Wednesday, 13 February 2008

Time To Buy The Big 4?

The Australian Banks have been severely smacked about since the market peaked on November 1st 2007. Whilst the XAO is down -18% all the 4 major banks are down more making or coming very close to 52 week lows today. Since November 1st NAB is down -30%, CBA down -25%,WBC -25% and ANZ -22%.

However, considering the pummeling their counterparts in the US and in some parts of Europe have taken, the share prices of Australian banks have held up relatively well. That's mainly because their profits have held up well and they have steered clear of the sub-prime meltdown....for now.

'For now' is the important part. As we move further into the sour end of the credit cycle we can expect profits to slow and bad debts to rise. CBA showed that trend today reporting diluted eps growth of just 3% for the half year to December 2007. Also their provision for doubtful debts rose significantly but not anymore than you would expect at this point in the credit cycle.

I would expect that trend to show up in the other major banks. Fortunately for them, they won't report half year earnings until May so we'll have to wait and see.

Bad debts would have to rise significantly to set off alarm bells. Impaired Assets on the books of Australian Banks are still at record lows although you can see signs in the graph below that they are starting to tick up slightly.

Also in the above graph you can see the last turn in the credit cycle, represented by the spike in impaired assets around mid 2001. At that time, banks were well provisioned and absorbed the rise in defaults well. You can expect impaired assets to increase over the next 12 months, however they would have to push through that 1.5% level to sound major alarm bells.

Despite already significant declines in share prices, credit problems are only going to get worse before they get better. Also the banks net interest margins will come under increasing pressure as the cost of funding has increased.

Share prices typically pick up when the market can see through the tunnel to the other side. However, in Australia we've only just entered the tunnel and have no idea where it is going to take us.

Current prices may prove to be attractive entry points. All 4 major banks are now yielding in excess of 6.0%. However, as noted above, things will get worse for the banks before they get better and more attractive entry points will come for those who are patient.


Glen said...

Fantastic analysis as always.

Even the technicals for the financials look shite.

The Fundamental Analyst said...

Thanks chops. I've noticed a lot of psoters on ASF are asking questions like "Anyone know why XYZ has fallen so much lately?" wth repsect to the bank and other previous market darlings such as JBH. The real question they need to ask is "did XYZ really warrant such a high price in the first place?"

From a fundamental valuation stand point a lot of these companies are just coming back to reality.

Think about it, at $62, CBA was trading at more than 18x 2007 earning heading into a worsening credit enviroment. This is bank mind you, whihc usually trades anywhere from a 10 -20% discount to the market average.

Glen said...

Well, that's why historically, value investing has been the most profitable strategy in down turns.

Things that are over valued are ignored, and things that people have thrown away without thinking become good long term buys.

But with banks, since I have been trading seriously, 18 months or so. I have just steered clear of them apart from shorts, because I just couldn't see a reason to hold them. Good dividends and all, but very little growth potential in a mature and already consolidated banking industry.

Perhaps the junior banks may be the place to be when all this washes up... Wont be anytime soon though!