Two weeks ago the big four Australian banks underperformed the index as interim results for ANZ and National Australia Bank revealed an increase in bad debts that caught bank analysts off-guard. Someone has now explained to them that there's a recession on, so forecasts have been adjusted accordingly.
Last week the banks outperformed the index despite Westpac revealing a similar first-half result to its peers. With a best in show for both bad debt provisions and tier one capital however, Westpac was happily swept up in more bank euphoria emanating from the United States.
The euphoria was centred around leaked stress test results, which proved to be not as dire as some had feared (or, if you like, just as positively manipulated as the cynics suggested they would be). The confident attitude was not to last however, as US banks quickly began to do what they were told to by the White House, being to raise fresh capital. It wasn't a difficult decision to raise immediately, given the US bank sector had rallied nearly 100 per cent from the March low. It was cash-in time.
Bank capital raisings have since weighed on Wall Street, and across the broad spectrum of sectors there has been a similar deluge of "secondaries".
The same has been going on in Australia as a similar rally has brought forth capital raisings from all and sundry, including those who really need to and those who just think it's a good opportunity. The result of global equity raising has been a swift slap in the face for the global stock market rally, which in Australia has culminated in, at least to date, a rather bad Thursday session, with the index down 3.4 per cent.
This has resulted in a fall in the ASX 200 for the week (ending Thursday) of 5.5 per cent. The big banks, however, fell only an average 3.2 per cent. They have already had one round of capital raising and have made it through the interim result season with across-the-board dividend cuts, but no further capital issuance of note. Thus, in comparison to the broader market, banks have this week looked pretty good.
ANZ managed to cop the brunt of the selling this week, falling 7.2 per cent. NAB, considered to be the other of the weaker pair fell 3.7 per cent, while in the stronger pair, Commonwealth fell only 1.7 per cent and Westpac merely trod water, falling 0.2 per cent.
Commonwealth Bank runs on a standard Australian financial year, unlike the others in the big four, which run a September 30 year-end. So while the others have just posted interim results, CBA enlightened the market this week with a third-quarter update. Expectation from analysts was that the same theme would permeate - operating profits would be healthy but rising bad debts would be a problem.
But CBA surprised. Bad debt growth, believe it or not, fell. The bank's overall result was in line with analyst expectations however, which meant that operating profit growth was not quite as good as many had hoped. BA-Merrill Lynch, for one, called it a "weaker than expected pre-provision result".
But it's all about how you look at it. Macquarie is one stockbroker that has decided to take a more medium to longer term view on the stocks it covers. The Macquarie analysts have begun a lot of "look through" analysis, believing now is a good time to be setting up for post-recovery investment. This has meant, for example, that Macquarie is now rating housing-related stocks on their capacity to grow earnings after the recession has run its course.
In the case of the banks, Macquarie is lead optimist among its peers. The analysts' enthusiasm is apparent in this quote from their CBA report:
"CBA's third quarter 2009 results imply cash return on equity of 15 per cent, but more importantly a pre-provision return on equity of around 29 per cent. The pro-cyclical nature of Basel II means this exceptional level of profitability will be similar or even higher when the cycle improves, leaving ample scope for a recovery in bottom-line profitability."
A slightly different take from Merrills, one might conclude. [Basel II is the international bank accounting system to which Australian banks have been gradually switching].
Yet Macquarie does still concede that things must first get worse for CBA before they get better, as credit growth continues to slow amidst ongoing funding pressure.
Indeed, a contrasting view from lead pessimist RBS is that CBA's third quarter "may well be the best quarter for some time".
RBS believes CBA should have always performed better than its peers in the third quarter given the bank's loan portfolio mix. But RBS is one broker that has been at constant pains to point out the "three phases" of a recession's bad debt cycle. First the big-name corporates go under, then all the SMEs and finally the consumers. We've had Phase I, we're in the middle of Phase II, and Phase III is around the corner. CBA is the most heavily weighted of the big four to consumer loans.
Merrills is also keen to point this out, while JP Morgan makes special mention that CBA has been the most active in growing its housing loan book right through the GFC, particularly taking advantage of government homeowner grants. Is the bank setting itself up for a fall? Already the big four are backing away from the use of government grants as deposits, and reining in their loan-to-value ratios.
Citi notes that while CBA's first-half bad debt growth bucked the trend of peers, and the second half might even be better still, the first half the 2010 financial year will probably be higher again.
CBA has, however, increased its provision against bad debts from a big four low of 89 basis points of risk-weighted credit to a much more comfortable 115 basis points.
This compares to Westpac at a peer-leading 123 bps, NAB at 110 basis points and ANZ at a reasonable 106.
CBA's tier one capital ratio is also still a solid 8.33 per cent, but this is down from 8.75 per cent previously. Just as Westpac inherited a little bag of trouble when it swallowed St George, CBA has done the same with BankWest. The WA-based aspirant has brought with it more troubled loan exposures than budgeted for and perhaps fewer deposits.
Westpac has long been afforded the mantle of "best value" among the four on a net basis from brokers in the FNArena database. This is despite Westpac having long traded at a premium to ANZ and NAB.
CBA has traded at a much higher premium to ANZ and NAB, so for that reason, while CBA is still considered to be less risky than those two, brokers have considered CBA the least value on a net basis. And the question must thus be asked since the Q3 update, does CBA still deserve that premium? It is currently represented by a PE of 12.9 times forward earnings to a sector average of 11.1 times.
Goldman Sachs JBWere is in no doubt the answer is no. The analysts downgraded the bank from hold to sell following CBA's third-quarter update. Macquarie remains the one lonely buy rating based, as explained, on its longer term view. CBA was already in fourth place among the big four in terms of FNArena's Buy/Hold/Sell ratings, and has now fallen further behind at 1/5/4. The total of sell ratings on all the big four has now risen back to 10, against seven buys, three of which are for Westpac.
CBA has been well supported during the general stock market rally, and as a result brokers took the opportunity of an update to sneak up their target prices using all sorts of valuation methodology arguments as an excuse. The reality is they're simply catching up with the market to some extent. CBA is now trading almost level with its average target among the FNArena brokers. NAB remains at a 3.8 per cent premium and Westpac at 1.1 per cent.
ANZ has now fallen to a 3.2 per cent discount to its average target.
FNArena