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The big four banks are getting cheaper: Time to buy?

Over the past six months, the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO) has dropped nearly 14%, while the big four banks Australia and New Zealand Banking Group (ASX: ANZ), Commonwealth Bank of Australia (ASX: CBA), National Australia Bank Ltd (ASX: NAB) and Westpac Banking Corp (ASX: WBC) have fallen much further and are looking interesting.

ANZ is down nearly 26%, CBA 22%, Westpac 24% and NAB the best of the lot, down 21.2%. All four are in the red again today, as the market sinks 0.7%.

Many investors are no doubt asking, “Is this the time to top up on the big four banks?”

There’s no doubt their dividend yields look very attractive as I pointed out yesterday, especially compared to the measly 2.7% average interest rate available on term deposits.

Bank Share price Dividend yield Grossed up yield
ANZ $27.49 6.6% 9.4%
CBA $73.81 5.7% 8.1%
NAB $30.53 6.7% 9.6%
Westpac $30.18 6.1% 8.7%

Source: Google Finance

With those sorts of yields, investors need very little capital growth to see 10% annual returns from each stock.

Looking at the P/E ratio for each also suggests they might be cheap. ANZ 10.4x, CBA 13.7x, NAB 12.9x and Westpac on 12.6x according to Google Finance. (Commsec has similar figures).

ANZ’s average P/E ratio since 1992 is around 14x according to Capital IQ, so today’s price looks like a bargain. Likewise CBA, with Capital IQ showing a long-term average P/E of 16.6x for Australia’s largest bank.

The problem is that the market is pricing the banks’ shares cheaply for a number of reasons.

  1. Australia hasn’t had a recession since 1991. That’s 24 years of uninterrupted growth and the banks have been at the centre of that. With China’s economy slowing, the risks of Australia heading into a recession appear to be growing. A recession would be a major headwind for the banks, with credit growth like to turn negative, making their earnings growth even harder to come by. A recession would also likely see provisions for bad debts rise, something the banks have seen at almost record lows recently.
  2. We are still awaiting the outcome of the recommendations from the Financial System inquiry. That could see banks forced to raise even more capital. Raising capital dilutes earnings and lowers returns on equity, which could impact not only on their share prices but also result in lower dividends. Citi Group is already predicting the big four will have to cut their dividends by 2018.
  3. Further capitalisation rules may be pushed through by the regulators to make the banks more resistant to sudden shocks to the financial system. That’s good news for current shareholders in that the banks will be inherently safer and less likely to fall into trouble. But it also means more shares are likely to be issued, further diluting earnings and dividends.
  4. A soaring property market in Australia over the past few years has seen credit growth soar. That may be coming to an end, with the regulator implementing a number of ‘rules’ to get the banks to limit lending to investors.
  5. Worries about China’s slowing economic growth is likely to see international investors dump any investments related to China, including Australian stocks, adding further downward pressure on the banks’ share prices.

These factors however, may or may not have a major impact on the big four banks in the short-to-medium term, but the market is being cautious.

Foolish takeaway

What I do know is that this is probably the closest I have come to be interested in the banks in the past few years. Concerns over the big four may be overdone and this could all be a storm in a teacup – in which case the banks’ shares start to look very attractive.

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Motley Fool contributor Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga

Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.