The surprising resilience of the Australian economy and lead indicators bode well for a much-maligned sector of the market – Australian banks.

Fortress Australia has held firm during the health crisis (so far at least). With government support the recession was short and sharp, the recovery is now underway. Thankfully, fears of mass long-term unemployment and a free fall in house prices did not eventuate. Instead:

• Unemployment peaked at 7.5% at the height of the Victorian lockdowns in July, and is now on its way back down as employers re-hire.
• Australian property values actually finished 3% higher over 2020. Median prices rose in all major markets except for Melbourne metro, which itself is now recovering.

Chart 1: Australian labour market recovering strongly

Increasingly confident and cashed up consumers

Over the past year the combination of government support and Covid-related deferral of discretionary spending have built up significant household savings buffers. A rapid rebound in sentiment indicates that consumer spending should continue to grow strongly over the year ahead. Even the tapering of JobKeeper in March is unlikely to offset this trend, given the size of the excess savings that have been accumulated and are likely to be spent.

Chart 2: A rapid rebound in Consumer Sentiment and Spending Intentions

Residential property gets its mojo back

These high household savings balances, the best mortgage affordability since 2002 (due to record low interest rates) and the $2 billion Government HomeBuilder stimulus program have led to a surge in residential property construction – another key plank of the Australian economy. Building approvals for new houses is up 34% YoY to November 2020. A strong property sector is good for future profitability of Australian banks, given their significant exposure to housing credit.

Chart 3: New Loan Approval suggests increasing momentum in housing credit growth

New loan approvals data suggests there will be a strong increase in housing credit growth. Critically, demand for new credit has been driven by owner occupiers. A return of investors to the property market (given relatively attractive yields of this asset class) is likely to fuel a further leg up in credit growth.

After bearing the broader economic fallout, banks are leveraged to the recovery

In the face of an economic crisis of unknown magnitude, Australian banks cut dividends hard over 2020. The big four banks' reported profits fell by 36.5% as they set aside billions of dollars in additional provisions for potential loan defaults. As the economy recovers these loan provisions are likely be released over 2021, helping a bounce back in bank profits. Under this scenario much higher dividends are expected to follow, after APRA lifted its dividend payout ratio limits in December 2020. Dividends that would be more attractive than ever in such a low rate environment.

Chart 4: Major Bank Dividend Cash Yield (in blue), Grossed Up Yield (in grey) and RBA Target Cash Rate (in red)

With many market sectors trading at stretched valuations, we consider that Australian bank shares currently offer relatively good value and should benefit further during 2021 with improving economic conditions. Bank share prices have started to recover, but are well below their pre-Covid levels and all-time highs (NAB, ANZ and WBC in particular).

Implementation

You can get exposure to Australian banks through BetaShares Australian Financials Sector ETF (Ticker: QFN) in a single trade on the ASX. QFN aims to track the performance of an index comprising the largest ASX-listed companies in the financial sector, including the big four banks, regional banks and insurance companies but excluding A-REITs.

For investors looking to express a view on Global Banks, these can be accessed via the BetaShares Global Banks ETF – Currency Hedged (Ticker: BNKS).

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