Financial services and wealth management company Morgan Stanley has conducted a review of Australia's big four banks and found that Commonwealth Bank (ASX: CBA) remains the preferred holding.
Following earnings reports by all four in the past few months, Morgan Stanley updated its forecast for the banks and outlook for the sector as a whole with the expectation that rates will remain low for some time yet.
Morgan Stanley's favourite bank remains Commonwealth Bank thanks to its strong, sustainable growth, and lower risk profile compared to its peers. Commonwealth is expected to deliver 7-8% earnings growth in 2013-14, and has a number of sustainable competitive advantages over its peers, which should provide share price support over the medium term.
Morgan Stanley noted that the company is Australia's largest bank and has the largest loan book, giving it pricing power over rivals and the ability to grow without sacrificing loan quality. This will lead to lower bad debts (read: defaults) when interest rates rise and will allow the company to maintain or grow dividends.
ANZ Bank (ASX: ANZ) is Morgan Stanley's second favourite since the company has successfully turned around its Australian retail lending division, leading to an upgrade in revenue and profit for 2013-14. ANZ is also predicted to grow earnings by 7-8% this financial year thanks to its 'Super Regional' strategy of expanding into Asia. Key risks include a slowdown in Asian economic growth and lower margins in business banking.
Rounding out the number three position is Westpac (ASX: WBC). Morgan Stanley believes that Westpac has little potential upside to broker forecasts as the majority of costs have already been cut from the business. While earnings for Westpac are also predicted to rise between 7 and 8% in 2013-14,
Morgan Stanley believes that ongoing weakness in business banking could result in an 8% decline in earnings from institutional lending. Morgan Stanley noted that while Westpac had a successful 2012-13, it expects bad debts to rise in 2013-14 after it recorded the lowest default rate of the big four.
Bringing up the rear is National Australia Bank (ASX: NAB). NAB is recovering well after years of underperformance as a result of some poorly timed purchases. Morgan Stanley believe that the market is not accounting for any hiccups in the recovery.
If NAB's business banking revenues grow less than expected, UK operations degrade further, or costs increase unexpectedly, Morgan Stanley believes the market will treat the company harshly. On the flip side, Morgan Stanley notes that any of the above risks could also surprise on the upside, delivering profits above those predicted.
Foolish takeaway
Morgan Stanley's analysis seems to point to Commonwealth being the best choice for risk-averse investors, while NAB could provide the greatest upside — and downside — of the big four banks.
While all four have risen spectacularly over the past 12 months, there could be more to come if the US tapering is further delayed and overseas markets continue to rise. The recent decline in the Australian dollar means that Australian shares become cheaper to overseas investors and the 5-6% dividend yields on offer may result in more offshore buying in coming months.
