A Tale Of Two Banks

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This story features MACQUARIE GROUP LIMITED, and other companies.
For more info SHARE ANALYSIS: MQG
The company is included in ASX20, ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

By Greg Peel

Yesterday Macquarie Group ((MQG)) issued arguably its first ever true profit warning. Under previous CEO Alan Moss, many profit “warnings” were issued that amounted to “it’s been a record quarter but don’t expect these sorts of numbers to be maintained”. Year in, year out, Moss would make such claims, and then the following quarter would break the record again. But under Nicholas Moore, Macquarie has just announced profits will halve in FY09. That will represent the first profit fall in 16 years.

Bank analysts became so used to Moss’s conservative updates that they would always lift earnings expectations well above guidance anyway. But the game has changed. It must be appreciated, nevertheless, that Macquarie’s profit will fall 50% but it will thus still make 50% of what it made in FY08. In this market, and compared to global peers, that is actually a great result. One can’t say it’s all Moore’s fault. A lot has to do with something called the GFC.

For the last few decades Macquarie has been known as Australia’s own investment bank – the local equivalent of a Goldman Sachs or Lehman Bros. Macquarie actually became a commercial bank in 1985 but up until the nineties it truly was an investment bank by nature. It was around that time (and following the 91-92 recession) that the bank’s focus swung towards the specialist fund model – the model that packaged up toll roads, airports, bowling alleys and just about everything else under the sun to then flog off to punters as supposedly high-yielding securities. Macquarie was the global pioneer in this field, and by the noughties the “investment bank” tag had become a bit of a misnomer. The market decided something like “financial engineer” was more appropriate.

Until, that is, the credit crunch hit, and the whole world roped Macquarie in with Bear Stearns and the rest of the investment bank fraternity. The bank saw its shares halve in a flash, yet its exposure to CDOs and the like – the supposed cause of the credit crunch, was minimal. At that point, bank analysts were generally quite prepared to say that MQG had been well oversold on suspicion. But as the credit crunch became a global credit crisis, the new “Macquarie model” – one which relied heavily on debt – began to haemorrhage. It then died.

By this stage, Macquarie shares had been sold down about 75%, again close to mirroring the falls of US investment banks. When the Rudd government jumped in, in response to a global governmental response, to guarantee Australian bank deposits, Macquarie quickly made sure it qualified for such insurance. That means Macquarie Group is once again, in simple terms, a bank.

Most analysts agree, despite yesterday’s profit warning, as a bank MQG has performed rather well this past quarter. If you hold Macquarie up against other banks around the world, it’s performed exceptionally well. And while there is no real end in sight to the GFC at this point, there is no reason to believe MQG won’t rise out the downturn quite comfortably.

Said Deutsche Bank this morning: “MQG remains profitable, a feat few of its peers have been able to achieve”.

Said ABN Amro: “MQG’s balance sheet remains strong with no need for capital raising and plenty of room to make accretive acquisitions”.

And BA-Merrill Lynch: “Macquarie has gone to lengths to reposition the business for the downturn. Concerns over liquidity have been addressed through utilising its bank (and guaranteed) status as well as shedding assets.”

The upshot is that in the longer term, there’s nothing to worry about. Macquarie will emerge chastened and wiser when the GFC concludes, but most importantly it will emerge. The problem in the short term, however, is that we still just don’t know how bad things can get before they ever get better again. No one knows. This means that Macquarie is still at risk of further write-downs.

And this is where analyst opinion begins to diverge. Roughly half of the brokers in the FNArena database see that downside risk as potentially having an impact on the share price ahead. The other half are either less of the belief more write-downs might be needed, or at least happy that the current MQG share price has more than accounted for such risk.

Hence we have five Buys and four Holds in the FNArena database (with JP Morgan this morning downgrading to Hold) but no Sells. By contrast, every one of the Big Four Aussie commercial banks is currently carrying at least one Sell rating. And at $31.54, the average target is still a good 33% above the current trading price despite the brokers all this morning reducing their earnings forecasts by varying amounts.

Now it’s just a case of watching to see what happens next.

The same uncertainty haunts Suncorp-Metway ((SUN)). This week Suncorp CEO John Mulcahy either fell on his sword or was told he’d be taken out and shot if he didn’t do the honourable thing. While Nicholas Moore’s ascendency has been a case of unfortunate timing, Mulcahy has overseen a disaster. No more is this evident than in yesterday’s Suncorp capital raising at a 35% discount to the last traded price. You’d be hard pressed to find an analyst who hasn’t breathed a sigh of relief at Mulcahy’s departure.

But while new leaders at the helm might be a positive development for Suncorp, there’s not much else to be particularly confident about. The capital raising is a positive step but only because it was a necessary one, and a slashing of the dividend payout will also assist Suncorp’s balance sheet but is cold comfort for shareholders. The question now is: If we ignore the past and consider Suncorp as an investment at $4.50 (which is where the shares are likely to re-open at on Monday) is there value there?

While Macquarie had become a unique hybrid of commercial bank, investment bank and financial engineer as it approached the GFC, Suncorp was, and still is, an unusual combination of commercial bank and general insurer. While there are obvious crossovers in both operations, the combination has actually proven a double-whammy disaster for Suncorp. The Queensland-based corporation has been beset by storm and tempest on a statistically unusual scale these past couple of years, which has hit the insurance business hard, while financial storm and tempest has brought the banking business to its knees.

Citi analysts recalled this morning that back in November, Suncorp management suggested that a capital raising would only be necessary if a “massive problem” were uncovered. No one has since pointed a finger at a “massive problem”, unless the GFC is itself a contender. Suncorp’s banking numbers didn’t actually look too bad in the first half, but the big increase in bad debts announced yesterday does nothing other than fuel concern that there could be plenty more to come.

As we now see television images of Far North Queensland again under water, one wonders why anyone would ever open an insurance business in a state where, as the wags like to put it, it’s “beautiful one day – p*ssing down the next”. But analysts all agree that it is the insurance business that can provide Suncorp shares with upside and the banking business that is holding the value of the insurance business down.

In other words, the time has come for Suncorp to rent itself asunder. It must be cleft in twain.

BA-Merrill Lynch believes Suncorp management “still seems to be unwilling to state what is obvious to most: that the bank and SUN needs to part ways”. Macquarie analysts state “we still believe the bank must and will be sold (the board simply cannot ignore the reality any longer)”.

Macquarie goes on to suggest that Suncorp can no longer go on trying to compete as an A-rated bank when its banking operation is “clearly more valuable” to an AA-rated bank than it is to Suncorp shareholders. (An AA credit rating is better than A but not as good as AAA. The Big Four Aussie banks are all AA). Deutsche Bank further suggests that a $4.50 share price for the combined banking and insurance group implies a valuation for the banking business which is actually negative.

Of the seven brokers in the FNArena database who have continued to update their Suncorp coverage into 2009, five have Buy ratings on the company. The other two are Holds. For a stock that is such a disaster, that ratio seems paradoxically positive. But the point is the analysts are all of the belief Suncorp investors will do very well (from $4.50) if the new management makes the decision that has to be made. They are mostly assuming it MUST and therefore WILL happen, one way or the other. The average target among those seven brokers is $8.08. That’s 80% above the placement price.

It had better happen.

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