Intimations Of A Credit Squeeze Prompt U-turn

Sydney Morning Herald

Tuesday March 11, 2008

Malcolm Maiden

A MONTH ago the Commonwealth Bank board decided against changing its dividend reinvestment plan and continued offsetting shares issued under the plan with on-market purchases.

The chief financial officer, David Craig, said the bank did not need a naked DRP share issue because its capital base was "very strong", at more than 11 per cent of assets, well above the regulatory minimum of 8 per cent.

Yesterday that decision was overturned. After about $150 million of on-market purchases CBA has stopped buying on-market to neutralise the dividend plan, turning the DRP in effect into a $400 million tactical capital raising.

CBA doesn't need the $400 million right now. The old DRP structure would have shaved its capital ratio from 11.27 per cent to 11.06 per cent, and that would still have been comfortably above the mandated minimum. But the change will keep the ratio up around 11.2 per cent, and maximise the bank's lending power at a time when the supply of credit is tightening and the risk of writedowns increasing.

CBA took the decision after its two top officers returned from abroad last week. Its chief executive, Ralph Norris, visited New York and David Craig went to London, and the view from both vantage points was the same: the liquidity crisis shows no signs of ending soon and is morphing into a credit squeeze.

Given that, the decision to maximise lending power with a tweak of the DRP was a certainty - as was yesterday's other decision by the bank, to boost variable lending rates by 35 basis points - 10 basis points more than the increase in the cash rate announced by the Reserve Bank last week.

CBA has now boosted rates in three steps by 25 basis points more than the Reserve's two-step, 50 basis points, cash rate increase since Christmas. Westpac and NAB have gone up by 20 basis points more than the Reserve. ANZ announced a 20 basis points solo increase in January, and will add five or 10 basis points to the Reserve's 25 basis point increase tomorrow. St George went alone with a 20 basis points rise in January and is expected to add 10 basis points to the latest official rise.

But even after those increases, the banking sector is behind the curve; the cost of raising five-year funds on the global markets has gone up by about 35 basis points in the past month and three-year money has risen by the same amount. Westpac recently raised three-year funding at 105 basis points above the bank bill swap rate: the same raising last year before the debt markets imploded would have been done at about 13 basis points above the swap rate.

If a credit squeeze develops, the banks must consider raising capital from shareholders, to give them the maximum ability to build quality borrowers from the conga line of corporations fleeing the frozen debt markets to the safety of the banks.

CBA and the other banks are baulking at the idea of full-frontal share issues, because at current depressed share prices their cost of equity capital is high. But they will revisit the subject if the squeeze continues, and CBA's share reinvestment restructure is a useful tactic in the meantime: the board has a strategy meeting in Canberra today and will brief the Treasurer, Wayne Swan, about it all in the evening.

ABC LEARNING'S shares bounced modestly yesterday to close 8c higher at $1.55, and although he has had margin calls on his entire personal shareholding in the child-care group, the weight is on Eddy Groves to build from here.

Groves knows the business because he created it and he has to answer several questions as the group restarts its roadshow after the sharemarket sell-off two weeks ago, and the subsequent negotiation of a private equity joint venture with Morgan Stanley covering ABC's US child-care chain.

The deal freed $750 million for debt reduction, but pruned ABC's exposure to the US centres to 40 per cent. Groves must now convince investors the December profit downturn was not the beginning of a trend, and that the US business can add value over time. The US private equity joint venture will be geared heavily, so capital gains is the new game, not annual income generation.

And investors will also want comfort on execution risk. The US deal has not been closed, and on Morgan Stanley's side is subject to funding. Its full effect on ABC can't be assessed until the uncertainties are resolved.

BABCOCK & BROWN and its satellites remain under sharemarket pressure, but Phil Green has at least shown in recent days that the group can fight back. The refinancing of margin loans Babcock was using to support shareholdings in satellites using internal resources and expanded bank debt was a shuffle, but one that needed balance sheet headroom to complete.

Babcock also confirmed its 2008 profit forecast, and announced the acquisition of two Boeing 777 aircraft leases as a start-up for a lease packaging joint venture with Germany's HCI Capital.

It was all enough to get Babcock's shares up off a low of $12.90 to $13.80.

But that was still down 16c on the day - and a country mile from a one-year high of $34.78, set last June.

mmaiden@theage.com.au