The Banking Wrap - Week To Wednesday August 1

Greg Peel and Rudi Filapek-Vandyck
There are two ways to look at the performance of the banking sector this week - absolutely and relatively. Absolutely, it's been a very bad week as the broad equity market has suffered from the growing contagion of the US mortgage crisis and local interest rate rise fears have intensified.

Relatively, the five major banks have slightly outperformed on a simple average, but both Commonwealth Bank and National Bank underperformed. Westpac, prior to this week considered the cheapest in the sector by many experts, was least affected.

Relative movements for the week ending 1 August 2007:
Westpac -3.55 per cent
St George -4.82 per cent
ANZ -5.75 per cent
National -7.37 per cent
CommBank -7.42 per cent
ASX 200 -6.30 per cent

It's been a shocking week in the diversifieds, as Macquarie Bank suffered a 15.3 per cent fall (10.7 per cent on Wednesday alone) driven initially by market perception of being at risk in a credit crunch, and finally by proving so. Babcock& Brown fell 20 per cent in sympathy.

Macquarie Fortress Investments announced on Tuesday that two of its leveraged high-yield funds had lost 25 per cent in value - thought to be some $300 million - despite no direct exposure to US sub-prime mortgage securities.

The credit crunch is now a much bigger playing field than just the catalyst sub-prime crisis, and all high-yield debt is in the process of being marked down as the world adjusts its risk tolerance. This has placed any leveraged fund in all sorts of bother.

The credit panic has set off a spiralling effect which has seen asset prices marked down, spurring investors into wanting to withdraw funds. To cash out such investors, the fund managers must sell assets. But there are few buyers. This results in much lower asset valuations, which in turn sets off margin calls from lenders, which again require asset sales to cover. But there are few buyers. So the spiral must continue until it can continue no more, or until the market regains the gumption to start buying debt securities at knock-down prices. So far there is little evidence that day will come soon.

Whether or not Australia's largest investment bank really needed to be sold down 11 per cent on the back of the decline in asset values within two small, high-yield funds is by the by, as any contrarian buyers looking for value have stepped in front of the freight train of market perception. In B&B's case, that's what you get for being Mini-Mac.

Current FNArena ranking, Buy/Hold/Sell ratios and average target price (between second brackets suggested share price upside):
#1 Westpac 6/4/0 ($28.58) (+11.86 per cent)
#2 ANZ 4/6/0 ($31.76) (+15.41 per cent)
#3 CommBank 5/4/1 ($56.11) (+7.39 per cent)
#4 National 4/5/1($42.83) (+15.51 per cent)
#5 St George 0/9/1 ($35.76) (+9.0 per cent)

Coming back to real banking, there have been no changes to FNArena rankings this week, with no ratings changes from sell-side analysts, at least not for the big five in the sector.

Regional player Bendigo Bank received a recommendation downgrade from Credit Suisse this week, with the broker joining most other colleagues in stating the shares are no less than way over-valued.

Bendigo Bank is now rated four times Neutral and five times Sell. Its rating on the FNArena Sentiment Indicator is now minus 0.56. This makes Bendigo Bank part of a select group of least recommended stocks in the local stock market. Fellow regional bank and former suitor Bank of Queensland fairs only slightly better with a reading of minus 0.44 on the Indicator, the result of five Hold ratings and four Sells.

And what about Adelaide Bank? The stock is currently rated six times Neutral with one Sell (FNArena Sentiment Indicator 0.0).

There were no noticeable target price movements among the big five. As a sector, securities analysts continued to suggest valuations were looking stretched against increasing competition and an inevitable interest rate rise. But the analysts were all writing ahead of Wednesday, and no one had yet suggested a connection between US mortgage crisis and a potential sell-off.

Westpac was the only bank to draw any real attention this week in providing an update from its Consumer Financial Services division. The division had been underperforming, but analysts were heartened to learn things were on the improve. This did not prompt any notable changes to forecasts, with Westpac already the number one pick at most stock brokerages.

On a more macro level, the release of the June RBA credit aggregates showed a strong rise in housing credit growth as borrowers push their loan-to-value ratios out to ever more risky levels and the banks and mortgage insurers were happy to oblige. But there is little likelihood such figures will be replicated much past July.
JP Morgan, in particular, is cautious on the home loan growth outlook and let's face it - this is not the environment now (since June) to be issuing riskier mortgages. This adds to analyst belief that the sector is over-valued, but then equity as an asset class is feeling rather over-valued as we speak.

Source: FNArena