Outwardly Australians hate banks. Quietly, though, they love them.
Yes the banking royal commission has customers seething at the many examples of poor advice, high fees and dodgy behaviour. But then those same people have loved what the share price performance, and attractive fully franked dividends, from the big four banks have done for their superannuation and investment portfolio returns.
But given share prices of the major banks are now hovering around 12 month lows, are the banks completely on the nose … both in reputation and investment potential?
For decades the major banks have been a trusted loyal foundation for any quality investment portfolio. It used to be that investing in bank shares provided a better return than any product a bank offered a customer.
They have been extraordinarily good performers on the back of, what turned out to be, shall we say “flexible” lending practices. Since the royal commission the banks have been forced to be stingier with lending, they’ve been offloading insurance and wealth management divisions and profits are falling.
So the big question now is: Do the banks still deserve that exalted position of being a foundation investment for every quality investment portfolio? Or is it time to dump them?
It’s a big call to make … and what do you replace them with? It is a big hole to fill — a solid, quality stock with a good dividend yield.
DON’T EXPOSE YOURSELF
“Banks have gone from three decades of double digit mortgage lending growth almost every year to Westpac now predicting mortgage lending growth of just 4 per cent in 2019,” sums up Bell Direct equities strategist Julia Lee.
“This is a difficult environment to grow profits in and, if anything, banks would have to look at cost cutting and reining in expenses to try and maintain current levels of profitability.
“I would be underweight banks.”
It’s a sentiment also shared by Elio D’Amato, executive director at research group Lincoln Indicators.
“There is very little in the way of catalyst for strong earnings growth,” says Elio.
“Most are trying to be smaller and leaner institutions tomorrow than what they are today. Despite the fact they are cheap relative to historic levels, it is difficult to see how any re-rate to the growth prospects will occur.
“Therefore, in our view, investors seeking dynamic growing companies should not be exposed to the banks.”
It’s pretty clear the stock gurus aren’t overly impressed with the investment potential of the major banks in the immediate term despite attractive fully franked dividend yields of between 8 and 11 per cent. Those grossed up yields have been inflated by the falling share prices but the big question is whether, given falling profits, current dividend payouts can be maintained.
“At the moment, banks would be able to maintain dividends,” says Lee. “I wouldn’t expect any growth in dividends over the next three years and there is a risk that there could be a cut to dividends given the soft outlook for Australian banks.”
D’Amato agrees, and sees Westpac and NAB as the most likely of all the banks to cut dividends in the future because of their current payout ratios.
Both D’Amato and Lee agree that, of the Big Four banks, ANZ is their preferred choice in terms of dividend yield and potential.
It’s important to point out no-one is suggesting any of our Big Four banks are in any sort of trouble. Far from it. In fact, despite their poor investment performance and falling profits of late, they are still among the strongest, safest financial institutions in the world. With balance sheets that are still rock solid.
“The only bank we like from a growth perspective among all of them, is not one of the top four. It is Macquarie Group,” says D’Amato.
“It recently upgraded its full-year guidance following a strong performance from its capital markets divisions, which demonstrated the strength and diversity of its business mix.”
Julia Lee agrees that Macquarie is a good substitute for the Big Four in an investment portfolio that needs higher growth options among diversified financial stocks. She also thinks investors should look at Challenger Financial Group as well.
Apart from Macquarie Group, Elio D’Amato likes:
• Magellan Financial Group, a fund manager with an overseas investment focus. It has committed to paying 90-95 per cent of after tax earnings in dividend.
• Charter Hall Group, a property developer with a funds management arm. In our view it’s the premium traditional real estate investment trust in the marketplace.
• Insurance Group of Australia: an improving insurance premium rate environment with industry-leading margins should see them continue to pay a high dividend.
• Rural Funds, an owner of agricultural land. Strong tailwinds underline strong demand for the properties, and hence expected distribution increases in the future despite a strong run up.
It’s a great lesson on why investment portfolios need to be constantly monitored and advisers consulted regularly.
The major banks have been a great ride for investors over so many years. But times have changed. Authorities are tightening regulations, loan demand is softening and margins are under pressure. They are still great businesses … just not as good as they have been.