Another week of recovery in the Australian stock market, and another week of underperformance for the banks. If investors have been looking to pick up bargains in the run back towards all-time highs, then the banks have not been the first place to turn. The ASX 200 put on 2.7 per cent over the week while the big five banks averaged 1.2 per cent. All price movements were positive with the exception of ANZ (ANZ) which was flat. Only Westpac (WBC) came anywhere close to the index with a 2.1 per cent rise.
Relative movements for the week ending 5 September 2007:
Westpac +2.11 per cent
CommBank +1.66 per cent
National +1.37 per cent
St George +1.07 per cent
ANZ -0.07 per cent
ASX 200 +2.67 per cent
Last week's wrap came on the heels of a ludicrous sell-off in US equities in thin trading on the Tuesday night. After publication the US markets rebounded with an equally ludicrous equivalent rally on the Wednesday night. The movements were ludicrous because both were based on very old Fed statements that were dragged up once more.
The statement made by chairman Ben Bernanke on Friday night now supersedes all others, and suggests the Fed is most likely ready to cut the cash rate on September 18. By how much is now the matter of conjecture. But suffice to say the ASX 200 kicked off on Thursday and posted a good week's gain, only to find some selling on Wednesday afternoon as the yen turned up against the US dollar once more.
The movements of the yen are closely followed by professional traders and investors these days as it is regarded as the barometer of global risk appetite as well as for global liquidity. The relationship is an inverse one; hence a surging yen is seen as negative.
If you want to trade the Australian market intra-day at the moment watch the US dollar-yen. Every time it falls (yen rises) the stock market follows shortly after, and vice versa for a rise. A rising yen indicates further unwinding of the yen carry trade, which implies a further flight away from risk, which is really not good for stock markets in general and financial sectors in particular.
As to how bad it is for the Australian big five is a matter for debate, as there are now conflicting influences.
ANZ provided the highlight of the sector's week by issuing its 10-month update last Thursday. Analysts were largely disappointed and small earnings forecast reductions followed. There was, however, no change to ANZ's 5/5/0 buy/hold/sell ratio.
The earnings reductions came about largely because of a poor result from institutional banking, which managed only flat earnings growth compared to a pick-up in retail banking and a better result from the New Zealand operations. Costs overall were also up, which raised concerns. But the real point of interest was related to effects being felt from the global credit crunch.
ANZ pointed out that the spread between the cash rate (from which banks base their mortgage rate spreads) to the 30-day bank bill rate (the cost of bank funding) had steepened considerably, knocking up to 25 basis points off mortgage margins. While management suggested the curve would eventually settle down again, it did assume the curve will not quite return to where it was, given the now changed nature of global credit.
Every one basis point difference in mortgage margin costs ANZ $10 million after tax.
ANZ dropped the hint that if any one of the majors were to increase its mortgage rate, ANZ would follow. For now, management is just watching closely. Adelaide Bank, which does not enjoy any sort of sizable deposit base - unlike ANZ - increased its mortgage rate by 30 basis points this week. This is over and above the rate increase forced by the RBA's increase of the cash rate in August.
It is this move that raises an argument that the credit crunch is going to prove a two-edged sword for the big banks. While the banks may suffer in the short term from a steepening yield curve, the flip side of the credit crunch is that smaller banks and non-bank lenders will not be able to offer the same sort of competitive rates as they have been able to over recent years. Mortgage-backed securities are currently poison, and it is through this asset creation that smaller institutions raise lending funds. Those hopeful homeowners seeking mortgages may well have to turn back to the traditional lenders.
The big banks will also enjoy a similar revival as global corporate paper markets remain problematic. If smaller corporations cannot raise asset-backed funding, they, too, will have to return to traditional concepts of borrowing from the bank.
In the short term however, the big banks will be forced to take poisonous asset-backed securities on to their balance sheets. These securities represent the collateral used by investors such as hedge funds to acquire leveraged loans, and those securities no longer have a market. ANZ disclosed it was exposed to $5.5 billion of such collateral, which once brought on to the balance sheet would reduce the bank's adjusted common equity (ACE) ratio by ten basis points. JP Morgan calculates the big five have a total $25 billion of exposure to such collateral, but that they should be able to cope quite sufficiently with resultant ACE ratio reductions.
While the banks might gain more corporate business, they will also face what ANZ described as "significant" loan losses stemming from the credit crunch. Two-edged swords everywhere.
The other big sector news this week came from regional player Bank of Queensland. Having been rejected by Bendigo Bank, BOQ seems determined to take over everything else. This week it moved to gobble up Home Building Society in Western Australia, hot on the heels of two other local building society acquisitions.
While analysts see method in BOQ's madness, they generally believe the price paid for Home was a bit rich. BOQ is clearly exploiting its own inflated share price in order to push regional consolidation along, but it is this over-valuation that has provided a 0/6/4 buy/hold/sell ratio for BOQ in the FNArena database. BOQ is now going to face the problems of acquisition integration in the next six to 12 months, and may be running out of play money.
Some securities analysts also believe management is too optimistic in its earnings contribution projections for Home Building Society, at least for the first two years. In essence they believe BOQ overpaid. None of the major brokerages downgraded its rating for the stock as most have a Neutral/Hold rating anyway, but we detected a recommendation downgrade by medium sized stock broker Austock, to Neutral from Buy, and the explanation given was: BOQ overpaid for Home Building Society.
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