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Time to buy bank stocks - or one for the suckers?

Discussion in 'Shares' started by Billv, 19th Oct, 2008.

  1. Billv

    Billv Getting there

    15th Jul, 2007
    Sydney, NSW
    SHARES of the Big Four banks are cheap. Their share prices are down as much as 40% from their all-time highs of late last year.

    Will bank shares pay off handsomely over the long term for investors who take the plunge now? Or will investors end up with a black eye?

    Non-bank lenders and regional banks are not as competitive in mortgage lending as their larger peers because they find it harder to access funds due to the global credit freeze.

    Commonwealth Bank's purchase of BankWest and Westpac's of St George is only the start of consolidation. The four are highly rated by credit agencies, have strong balance sheets and remain hugely profitable.

    Morningstar head of equity research Peter Warnes says the Big Four are "very close to the 'buy' zone, or in it, at these prices". The Big Four are trading on price-to-forward-earnings multiplies of about 10 times, with CBA more than 13 times. On their expected earnings for the 2009 financial year they will pay shareholders cash yields of between 6% and 9% at current share prices.

    Three of the Big Four will report their results within the next fortnight. Commonwealth Bank released its results in August and, as the first to report, is an indicator of how the others are likely to be weathering the storm. Commonwealth Bank increased its cash profit by 5% in the year to June 30, over the previous year, well down on the double-digit earnings growth of recent years.

    Warnes is not expecting any nasty surprises when the others report. He still has a "niggling" doubt about whether NAB will have to make more provisions for credit impairment.

    However, in a guidance to the market this week, NAB said it was bringing forward its 2008 full-year results in the "interests of providing certainty to the market" and that it did not "foreshadow any proposed material announcement". Nevertheless, Warnes says NAB's exposure to the British mortgage market through its Clydesdale and Yorkshire banks makes it the riskiest of the four.

    Other analysts and fund managers are not so sure. Lending commitments (for housing, personal, commercial and lease finance) for August were 30% lower than a year ago; although that was before the Reserve Bank's surprise 1 percentage point cut to the cash rate to 6% and the likelihood of more cuts.

    "I do not see tremendous value in the banks at the moment … because the Australian economy is going to slow," says James Falkiner, founder of Falkiner Global Investors.

    He says the banks' competitive position is enhanced now, but when credit markets return to normal, non-bank lenders will be able to get cheaper funding.

    The Federal Government has also provided small banks and non-bank lenders with $8 billion to help them provide competitive mortgages.

    Fat Prophets head of Australasian research Greg Canavan says the "whole appetite for credit is diminishing and that is going to continue for some time". Although the level of credit impairment is still low, he expects it to increase over the next few years, constraining banks' profitability.

    Falkiner says the banks' significant wealth management operations will help them, but that their "stock in trade" is raising cash from depositors and lending. This is going to be more difficult as the economy slows to perhaps 2% annualised growth over the next year. He says banks' credit impairment of their corporate loan books will almost certainly increase.

    Canavan says another risk is that house prices may fall as the economy slows and unemployment increases. The danger is that mortgage defaults rise sharply and that falling house prices will hit those who borrowed against their houses for investment and consumption.

    Australian consumers are as highly indebted as consumers in the US and Britain, where house prices have fallen significantly and helped to push those economies into probable recession.

    A report on Australia by the International Monetary Fund, released late last month, said house prices were "only moderately" overvalued at no more than 15%. The report noted that a main driver of house prices was high immigration. But last week Prime Minister Rudd hinted the Federal Government would cut back on immigration levels as the economy slowed.

    The Federal Government has also increased the first home owners' grant. But Canavan says would-be home buyers will continue to rent because "in general, people buy when they think prices are going to go up".
    Time to buy bank stocks - or one for the suckers? |