Still positive on the banks

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.