To Raise Capital Now Or Not To Raise Capital? That Is The Question For Our Banks

The Age

Saturday March 8, 2008

Malcolm Maiden

What is expensive capital now could confer a huge medium and long-term market share advantage.

THE sell-down in Australian bank shares continued yesterday in a sharemarket that is displaying growing fear about where the credit crisis is leading, and around the board tables of the big banks, an excruciatingly difficult choice is looming.

Should they try to raise capital before they need it, and give themselves the best chance to win market share, or be cautious, in the belief that any bank that puts its hand out in this environment will be hit by a selling tsunami?

NAB's 5.4% slide led the financial sector to a 4.5% loss, and the debt-asset packagers did even worse, with Challenger shares gapping down a gut-wrenching 18.8%, and Babcock & Brown losing 9.9% as it revealed it was topping up margin loan facilities supporting investments in satellites that are also being sold.

NAB shares have lost 28.5% this year, ANZ is down 26.15%, Westpac is down 22.3% and CBA shares are down a third. CBA, NAB and ANZ are yielding 9.5% based on the dividends they have been paying, and Westpac is close behind at 8.5%.

Share issues at these levels by the banks would normally be considered madness. But with the world's banking system lining up for new capital and a host of corporate lenders turning to the banks here and overseas for funding as the capital markets remain in intensive care, it is probably a question of when the banks go for new equity, not if.

There is a risk that the banks would be mauled by investors, on fears that funds are being raised to cover losses that are emerging. But if they can convince investors that they are boosting capital bases to give them the ability to pick and choose between corporate borrowers who are retreating from the illiquid debt markets, what is expensive capital now could confer a huge medium and long-term market share advantage, with the banks that move first leading the pack.

Australian banks have relatively low exposure to the debt crisis . . . so far, at least.

But there are multiple intersections - through normal commercial lending, such as the exposure ANZ, St George, CBA and NAB have to Centro, for example, through their exposure to the economic slowdown the crisis will cause, and through boom-time deals they wrote, to provide small standby facilities to the US mortgage market near-fatality, Countrywide for one thing. For another, through conduit support for securitised mortgages. And as NAB at least confirmed on Thursday, through providing margin loans, in NAB's case, loans to Allco Principals Investments, that have gone sour.

The banks are also being sold because Australia's giant superannuation savings pool has left them with lower retail deposit bases than many overseas peers, increasing their reliance on wholesale funding that is becoming more expensive as the liquidity crisis continues. Sold too, possibly, because they are operating in the home market of the asset-debt restructurers.

They are nevertheless at a point of considerable opportunity as well as risk.

Their exposure is not causing huge write-downs and big offsetting capital raisings, as is occurring in the northern hemisphere.

Write-downs of $US18 billion, $US9.4 billion and $US18 billion respectively by Citigroup, Morgan Stanley and UBS, for example, form part of a hit that eventually is expected to total more than $US350 billion in the banks and at least $US600 billion across the financial system. And they have been accompanied by deeply discounted issues of new capital to sovereign funds that have an estimated $US3 trillion of investment power.

The $US1 trillion Abu Dhabi Investment Authority sank $US8 billion into Citigroup for a 5% stake, China's new $US200 billion fund, China Investment Corporation, invested $US5 billion in Morgan Stanley for a 10% stake, and Singapore's sovereign fund invested $US13 billion in UBS.

The alternative in every case would have been to allow write-downs to cause a contraction in the banks' capital bases, which would in turn have forced a reduction in the size of their loan books, because bank loans are supported by capital, roughly in a ratio of 12 to 1.

Write-downs to come will also need to be offset by new capital - and on top of that, the banks that can must raise capital to meet new loan demand from companies, as funds the companies raised on the now-frozen debt markets fall due.

This renewed call on the banks from corporations that took part in the great "disintermediation" migration to the debt markets in the final quarter of the 20th century and the years of the 21st has the potential to combine with a crackdown on existing loans by the banks in response to higher lending costs and declining asset values to create a credit squeeze.

The prospect is being openly discussed, by company bosses, bankers and our Reserve Bank. The sovereign funds are key players, and in that context, ANZ CEO Mike Smith's comments yesterday were fascinating. ANZ welcomed "strategic, long-term investors like the sovereign funds", he said.

And while the Rudd Government has stated it does not favour investment by sovereign funds in "strategic" Australian assets, Smith said governments needed to balance such concerns "against the risks of forfeiting the benefits that their infusions of capital can bring".

Australia had to consider "what is and isn't in the national interest", he said. Don't be surprised if one of the banks hands the Government a working example of that conundrum before the crisis is over.

mmaiden@theage.com.au

© 2008 The Age

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