Has the time come to buy the big four banks?

Source: Australian Broadcasting Corporation

Over the past few days, the share prices of the big four banks have surged higher – could this be the start of a recovery?

And today, 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) are up 2.7% to $24.76, 0.9% to $74.60, 2.4% to $26.17 and 1.0% to $31.01 respectively.

But despite today’s gains, the banks’ share prices are still down considerably compared to 12 months ago. ANZ and NAB are down 30%, while CBA and Westpac are down around 19%. That is partly to do with the banks issuing tonnes of new shares at significant discounts, which dilutes the value of the existing shares. (You could compare it to splitting a pizza into 10 pieces instead of 8.)

The reason the banks issued many more shares is because they were required by the banking regulator to hold more Tier 1 capital to protect against shocks to the banking system and financial risk within the banks themselves.

NAB has also demerged its Clydesdale banking business – CYBG PLC CDI 1:1 (ASX: CYB), so in effect is a smaller company.

Global risks

The banks’ share price have also fallen as investors pulled out of banks globally – with concerns that ultra-low interest rates are an unknown threat to the banking system. Some central banks have even begun setting negative interest rates – which has never been done before.

In fact, there are a whole host of risks the banks face, from rising bad debts, fears of a slowdown in China, how the US (and the world) will cope with rising US interest rates, not to mention any impact from a slowdown in credit growth or a fall in property prices in Australia.

But against that, investors could also argue that the falls over the past 12 months have factored in those risks now, the banks are arguably less risky given they hold billions more in capital, and their dividend yields are all well above 5% – and fully franked. In fact, ANZ and NAB’s trailing dividend yields are above 7%, while CBA and Westpac boast yields of 5.6% and 6% at today’s prices.

2015 dividend (cents) 181 420 198 187
Current share price $24.79 $74.60 $26.17 $31.01
Dividend yield 7.3% 5.6% 7.6% 6.0%
Cash EPS (cents) 260.3 560.8 227.6 249.5
P/E ratio (x)             9.5           13.3           11.5           12.5
EPS growth 0% 4.6% -2.80% 2%

Source: Company reports

Competitive advantage

Additionally, thanks to their dominance of the Australian financial system, the big four banks have a major competitive advantage in that they can pass on costs to their customers with very little negative impact.

And pass on those costs is one thing they are certainly doing.

Very few of the big banks’ customers switch to cheaper lenders or higher-paying deposit institutions despite plenty of choice. That ability to charge higher fees or pay less deposit interest is a major advantage for the big four.

Last year the banks increased their interest rates for investor property loans, and today CBA became the last of the four banks to increase interest rates on a wide range of business loans, with a spokesman saying, “We have increased our rates across a number of business lending products in response to higher funding costs and increased regulatory requirements impacting all banks.

NAB is reported to have started the move in February, raising business interest rates by up to 0.29%. ANZ and Westpac followed, also increasing their line of credit interest rates to retail customers, and now CBA is following suit.

Where to from here?

On a P/E basis, ANZ and NAB look cheap relative to Westpac and CBA. But analysts and fund managers appear to be wary about both ANZ and NAB. In particular, ANZ’s exposure to Asia and lending to resources companies, according to Anton Tagliaferro from Investors Mutual.

The big four may yet have to raise more capital, but you can bet your bottom dollar that the banks are going to pass on the costs to customers somehow – and it does come with the added benefit of making the banks stronger.

Foolish takeaway

The main question though is where are the banks going to get earnings growth from? Forecast growth is for low single digits (4.5% for CBA) and dividends are expected to stay virtually flat. Unless the banks can generate higher earnings growth, those dividends aren’t going higher, and that’s my main concern.

Having said that, for the first time in years, I’m entertaining the thought of adding at least one bank to my portfolio.


Motley Fool writer/analyst 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.

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