There is plenty of bad news buffeting the banks, but I remain positive on the sector because pricing suggests that investors have become too gloomy on the sector’s prospects. The sector is trading on a book multiple of 1.9x which represents a 50% discount to the non-bank industrials.
In the past two decades, dispersion of this size has only occurred two other times; during the financial crisis and in the early 2000s (see chart). Despite the fact that higher capital requirements have crimped the banks’ ROEs, the sector’s profitability remains higher than non-bank industrials.
A lift in bank provisioning was a key theme to emerge from the sector’s reporting season. The historically low rental yields in residential but particularly commercial property have seen the banks rightly adopt a more conservative stance provisioning. The focus on asset quality in these areas is likely to continue for the foreseeable future.
A key risk to the sector has already played out, with the Government announcing the introduction of a 6 basis point levy on banks’ liabilities in the Budget, which has already been endorsed by the ALP. APRA recently flagged the prospect of more stringent capital requirements.
But a downturn in the commercial and residential property markets represents the key tail risk to the sector thanks to historically low rental yields. Rental incomes – which are already growing at their slowest rate in two decades – are likely to be subject to downward pressure as a glut of apartments come onto the market in Brisbane and Melbourne over the next three years.
Founder of Evidente, Salvatore Ferraro, is a top rated quantitative analyst and has over 17 years of experience in financial markets, with investment banks, Goldman Sachs and Merrill Lynch, providing advice on best practice to portfolio managers...
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