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Monday, 6 November 2017
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Banks better than Bonds

We have just been through the bank results season for the September year-end banks which include the majors, ANZ, Westpac Bank and the NAB. The Commonwealth Bank has had a quarterly update but has a June year end, so their results our out of step with the rest of the banks and aren’t until February.

None of the major bank results have impressed anybody. The banks have truly turned off the growth engines as they focus on cutting costs and building capital. The NAB, for instance, announced 6000 job losses and a provision of $500-$800 million to be taken in the first half of next year. They all reported maintained rather than increases in dividend as well.

The sector is now factoring in low, or at least, no significant growth anymore, with forecasts for revenue to grow at 3-4%, earnings growth at 1-3% and dividend growth at 1-2% if at all. In the end, the sector has become a collection of four large income stocks without excitement. Why would you buy them?

I’ll tell you. Because while low or no growth in revenue and earnings may seem dull, when you consider that the Australian yield curve is forecasting interest rates to stay around 2 to 3% for the next ten years, there is something rather attractive about an 8.1% yield based upon a very stable earnings stream.

If I were to offer a bond with an 8.1% yield, I would be hit with billions of dollars in the current markets. But the banks, after three years of pain and balance sheet building, have become as bond-like as they are ever likely to get. Capital ratios are already above the “unquestionably strong” APRA guidelines for 2020. They have spent the last three years building a safety buffer as strong as any they have had in their existence. That transition process has been very costly for the sector. Share prices had a torrid couple of years there as expectations were reduced, but at the same time, the volatility or risk has also been progressively engineered away.

From this point, for the first time since the growth bubble burst in early 2015, these stocks are stacking up once again as the perfect income stocks four low-risk income-focused retirees. After almost three years of adjustment in which the growth expectation has been squeezed out of the share prices, the major banks now, once again, offer some of the lowest risk businesses in the market, at some of the highest yields.

You can look around the rest of the market and find stocks with a yield, but very very few are going to have the earnings stability and reliability of the big banks. If you dumped your retirement money in here, as opposed to holding it in a term deposit, you would achieve a 5% lift in income. What you have to ask yourself is whether it is worth it.

Of course, you will have to worry about a seismic market event that will take everything down with it, or some disruption in the bank sector model if say Google banks appear on the high street, but if you are half vigilant you can hopefully pick up on a rare seismic market event as it develops and, by staying in touch with the market, get an inkling about the business landscape changing should it happen.

I’m not sure I would be buying “the market,” which includes “the banks,” at this very moment because I think we are due some sort of US market correction. But as a retiree looking for a hassle-free income, I would be looking for that moment to buy banks on any correction as an alternative to a term deposit. Of course, you will then have to keep the market in your peripheral vision, but that’s the cost of a 5% increase in return.

The sector has been through a lot in the last three years. $20 billion worth of capital raising was a big killer, they have also weathered a quite bizarre political attack from Scott Morrison, they have seen the big bank levy introduced by a government that had run out of financial imagination, they have been dented by APRA’s cultural investigation, the AUSTRAC uncertainty, the regulatory interference in mortgage lending growth and the imposition of arguably unnecessary capital requirements that are 10 years too late.

It doesn’t get much worse than this, but the likelihood is that many of those factors will now improve allowing the sector to move back to growth one day, and it will probably do it under the radar. So now is not the moment to dismiss the sector because of its lack of growth, now is the time to think about buying, for income, for the long term.

Growth focussed investors - look away....nothing to interest you here.  - Of course, growth focused investors should simply ignore this article. There is nothing to interest you here, although, as banks become appreciated for their solidity rather than their excitement, who knows, a share price rise would nothings be a handy bonus.

Note: We have the dividends coming up in the next couple of weeks - Macquarie ex-dividend on 7th November (tomorrow). NAB ex-dividend on 9th November (Thursday). ANZ ex-dividend on Nov 13 (next Monday) and I have yet to determine the exact Westpac ex dividend date. (Once these stocks have gone ex dividend the focus moves to the Commonwealth Bank which has a June year end and interim results coming up in February).

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