Why the banks are a buy

Wait for a correction to pick up the perfect income stocks

We have just been through the results season for the banks that have a September yearend, which include the majors, ANZ, Westpac and NAB. CBA had a quarterly update but has a June year end, so its results are out of step with the rest of the banks and won’t be known 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. NAB, for instance, announced 6000 job losses and a provision of $500 million to $800 million to be taken in the first half of next year. They all maintained, rather than increased, dividends.

The sector is now factoring in low, or at least no significant, growth, with dividends growing 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%-3% for the next 10 years, there is something rather attractive about an 8.1% yield based on 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. 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 past three years building a safety buffer as strong as any they have had in their existence. That transition has been very costly. Share prices had a torrid couple of years 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, the big banks are stacking up once again as the perfect stocks for low-risk, incomefocused retirees. After almost three years of adjustment in which the growth expectation has been squeezed out of the share prices, the major banks 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. Is it 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 hope- fully 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 present 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. 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 past three years. $20 billion worth of capital raising was a big killer. The banks have also weathered a quite bizarre political attack from treasurer 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.