So the 2009-2010 Budget has been released and was there an absolute firestorm in parliament or what ? It was amazing to watch Question Time today and one really wonders how anything is done at all over all the shouting. So all in all, it is clear that the main two words which come out of the budget are “spend” and “debt” – these are the two words that every media outlet and newspaper have smeared all across the front of their websites and papers over the last few days. So what does it all mean ? Well, I have prepared a brief breakdown.

Overview

This budget is all about spending, and spending big. The Governments position on this is that it needs to spend in order to reduce the levels of unemployment across our country and sustain economic growth in the short-term. The Government has proposed around $22 Billion to be spent per:

• $3.4 Billion on roads
• $4.6 Billion on rail
• $3.5 Billion on clean energy
• $3.2 Billion on hospitals
• $2.6 Billion on Universities
• $4.7 Billion on Broadband

The so called – big ticket items – were the significant increase in the aged pension , the tax cuts which were delivered and a new carers payment scheme which was introduced in addition to a paid parental leave scheme. Of course, this was negated by increased taxation on superannuation and a tightening of rules associated with superannuation for higher income earners, increased means testing for middle income earners and the dreaded increase in the pension qualifying age to 67 – ouch. These measures are meant to increase our GDP (Gross Domestic Product) by around 0.75% – or approximately $6 Billion – and lower our unemployment by 1.5% for the 2010 year. The Government has contended that without these measures we would be pushing 10% unemployment.

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So just how safe is your bank ? Well Global Finance has released its list of the worlds “Top 50 Safest Banks” and interestingly a number of Australian Banks feature on the list in high ranking places. National Australia Bank (NAB) takes the top place at spot 11 – yes, that 11th in the world and Commonwealth Bank of Australia (CBA) takes the next best spot at 12th. The “World’s 50 Safest Banks” 2009 were choosen from a comparison of ‘long-term credit ratings’ and total assets of the 500 largest banks around the world. Ratings from Moody’s, Standard & Poor’s and Fitch were used.

Interestingly – ‘long term credit ratings’ – probably would have rated Lehman Brothers up there … and we all know what happened to them …

Check out this list after the jump!

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The RBA has left interest rates on hold today on the back of overnight global woes. Most noticably, the Statement by Glenn Stevens states (in summary) the following:

• World economy has remained very weak following decreases in demand late last year
• Conditions in global credit markets have improved since November last year, but remain fraigle
• Demand has not weakend as much as in other countries and Australia has not experienced the sort large contractions seen elsewhere.
• Inflation is likely to decline over time.
• Overally, economy is not slowing significantly and therefore no need for a cut unless some event indicates it.

Thanks Glenn – ummm just to point out that overnight the Dow Jones Industrial Average (DJI) fell around 299.64 points overnight or around 4.2%. The S&P500 (GSPC) was equally slammed falling by 34.27 points or 4.7% to around 700.82 points and the Nasdaq (NASDAQ) also shed 54.99 points or 4% to finish at 1,322.85. Most of this bad news was on the back of the announcement by American International Group (AIG) that it posted a fourth quarter loss of around a $61.66 billion USD loss or around $22.95 USD per shore – much worse than the $5.29 billion loss in the fourth quarter last year when market proponents assumed the market was at its lowest point. This meant that the full year 2008 results for AIG were a reported loss of $99.3 billion USD or a whopping $37.84 USD per share.

Iconically, this is really an unprecedented fall and has never been seen in the history of the world and to put it in perspective – Australia’s total GDP is around $1 Trillion – so this is approximately about 1/10th of our entire countries GDP loss in one organisation. Surprisingly, the RBA should have really dropped interest rates on the back of this news and other continued severe credit-market deterioration, particularly in commercial backed mortgages in the United States, but they have decided against it – perhaps to keep interest rates cuts up their sleeve for the future and to wait for more economic data.

So what is all this going to mean ?

Well, I would think that things have still some time to go yet before we hit the bottom.

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I thought it would be useful to look at some of theories of capital structure and what their purpose is, how they apply to companies and whether we really need to know about them as investors. Evidently, the later part of this statement is true – all parts of finance are indeed useful – and capital structure is no less important. There are three main theories of capital structure – Trade-off Theory, Pecking Order Theory and Free Cash Flow – and today I am only going to focus on the first two. Please keep in mind that entire books have been written on these two theories and I intend on only covering the basics. A brief introduction to each are outlined below:

• Trade-off Theory – The Trade-off Theory is a theory which suggests that companies have an optimal capital structure based on a trade-off between the benefits and the costs of using debt. 
• Pecking Order Theory – The Pecking Order Theory – or the ‘Capital Shuffle’ as I call it – suggests that companies always follow a hierarchical pattern in financing sources such that internal funds are always preferred to external ones and borrowing is preferred to issuing risky securities. This theory is based on information asymmetry whereby all relevant information is not known by all parties interested in knowing it. Information asymmetry is the battle ground for most fundamental investors as it is involves the discrepancy between what insiders of a company know (managers) versus what those external to the company do (such as shareholders and lenders).

Trade-off Theory

The trade-off theory really emphasis the effects of taxes and the costs of financial distress in engaging in high leverage finance. This theory suggests that companies should borrow until the marginal tax advantage of additional debt is offset by the increase in present value of the expect costs of financial distress. Many opponents to the trade-off theory question how the theory actually explains capital structure decisions because there are many cases where corporate leveraging is much lower than what the trade-off theory suggests. Such opponents argue that many multi-national companies with high profit margins have operated for an extended period of time with low debt ratios and achieved solid credit ratings. Trade-off theory would suggest that these same companies could achieve significant interest tax savings by increasing their debt ratios without any remote possibility of financial distress becoming an issue.

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