It's been heady days for the banking industry since the November 2016 election of Donald Trump. Shares in Australia's biggest banks, including Commonwealth Bank of Australia (ASX: CBA), Westpac Banking Corp (ASX: WBC), and Macquarie Group Ltd (ASX: MQG), have shot higher:
As we can see, shares in each have rocketed higher over the past 12 months, hitting new 52-week highs this morning. Each of the banks looks pretty pricey on a Price to Book (P/B) ratio however, with Commbank, Westpac, and Macquarie priced at 2.4, 2.0, and 1.9 times respectively, according to Reuters data.
The old saying goes 'Buy a bank at 0.5x book value and sell at 2.0x book value'. Does that mean Commbank and Westpac are a sell? Not necessarily, since that saying comes from the USA, where the banking system is more fragmented and banks lack the monopoly of Australia's Big 5.
However, the price to book values do tell us that investors are pricing the banks quite highly, believing either that further lending growth is forthcoming and/or that higher interest rates will lead to wider profit margins in the near term.
That could prove true, but higher interest rates also increase the minimum repayments required on home loans, and an inability to meet payments is the primary cause of home loan defaults. Sure, the banks have been tightening their lending standards recently, but they've been writing loans at 90% to 95% Loan to Valuation Ratios (LVRs) in the past few years (higher is riskier), and those loans are likely still quite vulnerable to higher repayments and/or higher Australian unemployment levels. Higher interest rates and more stringent standards also make new loans less attractive, and I'm not expecting banks to be able to grow their loan books rapidly.
For those reasons I'm avoiding the Big 4 banks at today's prices. I would prefer to own Macquarie, although I note that it is also writing as many home loans as it can, and I would recommend shareholders investigate further before making an investment decision.
