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    Tuesday, July 15, 2008


    Aussie Banks Gone Wild

    I wrote about banks in late April , specifically that it was impossible to value them. This was generic but I think the Australian situation is worth discussing in more detail.

    There are lots of market prognosticators in Australia promoting the banks as a fantastic investment. They've fallen so far and have such high yields. The fact is no one knows what Australian banks are worth right now because there is no transparency about their assets and liabilities.

    The "Barefoot Investor" a common sense, popular, newspaper columnist, talks about Australian banks as being "strong companies" that you can "buy on the cheap". He goes on to say "Investors are reacting as though Australian banks are as vulnerable as their problem-prone European and US counterparts. They aren't." . The fact is he has absolutely no idea how prone they are. They don't have to report their assets and liabilities in a way that would give him or any other potential investor any idea about their financial strength.

    According to the "Report on Foreign Portfolio Holdings of U.S. Securities" there is 32.6bn of long term US agency debt sitting somewhere in Australia. There is a further 10bn of US Treasuries, 27Bn of corporate debt and 6.6bn of short term agency debt. For a start they have lost 10% (10% of 70bn is 7bn) over the last year in foreign currency movements or 33% over the last 3 years. The agency debt is not over mortgages (houses) but is only secured by Fannie and Freddie.

    "Australians are more indebted than Americans and Australian houses are higher priced and less affordable than those in the US. If anything, the Australian economy is more vulnerable to a housing/mortgage market crisis than the US.". This article briefly discusses the difference between US and Australian accounting standards. The fact is that Australian banks do not need to mark their assets to market and instead show them on their balance sheet at cost. This means that all the garbage they have purchased from the US, such as the CDO & CLO exposure that NAB had to admit to lately, is still shown at the price they bought it for rather than the much lower price that they could get it for it now.

    The banks have not come out with voluntary disclosures about their assets and liabilities precisely because they don't want you to know.

    Try this at home and see if the bank will value your home at what you paid for it when the price goes down!

    So far we've covered the fact that banks have toxic product on their balance sheet and that they don't have to value at market prices. There is another enormous set of liabilities and assets that they have completely hidden off their balance sheets. This includes derivatives with a notional value of 12.9 Trillion. Far more than the $110bn of equity capital (as of February 2008, the equity is probably much lower now and the liabilities have probably risen). As of September 2007, Westpac had nearly 100 times their equity in derivative exposure. The banks may believe that they have "slick" risk management systems but so did a long list of US and Australian institutions that are no longer with us. These systems use models based on the recent past and there is a long history of them failing at inflection points.

    Analysts and journalists are all making the same mistake. They're looking at the earnings power of the banks and not at their balance sheets. Sure the banks competitive position is improving. The problem is - are they a viable going concern?

    To value a bank and know that it's a viable going concern you need to be able to evaluate all of these factors. The banks do not release the appropriate data for you to do so. They may be a great buy at these prices or they may be technically insolvent. It's foolish to recommend them when the data just doesn't exist in the public domain to analyse them.
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