Shares in Australia's biggest banks such as Commonwealth Bank of Australia (ASX: CBA), National Australia Bank Ltd. (ASX: NAB), Australia and New Zealand Banking Group (ASX: ANZ) and Macquarie Group Ltd (ASX: MQG) are all touching 52-week highs this morning as investors re-rate them on the potential for rising base lending rates in Australia and North America.
In the U.S. giant banks like Wells Fargo, Bank of America and Goldman Sachs have all lifted more than 30% since the election of President Donald Trump, as the prospect of higher interest rates, company tax cuts and deregulation over the next three to five years fuels their profit-making potential.
I have written several times before about how the changing macro and political environment threatens to be a bonanza for bank stocks alongside 10 other stocks that could benefit from the Trump effect.
Return of the banks?
Of course simply buying shares in a company on the basis of a change of government in the U.S. is a dumb idea, but for defensively-minded Australian investors and dividend seekers the banks may be a good option given we look to be at the bottom of the cash rate cycle.
As cash rates rise big banks like the CBA or NAB are able to expand their profit margins as higher rates give them more room for manoeuvre in cranking their net interest profit margins.
Banks 'lend long' and 'borrow short' with a lot of short-dated liabilities usually in the form of customer deposits that become more profitable as the rates offered on them fail to increase at the same pace as the rates at which banks can lend to retail and business customers.
If banks can lend medium-to-long term at higher interest rates while keeping depositor rates steady just marginal basis point gains in their net interest margins can translate into hefty profit growth.
In effect the bankers' challenge is to make more on what they lend than they pay on what they borrow, but since the GFC and its infamous runs on European and U.S. banks (resulting in bankruptcies or part nationalisations via recapitalisations funded by taxpayers) the amount of liquid capital they have to keep in reserve for a rainy day has been lifted due to new regulations.
As a consequence the idle money sitting on the banks' balance sheets (as a percentage of risk weighted assets) is detrimental to their return on equity and any pullback from the policitcally-driven regulatory determination to lift liquidity requirements should boost profitability and total capital returns to shareholders in the years ahead, even if it threatens a return to the reckless pre-GFC leverage of old.
Should you buy?
In Australia the CBA just reported a 2% lift in operating cash profit for the six-month period ending December 31 2016 and offers a trailing fully franked yield greater than 5%.
Others like Westpac Banking Corporation (ASX: WBC) offer trailing full franked yields of 5.5% despite hitting 52-week share price highs this morning. Given the strength of Australia's property markets and potential for widening profit margins after a few lean years the big banks may offer good total returns ahead for income-focused investors.
I still prefer the banks' outlooks and valuations to other popular dividend payers such as Westfield Corp Ltd (ASX: WFD), Scentre Group (ASX: SCG), Sydney Airport Holdings Ltd (ASX: SYD) and Transurban Group (ASX: TCL) all of which offer lower yields.
Moreover, there's a big risk that rising risk free debt and benchmark lending rates globally are likely to sink their valuations and bring their yields more into line with historical norms that adequately reflect the compensation on offer to investors taking greater risks by investing in equities.
