The Factory, the Dutch And The Dragon

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            [1] => ((NAB))
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            [3] => ((SGB))
            [4] => ((ANZ))
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            [0] => WBC
            [1] => NAB
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            [4] => ANZ
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This story features WESTPAC BANKING CORPORATION, and other companies.
For more info SHARE ANALYSIS: WBC
The company is included in ASX20, ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

By Greg Peel

America’s largest deposit-taker bank, Bank of America, fell from a high of US$54.90 in December 06 to US$18.44 this month – a fall of 66%. The shares have since bounced to US$33.44 in less than two weeks, or 81%, which is nice work for a gutsy day-trader. But they are still down 40% from their highs.

America’s fourth largest investment bank Lehman Bros saw US$84.97 in August last year, fell 86% to US$12.02, and has bounced 60% to US$19.20. That’s down 77%.

One half of half of all US mortgages – Fannie Mae – has seen its shares fall 90% from US$70.57 to US$6.68, and has seen them bounce an extraordinary 109%. They are still, however, down 80%.

The latest bounce has been by far the most severe among financial stocks, once again prompting calls that the worst is now over. Yet the low set on July 11 – driven by the government’s promise to save Freddie & Fannie – was lower than the low set on March 17 – when the Fed “saved” Bear Stearns – which was lower than the low set on January 22 – when SocGen dumped its “rogue trader” positions – which was lower than the low set on November 26 – when Bank of America stepped in to save Countrywide from going down – which was about the same as the low set on August 16 – when the Fed made its “shock and awe” 50 point rate cut to “end” the subprime crisis. Yet on each occasion, a sufficient proportion of the market claimed it was “all over”.

So is it all over now? Is it different this time?

There is certainly a level of euphoria (or is that relief?) currently prevailing. Yesterday’s trading saw some of the most remarkable moves in Australian banking sector history. Westpac ((WBC)) bounced 7% and National ((NAB)) 8%, with the rest following along less violently, despite a week of solid gains. The moves might seem tame compared to what’s been happening over in the madness that is New York, but by Australian standards this is spectacular stuff. From yesterday’s point of view, it was all to do with Macquarie ((MQG)) adding to already positive sentiment. Macquarie shares rose 12%.

To go back to our initial comparisons, Macquarie shares fell from a high of over $99 last year to $46 on July 15 – a fall of 53% (although they did hit closer to $43 in March) – and have since bounced 13%. But they’re still down 47%.

Comparing these movements to Australia’s largest deposit-taker bank, we find Commonwealth shares have fallen 40% and bounced 17% to be down 28%.

So why has the Macquarie drop been that much more severe? The simple answer is that Macquarie has been lumped in with the US investment banks, such as Bear Stearns, on a tenuous connection of being active in dodgy financial markets. The market was very quick to slam down Macquarie from the get-go of the subprime debacle, all the while refusing to believe the Big Five had anything to worry about. Yet Macquarie’s model bears little relationship to that of a pure investment bank, and it’s not a commercial bank, and, indeed, it’s no longer even a “bank”. It’s now a “group”. Macquarie doesn’t even really fall into a pre-existing category, given its innovation in the field of asset-managing-funds was a world first. It is now loosely described by some as a “financial engineer”.

But to the market, it was simply a risky innovator, just as US investment banks had riskily innovated the infamous CDO. All US banks holding CDOs have been forced to write-down their values again and again and again. Thus yesterday the market was braced for the big Macquarie write-down. But it never came.

It didn’t come in the half-year profit report either, so one wonders what was going to be different this time. It’s true a couple of of Macquarie’s satellite funds are under pressure, but clearly the sum of the parts is still in good shape. For while Macquarie reported its first drop in profit in history, new CEO Nick Moore suggested only that FY09 will also be tough – not insurmountable. But then his predecessor Alan Moss became legendary for always warning of tougher times ahead, and then blowing everyone out of the water.

Bank analysts were unperturbed this morning, and despite UBS deciding to change its model and slash its target price from $85 to $60, the average in the FNArena database has only fallen from $72.40 to $69.36 – still some 33% above yesterday’s close. The B/H/S ratio remains at 7/2/0.

ABN Amro analysts summed up the general feeling. There’s nothing wrong with Macquarie Group, but the shares will continue to trade on sentiment. King Canute knows there’s point in buying Macquarie with gusto when any little setback in the US will trigger another tumble.

And the same can be said for the Big Five. It is remarkable to hear the umpteenth re-emergence of calls that Australian banks “have very little subprime exposure” and are thus offering extraordinary value. What time warp are these people stuck in? Here’s a tip – nor do Fannie & Freddie.

Australian banks are indeed on a more solid foundation than their struggling US counterparts – if you can call them counterparts – but they are also suffering along with the rest of the world in the global credit crisis. They are yet to regain margins as funding costs remain significantly high. They are yet to feel the full brunt of loan losses resulting from the global economic turndown which, if the value-players hadn’t noticed, is going on right outside the window.

Australian banks may have seen a bottom. But then, perhaps not. Either way, they, like Macquarie, will still be inexorably linked to what happens in the US.

It used to be a pretty good indicator that the top of a stock market had been reached when an Australian bank decided to buy a stockbroker. History is littered with tales of disastrous acquisitions ever since deregulation in ’83. Banks bought their first stockbrokers just before the Crash of ’87, and then they bought internet-based brokers just before the Tech Wreck. But this time it’s unusual. This time it may be that Commonwealth will buy ABN Amro (Aust & NZ) on the way down.

Commonwealth never got into the must-buy-a-broker game. Instead it very quietly but efficiently built its own – CommSec. It makes perfect sense for CBA to make the move now given ABN Amro will fill in the missing institutional broking strength, but for the fact capital is currently precious. JP Morgan warns CBA better not pay “overs”, or the market will not like it. UBS doubts CBA would pay overs.

No one’s yet asked ABN Amro whether it actually wants to be sold, but then that will be up to a struggling Royal Bank of Scotland on the one hand, and a big chunk of register held by senior ABN staff. RBOS would probably jump at the chance, but the staff? It would need to be a good price, one presumes.

Capital is clearly more precious for NAB at the moment, given it has now decided against making a bid for ABN Amro. Does this mean it will thus not make a bid for St George ((SGB)) either, given it can’t afford to buy anything at present, or does it imply a bid for St George may be forthcoming instead of ABN?

Analysts, for the most part, had already ruled out NAB as a suitor for St George. NAB has enough problems at home and abroad at the moment without stretching the balance sheet further. CBA was always seen as a more possible contender, but that’s now gone out the window since ABN is on the radar. ANZ ((ANZ)) was long ago dismissed, so that puts us back with Westpac.

The ACCC has now said it has no objection to a Westpac-St George merger. This outcome surprised few. It now opens the way for Westpac to get on with it, except for the fact that the 1.31 scrip offering means that May’s 25% premium is now a 7.5% discount. What now?

Well the reason the St George share price is now trading higher on a relative basis is because the market still clearly believes someone else (NAB?) will have a swing. Westpac doesn’t have to do anything, as it can always respond after another bid is made. So if all other contenders suddenly said “no, we are not interested in St George”, the St George share price would surely tank.

That would then help Westpac secure its goal, and if St George shareholders are smart enough to realise their bank is broken then they should be prepared to sell to Westpac in a flash, come the November vote. In the meantime, Westpac shares are being held back by the overhanging potential cost of swallowing – sorry, merging with – St George, despite the fact most analysts rate Westpac as a top pick in the sector.

It’s all fun and games, and all of it only provides a distraction from the real world. Australian banks are offering good long term value, but they may not make more money for a year. And if this particular bottom in the US isn’t the last one, Australian banks could yet be offering even better value still.

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