The ‘Debt Contagion’ Spreads From Australian Banks

Australian debt credit

From Bloomberg:

Commonwealth Bank of Australia posted a 4.5 percent increase in quarterly profit and joined its main competitors in reporting higher charges for bad and doubtful debts.

Oh dear. It’s spreading!

What can we call it? Hey, let’s call it ‘debt contagion’. That’s a nasty sounding disease if ever we’ve heard one.

It gets worse. From the same news story:

Commonwealth Bank’s quarterly disclosure is another indication of the challenge Australian lenders face from impaired loans as the commodity cycle turns, increasing corporate and consumer loan defaults in mining regions. Bad-debt charges at the lender rose to A$427 million from A$256 million reported a year earlier.

But don’t worry, the bank says that the increase in the provision for bad loans is due to a ‘small number of exposures in the group’s institutional lending portfolio.

Nothing to do with the housing market then…nothing.

As usual, we’ll happily give anyone the benefit of the doubt — especially an Aussie bank.

But we can’t help but feel that trouble isn’t far away. We’ve felt that for some time. We feel it every day, driving to and from the Albert Park office.

We look at the cars on the road and we think, ‘Wow! There are a lot of BMW’s and Mercedes out there.’

Sure, the two big German brands aren’t pure luxury drives. We’re not talking Rolls Royce and Bentley here. But compared to alternative cars from Holden, Ford, and Toyota, they are significantly more expensive.

And given the cost of these brands, we often wonder how folks pay for them. Our bet is that most folks borrow against the value of their home.

To quote the famous Commonwealth Bank commercial from yesteryear, they’re using their ‘equity, mate.

And based on the numbers from Business Insider, Aussies are likely using a big chunk of their ‘equity’ in order to finance that new car purchase. As Business Insider reported in January this year:

Australians love their luxury cars, and they love them fast, it seems.

Mercedes-Benz Australia sold over 4000 of their performance AMG models in 2015, the highest per capita sales rate of any country in the world. It’s also around 13% of their 31,700 cars sold in Australia throughout the year.

The raw figures also put Australia in the top five for AMGs sold in the world.

AMG models don’t come cheap. The report continues:

The top selling Mercedes-AMG models were the CLA45 AMG and A45 AMG, both of which can be bought for less than $100k if you’re willing to leave out a few optional extras. This lower entry point undoubtedly helped the sales figure surge.

No doubt. Thank goodness for the ‘lower entry point’!

Look, we’re not going all Amish on you here. Fair play. If you want a nice fancy car, and you can afford it, go for it. We’re just sceptical that so many Aussies really can afford it.

And that, rather than taking out a 9% personal loan to buy a car (or heaven forbid, save), most folks simply withdraw some of that good old ‘equity’ in their home, and use that to buy a Mercedes AMG model.

As we’ve pointed out previously, the idea of ‘withdrawing equity’ is one of the biggest misnomers in finance.

It’s no doubt a nice little phrase dreamt up by an innovative banker — ‘We won’t call it a loan, we’ll say that it’s “withdrawing equity”. The suckers will surely fall for it.’

Anyway, there’s a chance we’re drawing a long bow here. Our observations of the number of luxury German cars on the roads (you can add Audis into that) may have no correlation to anything, let alone suggesting it’s in some way connected to potential problems in the banking sector.

But we’re prepared to believe there is some relationship between car buying patterns, high house prices, and a sudden increase in bad loan provisions for the banks.

We’ll keep an eye on things. If we’re right, a year from now you could see an increase in used German luxury cars selling at bargain basement prices.

‘Peak oil’ lives on

Are you an oil bull or an oil bear?

Do you subscribe to the ‘peak oil’ theory, or do you think it’s a bunch of baloney?

Regardless of your view, there’s good news for you in an article from Sunday’s Financial Times:

Discoveries of new oil reserves have dropped to their lowest level for more than 60 years, pointing to potential supply shortages in the next decade.

Oil explorers found 2.8bn barrels of crude and related liquids last year, according to IHS, a consultancy. This is the lowest annual volume recorded since 1954, reflecting a slowdown in exploration activity as hard-pressed oil companies seek to conserve cash.

On face value, peak oil fans can loudly shout ‘Hah! Told you.’ The decline in new discoveries can only mean one thing — the world is running out of oil.

Maybe. But that’s not the full story. First, check out this chart:

Source: Bloomberg

[click to open in new window]

Since 2005, average daily oil production has increased from 85 million barrels of oil per day (MMBPD) to 96 MMBPD.

That’s a big increase. Much of the increase has been due to influences on either side of the supply and demand curve.

On the demand side, China has been the dominant factor. China’s economy has more than doubled in size since 2005.

On the supply side, the US experienced the shale oil and gas revolution. This caused a huge increase in US oil production as technology allowed US oil producers to access previously inaccessible reserves.

The chart below shows that US oil production was in a persistent decline from the early 1980s, stretching through to 2008. But, due to high oil prices, and new technologies, daily production almost doubled over the next eight years:

Source: Bloomberg

[click to open in new window]

Is the data from the IHS consultancy bullish or bearish news for the crude oil price and oil stocks?

Well, here’s some championship fence-sitting for you: the answer is that either outcome is possible.

Right now, the world still appears to be awash with oil. Inventories remain at record highs, and the Organisation of Petroleum Exporting Countries (OPEC) doesn’t seem to be in any rush to slow production.

Despite that, the oil price has rebounded since the low earlier this year. In February, West Texas Intermediate crude oil was trading for around US$26 per barrel.

Today, it’s significantly higher, at US$45.53 per barrel.

Why the surge? The market — and the investors that make it tick —should always be forward looking. After such a big fall, many investors will consider that the selloff was overdone.

Second, now that the price has stabilised, and Saudi Arabia has made its point about its ability to exercise control over the oil price, the market is now looking forward to the day when OPEC starts to rein in supply, potentially pushing the price higher.

That’s all entirely logical.

However, in terms of supply, and the potential for an oil shortage, or even ‘peak oil’, it’s worth remembering: the cure for high prices is high prices, and the cure for low prices is low prices.

When the oil price surged, and Goldman Sachs’ commodities analyst predicted US$200 per barrel oil, it led to a huge increase in production. However, it didn’t lead to a huge increase in new discoveries.

The reason was that technological innovation, specifically in hydraulic fracturing, meant that oil producers didn’t need to find more reserves. They could use new technology to exploit existing reserves.

This is a big deal. As a report from the US Energy Information Agency noted in 2013:

U.S. crude oil production rose by 847,000 barrels per day in 2012, compared with 2011, by far the largest growth in crude oil production in any country. Production from shales and other tight plays accounted for nearly all of this increase.

The point we’re making here is that new discoveries are down, perhaps because oil companies haven’t had to find new resources. They’ve just had to do a better job of producing oil from their current resources.

The issue now is whether that’s sustainable. For US shale oil producers, most of them need the oil price to be well above US$50 per barrel in order for it to be profitable.

So what happens if the oil price doesn’t rise? (And it may not if China’s demand slows, and OPEC keeps pumping.) Two things could happen. First, the technology behind fracking (hydraulic fracturing) could improve to such a degree that costs sink.

After all, it’s hard to think that fracking companies have given up on the technique just because prices are low.

The other possibility is that, if fracking isn’t generally profitable with a lower oil price, oil services companies and explorers find it easier to attract investors and financing for their projects — such as onshore and offshore conventional drilling.

That itself could result in an increase in new discoveries, pushing the oil price lower once again.

In short, we’re sure that the FT story will provide ammunition for both sides of the oil supply and demand debate.

For us, we’re neither ‘peak oil’ fans nor debunkers. We just look for the investment story. At the moment, despite all the negative news surrounding the oil market (energy company defaults, trillions of dollars in debt to refinance, and so on), we still can’t help but think that there’s a positive investment story in there somewhere.

As we noted, the oil price has rebounded since the February low. But oil services companies, as represented by the VanEck Vectors Oil Service ETF [NYSE:OIH] is still 51% below the 2014 peak.

2016 may still prove to be too early to jump back on to the oil stock bandwagon, but it’s a sector we’ll continue to watch with a great deal of interest.

RBA Cash Rate to fall below 1%?

Surely the Reserve Bank of Australia (RBA) can’t cut interest rates any further, can it?

Perhaps it can. As Bloomberg reports:

While the bank gave no guidance on rates, swaps traders pushed to about 60 percent odds that Governor Glenn Stevens will lower the benchmark to 1.5 percent before his term ends Sept. 17. JPMorgan Chase & Co. said Lowe may have to reduce rates to 1 percent or less.

Zero percent interest rates, here we come!


Kris Sayce,

Publisher, Port Phillip Publishing

Ed Note: This article was originally published in Port Phillip Insider.

Kris Sayce
Kris Sayce, dubbed the ‘Jeremy Clarkson of Australian finance’, began as a London finance broker specialising in small-cap stock analysis on London’s Alternative Investment Market (AIM). Kris then spent several years at one of Australia's leading wealth management firms. A fully accredited advisor in shares, options, warrants and foreign-exchange investments, Kris was instrumental in helping to establish the Australian version of the Daily Reckoning e-newsletter in 2005. He is currently the Publisher, Investment Director and Editor in Chief of Australia's most outspoken financial news service — Money Morning.

Leave a Reply

Be the First to Comment!

Notify of

Letters will be edited for clarity, punctuation, spelling and length. Abusive or off-topic comments will not be posted. We will not post all comments.
If you would prefer to email the editor, you can do so by sending an email to