

[peat]

i just think that in some time , say 3-5 years it will be approaching the current historic PE again and will have represented good long term value at these price.

The article in the herald quoting Mark Lister saying there was good value for longer term views - although that doesn't convince me for eg AIA (tourism related) but for pillars of the financial antipodes - I think even though there are clear setbacks coming at a time of intense public dislike stoking the regulatory fire , however possibly the necessity of having strong banks will mollify the financial punishment aspect of the authorities. Who knows, but there would appear to be a lot of provisioning maybe more than will become necessary.

The state needs Westpac and ANZ to do their job of providing credit and intermediating in the system and wont want to knobble them or increase the chance of a failure or even an increase in the perception of likelihood of failure.

[Snoopy]

From p13: https://www.westpac.com.au/content/d...ember_2019.pdf (except the last column that I have calculated)

Westpac averaged Risk Weighted Assets EOFY2019 ($m)

Asset Categories	Risk Weighted Assets {A}	Exposure at Default {B}	Averaged Risk Weighted Factor {A}/{B}
Business Lending	35,470	54,570	0.65
Small Business	16,090	33,365	0.48
	-------	-------
Total	51,560	87,935	0.59

One area that is causing me concern in this "Covid-19 market" is the amount of money that banks have loaned towards business. In particular I am thinking about those businesses not large enough to be listed on any market, yet still large, right down to SMEs (excluding traditional 'really small business' that is likely to be funded by a mortgage taken out over the proprietors home, out of sight of 'business lending' rules).

These businesses do not have externally verified credit ratings. Yet they are still a significant part of the business loan book for any bank.

I think such investments are classified under the 'Basel 3' Standardised Credit Risk Assessment Approach (SCRA). Under SCRA, there are three risk weighted loan grades: 'Grade A', 'Grade B' and 'Grade C'.

https://www.bis.org/bcbs/publ/d424_hlsummary.pdf (look on p7)

The standardised credit risk table and associated risk weighting for each of the three grades of loans is as follows:

	Grade A	Grade B	Grade C
Risk Weightings	40%	75%	150%
Risk Weightings (Short Term)	20%	50%	150%
Risk Weightings (50/50 ST LT)	30%	62%	150%

'Grade A' loans are not dependent on business cycles and economic conditions going 'just right'. 'Grade B' loans can be seriously affected by business cycles. While Grade C have 'material default risks'.

One way to interpret the 59% Risk weighting over all business loans is to think of the majority of these loan being 'Grade B' with a small percentage 'Grade A'. However, if more of each loan were directed towards 'stock for sale', then the average risk grade would be skewed more towards 'Grade B', with even a few loans classified in 'Grade C' under a 'business as usual' situation.

I am now going to produce a 'plausible' current scenario to work with. Using the format

a(RW Grade A) + b(RW Grade B) + c(RW Grade C) = 0.59

we need to solve for 'a', 'b' and 'c'. There is no unique answer to this equation. So I am going to make a couple of educated guesses and say that:

1/ In normal times business loans are precarious and 'something like' 10% are 'Grade C'.
2/ 'Around' two thirds (66%) of businesses are tied to business cycles and are 'Grade B'.

Given these two assumptions we can now calculate what proportion of business loans are 'Grade A".

a(0.3) + (0.66)(0.62) + (0.10)(1.5) = 0.59

=> a=0.1

The relative proportion of each loan grade A:B:C is therefore: 0.1:0.66:0.1

Normalising to a combined total of 100, that is the same relative proportion as: 12:76:12 OR

12% 'Grade A', 76% 'Grade B' and 12% 'Grade C'. (12% + 76% + 12% = 100%)

I am happy with that scenario, as it is not too far from my initial guesses and it sounds plausible. We now have a 'base scenario' to work from!

(0.1)(0.3) + (0.66)(0.62) + (0.10)(1.5) = 0.59

Now we can imagine a severe recession where half of all 'Grade A' loans become 'Grade B' and half of 'Grade B' loans become 'Grade C'.

0.05(0.3) + (0.05+0.33)(0.62) + (0.33+0.1)(1.5) = 0.90

0.9 is the new 'stressed' Averaged Risk Weighted factor. Now we can calculate a new 'risk weighted loan balance figure' from the existing 'exposed assets at default' figure.

The sum of the business related loan assets 'exposed at default' on the last balance date (30-09-2019) was $87,935m. So our new 'Risk Weighted Adjusted' figure is:

0.9 x $87,935m = $79,142m

This is an increase of: $79,142m - $51,560m = $27,852m

WBC requires a minimum of 8% of the incremental 'book value' of business loans on the books. So the amount of new capital WBC needs to cover off these business loans under my 'stressed business' scenario is:

0.08 x $27,852m = $2.2billion.

SNOOPY

[Snoopy]

Now we can imagine a severe recession where half of all 'Grade A' loans become 'Grade B' and half of 'Grade B' loans become 'Grade C'.

0.05(0.3) + (0.05+0.33)(0.62) + (0.33+0.1)(1.5) = 0.90

0.9 is the new 'stressed' Averaged Risk Weighted factor. Now we can calculate a new 'risk weighted loan balance figure' from the existing 'exposed assets at default' figure.

The sum of the business related loan assets 'exposed at default' on the last balance date (30-09-2019) was $87,935m. So our new 'Risk Weighted Adjusted' figure is:

0.9 x $87,935m = $79,142m

This is an increase of: $79,142m - $51,560m = $27,852m

WBC requires a minimum of 8% of the incremental 'book value' of business loans on the books. So the amount of new capital WBC needs to cover off these business loans under my 'stressed business' scenario is:

0.08 x $27,852m = $2.2billion.

Ouch!

SNOOPY

P.S. I have a feeling my stressed business scenario is too severe. I am effectively saying that close to 40% of all businesses operating in a sustainable way today will move into something approaching statuatory management. I intend to have another go with a less severe business contraction being modelled.

[nztx]

Ouch!

SNOOPY

P.S. I have a feeling my stressed business scenario is too severe. I am effectively saying that close to 40% of all businesses operating in a sustainable way today will move into something approaching statuatory management. I intend to have another go with a less severe business contraction being modelled.

Stop it Snoops .. too much more of this & I'll start having nightmares..

To balance how do you factor in for new business add ins, restructured loans, deferred loan arrangements etc ?

& there will likely be further who change banking shop for better deals elsewhere perhaps with/without added assistance

[Snoopy]

One area that is causing me concern in this "Covid-19 market" is the amount of money that banks have loaned towards business. In particular I am thinking about those businesses not large enough to be listed on any market, yet still large, right down to SMEs (excluding traditional 'really small business' that is likely to be funded by a mortgage taken out over the proprietors home, out of sight of 'business lending' rules).

These businesses do not have externally verified credit ratings. Yet they are still a significant part of the business loan book for any bank.

I think such investments are classified under the 'Basel 3' Standardised Credit Risk Assessment Approach (SCRA). Under SCRA, there are three risk weighted loan grades: 'Grade A', 'Grade B' and 'Grade C'.

The standardised credit risk table and associated risk weighting for each of the three grades of loans is as follows:

	Grade A	Grade B	Grade C
Risk Weightings	40%	75%	150%
Risk Weightings (Short Term)	20%	50%	150%
Risk Weightings (50/50 ST LT)	30%	62%	150%

'Grade A' loans are not dependent on business cycles and economic conditions going 'just right'. 'Grade B' loans can be seriously affected by business cycles. While Grade C have 'material default risks'.

One way to interpret the 59% Risk weighting over all business loans is to think of the majority of these loan being 'Grade B' with a small percentage 'Grade A'. However, if more of each loan were directed towards 'stock for sale', then the average risk grade would be skewed more towards 'Grade B', with even a few loans classified in 'Grade C' under a 'business as usual' situation.

I am now going to produce a 'plausible' current scenario to work with. Using the format

a(RW Grade A) + b(RW Grade B) + c(RW Grade C) = 0.59

we need to solve for 'a', 'b' and 'c'. There is no unique answer to this equation. So I am going to make a couple of educated guesses and say that:

1/ In normal times business loans are precarious and 'something like' 10% are 'Grade C'.
2/ 'Around' two thirds (66%) of businesses are tied to business cycles and are 'Grade B'.

Given these two assumptions we can now calculate what proportion of business loans are 'Grade A".

a(0.3) + (0.66)(0.62) + (0.10)(1.5) = 0.59

=> a=0.1

The relative proportion of each loan grade A:B:C is therefore: 0.1:0.66:0.1

That is the same relative proportion as: 12:76:12 OR

12% 'Grade A', 76% 'Grade B' and 12% 'Grade C'. (12% + 76% + 12% = 100%)

I am happy with that scenario, as it is not too far from my initial guesses and it sounds plausible. We now have a 'base scenario' to work from!

(0.1)(0.3) + (0.66)(0.62) + (0.10)(1.5) = 0.59

Now we can imagine a severe recession where half of all 'Grade A' loans become 'Grade B' and half of 'Grade B' loans become 'Grade C'.

0.05(0.3) + (0.05+0.33)(0.62) + (0.33+0.1)(1.5) = 0.90

0.9 is the new 'stressed' Averaged Risk Weighted factor. Now we can calculate a new 'risk weighted loan balance figure' from the existing 'exposed assets at default' figure.

The sum of the business related loan assets 'exposed at default' on the last balance date (30-09-2019) was $87,935m. So our new 'Risk Weighted Adjusted' figure is:

0.9 x $87,935m = $79,142m

This is an increase of: $79,142m - $51,560m = $27,852m

WBC requires a minimum of 8% of the incremental 'book value' of business loans on the books. So the amount of new capital WBC needs to cover off these business loans under my 'stressed business' scenario is:

0.08 x $27,852m = $2.2billion.

SNOOPY

Here is a second 'plausible' current scenario to work with. Using the format

a(RW Grade A) + b(RW Grade B) + c(RW Grade C) = 0.59

and filling in the numbers

(0.1)(0.3) + (0.66)(0.62) + (0.10)(1.5) = 0.59

Now we can imagine a severe recession where 20% of all 'Grade A' loans become 'Grade B' and 20% of 'Grade B' loans become 'Grade C'.

0.08(0.3) + (0.02+0.53)(0.62) + (0.13+0.1)(1.5) = 0.71

0.71 is the new 'stressed' Averaged Risk Weighted factor. Now we can calculate a new 'risk weighted loan balance figure' from the existing 'exposed assets at default' figure.

The sum of the business related loan assets 'exposed at default' on the last balance date (30-09-2019) was $87,935m. So our new 'Risk Weighted Adjusted' figure is:

0.71 x $87,935m = $62,434m

This is an increase of: $62,434m - $51,560m = $10,874m

WBC requires a minimum of 8% of the incremental 'book value' of business loans on the books. So the amount of new capital WBC needs to cover off these business loans under my 'stressed business' scenario is:

0.08 x $10,874m = $870m.

SNOOPY

[Snoopy]

Here is a second 'plausible' current scenario to work with. Using the format

a(RW Grade A) + b(RW Grade B) + c(RW Grade C) = 0.59

and filling in the numbers

(0.1)(0.3) + (0.66)(0.62) + (0.10)(1.5) = 0.59

Now we can imagine a severe recession where 20% of all 'Grade A' loans become 'Grade B' and 20% of 'Grade B' loans become 'Grade C'.

0.08(0.3) + (0.02+0.53)(0.62) + (0.13+0.1)(1.5) = 0.71

0.71 is the new 'stressed' Averaged Risk Weighted factor. Now we can calculate a new 'risk weighted loan balance figure' from the existing 'exposed assets at default' figure.

The sum of the business related loan assets 'exposed at default' on the last balance date (30-09-2019) was $87,935m. So our new 'Risk Weighted Adjusted' figure is:

0.71 x $87,935m = $62,434m

This is an increase of: $62,434m - $51,560m = $10,874m

WBC requires a minimum of 8% of the incremental 'book value' of business loans on the books. So the amount of new capital WBC needs to cover off these business loans under my 'stressed business' scenario is:

0.08 x $10,874m = $870m.

Here is a third 'plausible' current scenario to work with. Using the format

a(RW Grade A) + b(RW Grade B) + c(RW Grade C) = 0.59

and filling in the numbers

(0.1)(0.3) + (0.66)(0.62) + (0.10)(1.5) = 0.59

Now we can imagine a severe recession where 15% of all 'Grade A' loans become 'Grade B' and 15% of 'Grade B' loans become 'Grade C'.

0.085(0.3) + (0.015+0.56)(0.62) + (0.1+0.1)(1.5) = 0.68

0.68 is the new 'stressed' Averaged Risk Weighted factor. Now we can calculate a new 'risk weighted loan balance figure' from the existing 'exposed assets at default' figure.

The sum of the business related loan assets 'exposed at default' on the last balance date (30-09-2019) was $87,935m. So our new 'Risk Weighted Adjusted' figure is:

0.68 x $87,935m = $59,796m

This is an increase of: $59,796m - $51,560m = $8,236m

WBC requires a minimum of 8% of the incremental 'book value' of business loans on the books. So the amount of new capital WBC needs to cover off these business loans under my 'stressed business' scenario is:

0.08 x $8,236m = $659m.

SNOOPY

[Snoopy]

Now we can imagine a severe recession where 15% of all 'Grade A' loans become 'Grade B' and 15% of 'Grade B' loans become 'Grade C'.

0.085(0.3) + (0.015+0.56)(0.62) + (0.1+0.1)(1.5) = 0.68

0.68 is the new 'stressed' Averaged Risk Weighted factor. Now we can calculate a new 'risk weighted loan balance figure' from the existing 'exposed assets at default' figure.

The sum of the business related loan assets 'exposed at default' on the last balance date (30-09-2019) was $87,935m. So our new 'Risk Weighted Adjusted' figure is:

0.68 x $87,935m = $59,796m

This is an increase of: $59,796m - $51,560m = $8,236m

WBC requires a minimum of 8% of the incremental 'book value' of business loans on the books. So the amount of new capital WBC needs to cover off these business loans under my 'stressed business' scenario is:

0.08 x $8,236m = $659m.

0.08 x $8,236m = $659m

This figure is not the same as the amount of new capital needed. The amount of new capital required could be less as the total does not take into account any 'buffer capital' the bank may already have on the books in anticipation of a downturn in the business market. Selling off liquidated business assets is another way to reduce the amount of 'bank support capital' needed.

Of particular interest is how this 'potential increased capital requirement' squares off against the provision set aside under the newly adopted ECL (Expected Credit Loss) method of booking 'Expected' bad debts.

From

https://www.westpac.com.au/content/d...ember_2019.pdf

and on page 13, the 'Regulatory Loss for Non-defaulted Exposures' is on the books at $431million for 'business lending' and $351m for 'Small Business'. That is a combined total of $782million.

Comparing my projected loss of $659m to the ECL provisions of $782m already on the books:

$659m -$782m = 'a negative number'

That means the balance sheet is already set up handle such a loss. For current Westpac shareholders, I think that is encouraging.

SNOOPY

[Snoopy]

Stop it Snoops .. too much more of this & I'll start having nightmares..

To balance how do you factor in for new business add ins, restructured loans, deferred loan arrangements etc ?

Before I answer that question let's be very clear what I am talking about here. I am talking about the amount of capital on a bank's balance sheet that is needed to support a certain level and category of loan.

A balance sheet is taken at a snapshot in time. So whether a loan is 'new' or 'older' makes no difference. New or old, a total loan balance is a total loan balance on any particular date (in this case EOFY2019 which was 30th September 2019).

I am answering the rest of your questions assuming the loans you are talking about are categorised by the bank using the SCRA (Standardised Credit Risk Assessment Approach).

For me to answer the second bit of your comment, you would have to be more specific as to what a 'restructured loan' meant.

IF for example the borrower wanted to:

i/ split the loan that was maturing in four years INTO
ii/ three smaller loans of equal total value maturing in two years, four years and six years

THEN I don't think it would make any difference to the amount of capital the bank would need to support these loans (until the first loan was repaid anyway) PROVIDED the bank was in agreement with these changes.

However, if the restructuring amounted to some kind of deferred payment arrangement, this might indicate that the customer was forecasting having difficulty paying back that loan. If it was a loan to buy capital plant, then it could fall from being a 'Group B' loan to a 'Group C' loan. In that instance the amount of capital the bank needed to support that same loan would double, even as the underlying value of the loan did not change.

& there will likely be further who change banking shop for better deals elsewhere perhaps with/without added assistance

If a customer goes elsewhere, then their loan will move from one bank's book to another. Looking at the situation from this single loan perspective, then a customer leaving will result in the capital needed to support this loan no longer being required by the bank.

Next you speak of 'assistance'. What if the assistance is in the form a 'government guarantee' agreeing to repay the bank 80% of the loan if it goes bad? This makes no difference at all to the amount of bank capital needed to support the loan (as I see it). This is because a loan is graded on the likelihood of the loan being repaid in a 'customer operational sense'. So who might bail the lender out eventually, if the loan fails, makes no difference to how the underlying likely 'thin profit margin' customer business model works.

From page 9

https://www.bis.org/bcbs/publ/d347.pdf

"A Grade C loan would include higher credit risk exposures to counterparties that have material default risks and limited margins of safety."

Yet, I had a contrary closing thought. Maybe you could argue that with the government taking 80% of any loan loss on the chin, the 'material default risk' for the bank is less? On balance, I still think the 'default risk'(i.e. the act of defaulting) is different to the 'repayment risk' though. Happy to be corrected if I have that wrong!

SNOOPY

[nztx]

Before I answer that question let's be very clear what I am talking about here. I am talking about the amount of capital on a bank's balance sheet that is needed to support a certain level and category of loan.

A balance sheet is taken at a snapshot in time. So whether a loan is 'new' or 'older' makes no difference. New or old, a total loan balance is a total loan balance on any particular date (in this case EOFY2019 which was 30th September 2019)..

Very informative postings - Snoopy - thanks for posting for us..

[Snoopy]

some strong provisioning coming through today Snoops, a lot more than 200m , I'm reading 1,430m plus 140m in insurance.
Share price didn't react much though.

I finally got around to seeing the HY2020 pre-result provisioning as announced in the 14th April 2020 Press Release update.

Provisioning for HY2020

Item	Value	Notes
Internal Incremental Crime Fighting provision	$80m	(Tax deductible)
Wrongly categorised business loan refunds	$105m	(Tax deductible)
Missed collective court settlement + Refund of Wealth fees	$130m	(Tax deductible)
Incremental remediation program cost	$90m	(Tax deductible)
Litigation Matters	$40m	(Tax deductible)
Capitalised Software Value Adjustment	$100m	(Tax deductible)
Disentangling Westpac Life Insurance Services from BT Super	$100m	(Tax deductible)
Bushfire Insurance Claims (Operational but Unusual)	$140m	(Tax deductible)
Total Tax deductible Provisions	$785m
After Tax Effect (Total Tax deductible Provisions x 0.7)	$550m
AUSTRAC paedophile enabling punishment provision (Court to Determine)	$900m	(Not tax deductible, ref HY2020 Results p16)
Total After Tax Provisions	$1,450m

However, the telling first line in this press release is that all this 'excludes impairment provisions'. That sounds ominous. According to my own impairment estimates to date, current ECL (Expected Credit Losses) already set aside may cover most of these. But I wonder if these provisions are exhausted, whether Westpac must immediately re-provision on a similar scale in expectation of future crises yet to materialise (in reality a continued slide down the existing COVID slide beyond this year's provision?) Anyone know?

Provisions relating to the AUSTRAC civil proceedings have been expensed as costs, Provisions in relation to the Expected Credit Loss model (see Part 2, my post 226) and by extension Covid-19 will be added to the 'impairment provisions' in the accounts.

Impairment Category	Impairment Expense	Reference HY2020 Result Announcement
AUSTRAC Matters (1)	($A1,027m)	(Section 1.3.2)
Penalty Provisions (2)	($A258m)	(Section 1.3.2)
Total	($A1,285m)

This total does not correspond to the $1450m that I have estimated above. The difference my be mostly explained by the inclusion of the bushfire claims in the first list.

Notes

(1) After tax (HY2020 Presentation p4). The $1,027m total consists of a $900m provision for a fine (an educated guess as actual fine could be more or less) and $127m of additional costs chalked up to the Westpac in house rehabilitation response plan.

(2) A $258m reduction in 'cash earnings' (after tax, refer HY2020 Presentation p13) from contributions to higher regulatory and compliance costs and additional provisions for estimated customer refunds, payments, associated costs and litigation (HY2020 Result Section 2.1). This $258m is made up from pre-tax payments totalling $329m (ref HY2020 Presentation p59) to Banking customers (who were provided with business loans that should have been covered by the National Consumer Credit Protection Act and the National Credit Code) of $104m and Wealth Management customers (where certain wealth management fees were inadequately disclosed) of $133m. Associated implementation costs for these two classes of payments were $92m.

SNOOPY