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Undervalued banks look attractive

Peter V O'Brien

Friday 21st November 2003

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Shrewd investors should consider whether the market overly discounted shares in the three Australian banks listed on the New Zealand stock exchange.

Australians set the pace for movements in Australia & New Zealand Banking Group (ANZ), National Australia Bank (NAB) and Westpac Banking Corporation (Westpac) but New Zealanders have outwitted Australians in the past (apart from recent sporting occasions).

An increase in Australian interest rates in the past two weeks was part of the reason for the drop in bank share prices.

The interest rate rise went beyond the immediate effect on the bank lending/borrowing relationship and margins. It was expected to affect business banking activity and demand for loans at the retail level.

Banks shares anywhere are among the first to react to any whiff of economic contraction. They rebound when reality persuades brokers, investment analysts and advisers their gun-slinging, reflex actions were wrong.

That does not ignore the question of opportunity cost but long-term investors know eventual returns can be better than short-term trading.

The performance table shows a continuing cut in the institutions' cost/income ratios, regarded as the test of bank operating efficiency. There must be an eventual end to that, since it is based on people using the banks' call centres, electronic systems and rarely getting a face-to-face discussion with a bank officer in understaffed branches.

Bank claims of increased efficiency had an ironic twist this month when ANZ's New Zealand operation said it would open new branches. Wellington would get one, as would Whangaparaoa, north of Auckland. The bank had overestimated the customers who would use electronic and telephone-banking facilities.

A particular instance obviously does not prove a generality but the ANZ set-up in Wellington has been a shambles, as a personal experience showed last week.

ANZ has five branches in Wellington city and suburbs, compared with 12 for Westpac and eight for the Bank of New Zealand subsidiary of NAB.

ANZ has people in its branches whose job is to organise customer queues and ensure the issue of numbers for queue placements. Lateral thinking suggests more tellers could be the answer to queues. It took me a long time to make a cash credit payment to an ANZ account on November 7 (not mine, because I bank elsewhere).

That anecdote is probably immaterial to the worldwide banking scene, of which the local parts of the Australian banks are miniscule.

Business banking and investment funds, the latter including various insurance-linked products, are the profit drivers.

The three Australian banks' preliminary profit statements gave more space to international operations and fund management than retail banking. They talked about initiatives in relation to retail customers, but shareholders would probably note the underlying point that the banks have retail maturity in Australasia.

Retail market share is therefore a matter of banks getting business from each other, rather than "growing the business" in real terms.

Current and potential shareholders in the three banks look for returns on investment, irrespective of day-to-day frustrations they might have with personal retail banking.

The future of the banks, short and long-term, has increasing dependence on international activity in Asia, Europe and the US. They have a small base in Australasia but international trading exposure carries the risk of economic developments.

Assuming the stop-start economic recovery in the US gains momentum in 2004, other economies will show improvement. Australian bank shares will be seen as undervalued in that scenario.

Much could depend on ANZ's acquisition of the National Bank of New Zealand. ANZ agreed to pay $A4.92 billion, which was said to be 11.2 times NBNZ's cash earnings for the year ended June. ANZ shares sold last Friday at 12.6 times earnings for the year ended September, adjusted for a 2:11 cash issue at $A13 each.

Consequently, the potential to add value to ANZ shareholders could be limited, given the price paid and the Reserve Bank's constraints on the merged operation.

Australian-based banks seem a useful punt after recent discounting and their potential over the next two years.

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