Bank shares have enjoyed a renaissance this month with investors jumping back into the beaten down sector for their dividend payouts and on the back of the surprising federal election result that has effectively buried changes to the favourable tax treatment for housing investments.
Throw in the growing chance of an interest rate cut or three and the loosening of the mortgage serviceability test that APRA imposes on the banks, and you get the perfect environment for bank stocks to outrun the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index.
But don't be fooled into thinking that the banking sector is out of the woods. While the above factors are positives for the Commonwealth Bank of Australia (ASX: CBA) share price, the Westpac Banking Corp (ASX: WBC) share price, Australia and New Zealand Banking Group (ASX: ANZ) share price and National Australia Bank Ltd. (ASX: NAB) share price, many experts think the good news is already priced into the market.
Don't chase the bank rally
In other words, investors should be wary of chasing the bank rally, particularly given that credit growth still looks weak and provisions for loan delinquencies are likely to rise.
The analysts at Macquarie Group Ltd (ASX: MQG) hold a similarly cautious view on the sector and believes that underlying conditions for the sector remain challenging.
While interest rate cuts will stimulate the housing market and drive demand for home loans, falling rates are bad news for bank profitability – particularly when the Reserve Bank of Australia (RBA) lowers rates by more than 50 basis points (equal to two standard rate cuts).
The market is expecting two rate cuts this calendar year but some economists, like the ones at Westpac, are predicting three cuts which would bring the official cash rate down to 0.75%.
"Maximum lending capacity is likely to increase by up to 9% (~15% if the RBA cuts rates by 50bps)," said Macquarie.
"However, upcoming updates to HEM, automated document verification processes, implementation of comprehensive credit reporting, and Debt-To-Income limits are likely to continue to put pressure on credit availability."
Best value big bank stock
Low wages growth, record high household debt, a sluggish outlook for the economy and rising compensation and litigation costs linked to the Banking Royal Commission are other headwinds buffeting the sector.
"Excluding the impact of remediation, the banks sector is now trading at ~32% discount to All Industrials (ex. Banks) vs a 5-year average discount of ~28%," added the broker.
"However, we note that CBA, which is trading at a ~28% premium to peers, is lifting the sector's valuation."
The bank that's trading on the biggest discount is NAB at 41% (excluding remediation). This compares with its average discount of around 29% and Macquarie believes it has the "highest sustainable dividend at about 6.5%.
Based on these factors, Macquarie has upgraded NAB to "outperform".
