Feature Article on Business First Magazine Sept/Oct 2017 Issue

The Investment Case for the Big 4

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By Gabriel Yi, Managing Director of M3 Investment Group

Comprising over 25% of the market cap of ASX 200, the big 4 banks have long been considered a staple component of a model ASX portfolio. However in recent times, the banking environment has faced several headwinds including the predictions of a slowing housing market, calls for a Royal Commission, the introduction of a bank levy in the 2017 Federal budget, proposals for a state-wide levy in South Australia and most recently, the AUSTRAC money laundering allegations against CBA. In light of these headwinds, it would be prudent to analyse the big 4 banks in general and also scrutinise the premium that CBA has traded on in comparison to its peers.

In July 2017, the Australian Prudential Regulation Authority (APRA) increased the minimum tier 1 capital ratio requirements to 10.5% by 1 January 2020, affecting the big 4 banks and Macquarie Group. This announcement was well received by investors as most banks were in good shape to meet these levels. ANZ was in the best shape to meet the new requirements due to their executed and planned divestment of assets, allowing them to have their CET1 capital ratio at 10.1% as of 31 March 2017. Westpac and NAB were in similar positions, confident in meeting the new requirements. In CBA’s August 2017 full year report they also announced a CET1 capital ratio of 10.1%.

The Net Interest Margin (NIM) trajectory for the banking industry also appears to be improving as evidenced in CBA’s FY17 report which showed better funding costs, in addition to mortgage repricing acting as positive tailwinds for the bank’s NIM in 2H17 and into FY18. CBA’s net profit and cash earnings were impressive and judging from the stellar 3Q reports from ANZ, NAB and WBC which all showed strong quarterly cash earnings and solid capital positions, the big 4 banks appear to be solid investment opportunities. However, this positivity resulting from balance sheet improvements has not been reflected in recent share price action, with most banks trending sideways at best in 2017. This can be attributed to the recent plethora of unexpected events that have hit the investment case for the big 4. (Not to mention the looming cloud, that is, the risk of a declining housing market).

The unexpected bank levy which was introduced in the 2017 Federal budget sparked an initial negative reaction among investors but since the associated cost could quite possibly be passed on to consumers or shareholders, it did not become a lingering headwind. The statewide bank levy proposed by the South Australian government was also a surprise event and has since been met with strong opposition. The recent AUSTRAC money laundering scandal involving the CBA has been yet another incident which has brought into question the culture within banks and reinvigorated calls for a Royal Commission.

Furthermore, in light of the AUSTRAC pending court case, CBA’s premium share price in comparison to its peers have been brought into question. In the interest of minimising risk, WBC, ANZ then NAB are our preference. Although CBA has a history of trading on a premium to its peers, and deservedly so, the AUSTRAC allegations have clearly elevated their downside risk.

The events surrounding the banks, particularly in recent months, have instilled caution across the sector, as evidenced in their lackluster share price performances. However, their purpose in a portfolio should not be forgotten. Notwithstanding the fact that there continues to be a long line of headwinds anchoring the investment case for the big 4 banks, many ASX investors still possess a strong affinity for high dividend yields and franking credits.

In a portfolio with a focus on income, banks can certainly act as the stable source of approximately 5.5 to 6% yield plus franking credits. They are the financial pillars of the Australian economy and continue to show strong profitability.

So, it’s not a surprise the big 4 continue to be widely held across retail and institutional portfolios. Although there may be more surprises along the way, as long as the dividend outlook for the banks remains intact, we predict continued support for the big 4 among investors.

 

M3 Investment Group is a private wealth management firm specialising in Australian equities. The proactive investment approach implemented by M3 has been designed to help investors capture value in volatile markets. Visit us at m3group.com.au for more information and register your details for a complimentary portfolio consultation.

The content in this article has been prepared without taking into consideration any individual’s particular objectives, financial situation and needs. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.