Right now, our big four banks are under siege, being bashed like never before with a Royal Commission in progress, a bank levy in operation, APRA forcing them to hold more capital and cutting back their business with investors and Chinese property buyers. And they’re also coping with a few economic cycle challenges.
Tonight, on my Money Talks show on Sky Business, I have a team of bank experts, assessing whether banks are a screaming buy or ready for dumping.
As a long-term investor, I must admit the banks don’t look like a bad gamble, sorry, investment. But against that there are some serious headwinds, which I think have been well publicised and may have taken their share prices lower than they need to be.
Know your investment self
In wondering whether you should be a buyer of banks now, you have to know who you are. If you want to buy, hold and sell in short bursts, operating off the old maxim, “no one ever went broke taking profit”, the banks could be a more-risky play right now.
Why? Well the Royal Commission could create short-term gyrations. On top of that, the old “sell in May and run away” could easily work this year, so buying now could be bad timing for a short-term investor. The chart below also shouldn’t be forgotten.
However, the case for a long-term investor and the banks is a different kettle of fish.
The banks should be advantaged by rising economic growth, which looks like a certainty over the next two years. And the RBA forecasts endorse this claim.
The NAB survey last week showed businesses seemed to be poised to be investing and in the market for loans. In case you missed it, the NAB business conditions index rose from +12.8 points to +18.9 points in January – the fourth best monthly outcome on record. The business confidence index rose from a downwardly-revised +9.6 points (previously: +11.1 points) to +11.8 points – the highest level in nine months.
Over the next two to three years, interest rates are bound to rise and that helps the banks’ bottom lines. And we know they’re all investing in cost-saving as well as business-generating IT solutions, which also must help profitability over time. In the US, where they’re ahead in the economic cycle, banks have become flavour of the month again, with the likes of Bank of America seeing its share price go from $22 to $32 in the space of eight months! I suspect our banks will benefit as our economic cycle kicks along.
Those who see rivals in the online world forget that banks have the best balance sheets to buy the ‘best-of-breed’ if they really pose a threat to their long-term viability. And I don’t think the four pillars policy and the ACCC would stop them buying an online rival.
Still delivering dividends?
Given the bad publicity and hardly inspiring share price moves lately, let’s see what FN Arena has learnt from the analysts and brokers. Here goes:
Bank Price Target Loss/Gain Yield
ANZ $27.85 $30.34 +8.9% 5.7%
WBC $30.22 $33.46 +10.7% 6.2%
CBA $74.02 $77.75 +5% 5.8%
NAB $29.22 $31.81 +8.9% 6.7%
These yields are without franking but someone taking a punt on, say, Westpac or NAB, could stand to gain 17%-19%, if the consensus of analysts is on the money and the dividend is held constant.
If it happened in one year, that would be a terrific annual payout. If it took two years, an 8%-9% p.a. return is still pretty damn good when you’re investing in some of the best businesses in Australia.
And let’s imagine that their share prices don’t go anywhere, the yields plus franking credits still look appealing, so you only have to hope that their share prices don’t fall permanently.
OK, that’s a pretty compelling case to take the punt on the banks but what are the counter-views?
The risks
Some bank critics think the end of QE and easy money could hurt banks but in the early stages when rate rises aren’t hurting economic growth, the issue won’t be so worrying.
John Abernathy of Clime Asset Management is worried that our big budget deficits, our foreign debt, household debt at 170% of household income, housing affordability and our too big to fail banks leave us and our banks exposed.
I don’t see this as a threat to banks specifically but it could be bad for the economy, if overseas interest rates force us to raise rates before our economy can absorb them.
He also is worried about:
- House prices and their role in bank balance sheets.
- Shrinking net interest margins on loans.
- APRA and capital impositions.
- Bank leverage and a recession.
One positive view he holds, which is worth noting, is that banks are less dependent on foreign loans. “Should there be another extreme international event, our banks appear to be far better funded than at any time in the last 20 years.”
Interestingly, John also points to the banks’ better capital positions nowadays but this has hurt relative profitability. Sure, the dollar profits have risen but the return on equity is down as a consequence of safer banks.
At best, John’s bank view might not encourage you to go long banks, but the case for dumping them if you bought at lower prices is not a good one, especially with current dividend policies and my more positive view on where the Oz economy is going.
It would be good for banks to stop paying out too much profit in dividends, instead using it to create better profits and higher returns on equity. But, I think the case for holding and even having a bit of a nibble at current share prices is still compelling if you’re a long-term investor happy with an 8-9% return per annum.
My bet is banks will do better than that as our economy lifts a gear over the next 12 months. As a group, they remind me of our miners two years ago, when no one would support me when I used similar analysis to argue the case for BHP around $14.
The problem might be that who we talk to, read and listen to might have a shorter timeframe for their investing/trading than we do. And your time line is important in wealth-building.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.
