Westpac underperforms post-IT update

Banking stocks had a rough ride the past week (ending on Thursday) despite the broader ASX200 index edging slightly higher during this period.  The share prices of the four major banks lost around 0.6 per cent, while the benchmark index gained about 0.2 per cent.

The laggard among the big four was Westpac, which dropped 0.8 per cent. This isn't surprising given none of the major investment banks gave a thumbs-up to the stock following the IT update provided last week. Most were sceptical as to whether the efficiency forecast provided by Westpac was realistic enough.

Bank of America-Merrill Lynch used the update to do more detailed research on the stock and study its underperformance to the sector (by six per cent since May) which was mainly due to disappointment over revenue.

BA-ML analysed the margin performance of Westpac compared with its peers, and noted that the trend and divergence from ANZ was more pronounced in 2010.

One of the major factors contributing to this was pricing decisions around two specific products and the impact of commercial real estate portfolio run-offs. The combined effect of the two would amount to an impact of four basis points in the second half, BA-ML estimates.

BA-ML also studied whether the underlying franchise could be damaged and arrived at the conclusion there were no suggestions of "any significant issues".

BA-ML thinks Westpac looks relatively cheap but will not take a plunge until it gets greater comfort around pricing decision and investment strategy. It ranks the stock number three, as does Royal Bank of Scotland.

RBS, meanwhile, will be disappointed with the banks' underperformance this week after having tilted its model portfolio to "overweight" banks for the first time since April. RBS' preference is for banks more exposed to business lending, thus making ANZ and NAB as the key picks.

Citi provided an interesting research note last week, in which it advocated the creation of what it calls an "Australian Corporation of Housing and Mortgage Provision" as a solution to the funding problems of Australian banks.  The model would be based on Canada Mortgage and Housing Corporation. Canada's banks share some of the traits of Australian banks.

Citi says this would add to the budget deficit but believes this would be more than offset by the positives.  More families could get access to mortgage finance, thus freeing up funding capacity for more commercial lending.  Citi notes that even though Canadian banks have a lower credit rating than Australian banks they still raise their term wholesale funding at tighter prices given they have much lower issuance in open markets.

The gains in the Australian dollar have led to brokerages upping their currency forecasts; among them is Goldmans, which raised its AUD/USD forecast to 1.05 by September 2011. The brokerage reviewed the implication on USD funding for banks following this upgrade. It estimates that, even with such an appreciation, the funding requirement for the sector would increase by only US$2-3 billion, which is a relatively small addition compared with the total funding requirement of $120-140 billion per annum.

Meanwhile, Deutsche Bank focused on regulatory news across on the globe, including reports of a financial activities tax at the EU-level, the Swiss government's proposal to impose more capital requirements on two of its largest banks, and China's suggestion of an international treaty for large banks. While DB remains convinced the chance of a bank levy in Australia is unlikely, it believes the risk has "somewhat increased" due to growing integration of global financial systems.

DB has ANZ as its top pick in the banking sector.