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26/05/20

12:43

Post #: 44839538
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Originally posted by StefanF: ↑

There seems to be a continuous reference by posters to bank's provisions and linking that to why Afterpay will struggle. I'm a banking analyst and am probably well placed to address this misconception. This might not be the most interesting read but should be informative nonetheless.

I'll do this analysis by explaining why banks have to delay dividend payments and raise provisioning and you can be the judge if this applied to Afterpay in any shape or form.

Banks required to delay/stop dividend payments and/or raise capital
Before the GFC banks were highly leveraged and lending a lot of high-risk loans in an attempt to gain market share. When the housing prices dropped (in the US in particular) banks started taking massive loan losses and the governments had to bail out the banks (which are systemically important and cannot fail).

To avoid this happening again the regulators have made a couple of changes to how banks function. Firstly they had to increase their capital ratios, effectively holding large amounts of cash (or other high-liquid high quality capital instruments) for every loan they write. In addition, regulation now distinguishes between a high quality less-risk loan and a low-quality high-risk loan. The higher the risk the higher the amount of capital that needs to be held. This ensures banks don't do GFC-style lending as it would be extremely expensive from a capital perspective.

The way that loan quality is assessed is dynamic, which means you can be a high quality customer but circumstances change and behavioural credit risk models can pick up credit deterioration. This means that, in a crisis such as COVID-19, many loans move from low-risk to high-risk and banks have to hold more capital against them.

But capital doesn't grow on trees. Cash-like capital comes from retained earnings or capital raisings. At the moment capital raisings would be expensive for two reasons (1) low share price means bigger dilution and (2) getting a capital raise underwritted in volatile conditions is very expensive in fees to investment banks. So to increase capital that just leaves banks with reducing discretionary capital distributions such as bonuses to executives/board and delaying or stopping dividend payments.

How does this relate to Afterpay?
It doesn't.

Banks need to raise big provisions for expected defaults
Another recent change has been the introduction of the AASB 9 accounting standards which means banks need to be forward looking in losses. Due to the fact that most bank products are many years in length (up to 40) when credit deterioration is identified in a customer banks need to assess what the expected total loss will be. Banks then hold a provision against it, which effectively is cash that is held aside to absorb these expected losses. The main point to take from here is the fact that there is a lot of uncertainty that is created by the fact that the loans are such high value and lengthy loan terms and the losses the bank will incur will depend on multiple factors, including how much they can sell the property/asset for. Banks have had to put aside provisions as high as a billion dollars in response to COVID-19. The calculations would take into consideration macroeconomic factors such as a 20% houseprice downturn in Sydney/Melbourne and unemployment of greater than 10%, peaking in the June quarter.

How does this relate to Afterpay?
Afterpay has low valued loans that are paid back in 6 weeks. There is much more certainty in this process, and provision doesn't have to be large because the defaults would hit the bottom line very quickly. There is no need to wait a few months to see if the customer can make it through the crisis, it doesn't require the sale of a property or asset to see what the impact is. Afterpay customer doesn't pay will flow through to the balance sheet very quickly. Afterpay would not be holding any provisions now of delinquencies that were had in March and maybe even April and any bad deterioration of credit quality in the books would have been identified in their latest business update.

I hope this helps understand why banks have had to take the measures they are taking while Afterpay and other BNPL providers haven't had to. There is a lot more to banking and this is just the tip of the iceberg but these points are a good start in understanding that banking and BNPL are fundamentally very different.

Feel free to ask questions or provide input. Objective analysis only please.

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Are you sure you work for a bank? Youre on here 24/7,so productivity zero.

APT Price at posting: $49.42 Sentiment: Hold Disclosure: Held
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