Relieved investors sent National Australian Bank Ltd (NAB) shares up six per cent, as they focussed on the hedging protection the bank has taken to mitigate its exposure to $1.57 billion in toxic debt, rather the short term impact on earnings.
After plunging 5.57 per cent on Tuesday amid a broader market fall of 4.3 per cent, NAB's scrip finished $1.44 or 5.94 per cent stronger at $25.70.
The percentage gain outpaced rivals ANZ Banking Group Ltd and Commonwealth Bank of Australia Ltd, which rose 2.93 per cent and 5.26 per cent respectively.
"Westpac and CBA are the two leaders. ANZ and NAB are being looked at sideways," Bell Potter senior client advisor Stuart Smith said.
NAB warned late Tuesday it will take at least a $400 million hit to its cash earnings spread over the next 10 years from long-term hedges taken to reduce the risk of writedowns associated with its $1.57 billion synthetic collateralised debt obligations(CDO) portfolio.
"It's positive that they've revealed it. In several years these CDOs may have a market and they may be able to mark them to market at a reasonable market price," Mr Smith said.
NAB's share outperformance on Wednesday surprised some observers, given its total $4.5 billion exposure to debt conduits comprising infrastructure debt, commercial property, collateralised loan obligations and synthetic CDOs, Mark Zigouris, client adviser with Joseph Palmer & Sons said.
"They have one of the greatest exposures to debt write-offs so the worst case scenario is that they could write off a whole year of profits," he said.
In explaining the impact of the CDO hedges on its earnings, NAB said the first $100 million will hit its fiscal 2008 result, due to be announced on October 31.
Another hit to cash earnings amounting to at least $300 million in ongoing hedge costs will occur as NAB incurs hedge costs of around $60 million per annum for the next five years, and a lesser amount thereafter.
The hedging trades have been entered into with a large, global bank counter party that the bank declined to name.
But analysts put the total implied cost at between $500 million and $600 million - "very hefty" according to Deutsche Bank's Ross Brown, Victor German and Andrew Hill.
Citigroup's Craig Williams and Wes Nason said the total cost could run to north of $500 million or more than one-third of the face value of the $1.6 billion investment.
But the associated damage to the bank's market capitalisation could have been many times higher, they said in a note to clients.
"This has been the overwhelming drag on the stock over the last three months," Mr Nason told AAP, adding the hedges were a much smarter move than taking a write-down.
Having removed this risk discount from the share price and improved its tier one capital ratio, analysts forecast NAB's earnings will drop by between one and four per cent over the next two years and say the stock looks cheap.
Deutsche Bank is still factoring in provisions for conduit losses of $250 million.
Risks remain, primarily around the remaining conduits, asset quality and credit risk, and losses from NAB's UK subsidiaries who face exposure to mortgage defaults as the UK property market tanks.
Deutsche Bank and Goldman Sachs JBWere have a Buy recommendation on the stock, with Citi recommending clients Hold shares.
