In some respects the fact that rumours singled out Adelaide Bank yesterday as seeking help from the Reserve Bank isn’t all that odd. Although someone put one and one together (Adelaide Bank and its high level of short term funding) with troubled UK Bank, Northern Rock and came up with a furphy, which the RBA was quick to knock down, it wasn’t surprising that the shares tanked.

The shares were up 47c around 11.30 this morning at $14.18, but that was down from the early high of $14.50. The bank issued this statement to the market this morning before trading started at 10am:

Adelaide Bank would like to reiterate comments widely reported in today’s financial media. Any rumour that Adelaide Bank is seeking liquidity assistance from the Reserve Bank of Australia (RBA) is completely false, and without foundation. Adelaide Bank reiterates that it has a continued strong liquidity position. Adelaide Bank notes that the RBA itself has confirmed that no Australian bank is seeking funding assistance.

If you had asked broker or an analyst specialising in bank stocks who’d be at the top of their list as the bank “most likely” to have problems here in Australia, Adelaide Bank would feature prominently. Its business model is aggressive and based heavily on short term funding which has risen sharply in the past two years. In fact “wholesale deposits” more than doubled from $2.5 billion in December 2005 to $5.667 billion at the end of June 2007. In the sale time retail deposits only rose 11% $11.21 billion at June 30, from $10.08 billion at the end of December, 2005.

It was clearly financing much of its new business from 2005 with this wholesale (short term) money: it couldn’t have grown otherwise. Adelaide Bank provides residential mortgages, business loans, savings products, margin loans, portfolio funding, insurance and personal financial services. The banks branches are in SA but it sells these products and services interstate through brokers and distribution alliance partners.

More worrying for some analysts would have been the sharp contraction in its net interest margin in 2006-07 to 1.01% from 1.16%, although that slowed in the second half to June. Its return on assets fell to 0.35% (including securitised assets) from 0.40%. It’s business model will always make it hard to earn a lot on assets but banks generally aim at 1% return on average assets as a good outcome.

The contraction in net interest margin and falling returns would have made some analysts wonder, even though earnings rose to $104 million in the year to June, a record. But what has happened now to that margin with short term interest rates up by half a per cent, on top of the post balance sheet rise of 0.25% in early August because of the RBA’s lift in its cash rate.

Adelaide Bank has been quick to lift its lending rates because of the higher short term rates but it is merging with the bigger, more profitable Bendigo Bank which has a more stable balance sheet. It earned a cash profit of $118.5 million in 2007, up 15%. Bendigo Bank and Adelaide have completed due diligence on each other’s accounts without any hitches being reported or leaking out. It was carried out in August when the short term rates started rising. That should be enough to convince the market that the rumours were baseless.

The merger looks like being completed by the end of the year which probably means the two banks will not issue separate interim profit statements early next year, which would have been a pity because it would have been nice from a historical point of view to see what impact the spike in rates had on Adelaide’s returns and business model.

Peter Fray

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