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Five stocks to bank on right now

Bank shares have disappointed. Is now time to buy?

It is time to buy the banks. If you already own them, add more if possible. If you do not, take advantage of the best buying opportunity in banks in a decade.

Yes, risks to bank earnings and dividends are immense. Bad-debt provisions from NAB, Westpac and surely ANZ imply a $10billion hit for the big banks this year.

Morgan Stanley this week forecast cumulative losses of $35 billion for the major banks over three years as business and personal customers struggle to repay their loans. Bank losses could worsen if parts of industry are shut down for longer than expected, unemployment exceeds expectation and the economic recovery is more “U” or “W” shaped rather than the “V” snap-back that governments are desperate to engineer.

The market, at least, is expecting bad debts to skyrocket, judging by sharp falls in bank share prices this year. Less clear is what will happen if there is a meltdown in commercial property valuations as more companies cannot pay rent or seek large rent reductions.

A residential property meltdown is another threat. NAB this week presented a worst-case scenario of house prices falling 30 per cent cumulatively over two years. That forecast assumed a lengthy recession and high unemployment next year. Even a V-shaped economic recovery would drive house prices 10 per cent lower in 2020, tipped NAB.

I expect more muted house price falls – probably 5-10% over 12 months – as homeowners take advantage of government assistance, home-loan repayment deferrals, record-low interest rates, or use any equity buffer in their mortgage offset account to hold on to their home as long as possible.

I suspect the Federal Government will call on the big-four banks to provide even more assistance – yet another risk to their profits. Government pressure on banks to provide bridging loans to help small businesses cover wages before JobKeeper payments arrive is an example.

Do not be surprised if the banks sacrifice more of their future profits to provide extra concessions to support distressed customers. Granted, that sounds naive, but banks know that many customers will go bust without extra support, creating worse problems later.

Bank dividends are another worry. NAB this week reduced its interim dividend by 64 per cent to 30 cents per share and I expect other banks to follow with similar cuts. It could take three years before bank dividends return to pre-COVID-19 levels.

This is not the time to chase banks only for dividends; prospective investors should focus on the likely total return (capital growth and income) and be prepared to take profits on their shares over the next few years and use that for income.

I could go on with other risks – some known, some unknown – facing the banks. Much depends on when health-related restrictions are eased and how the economy recovers. That, in turn, depends on the fight against coronavirus this year and possibly next.

If, like me, you believe restrictions will be eased progressively in the next two months and that the economy will roar back to life in 2021, bank stocks look cheap. If you think parts of the economy will be shut down for many months to come and that a severe recession will linger well into next year, avoid bank stocks and the share market.

 

Turning bullish on banks

I have mostly avoided bank stocks entirely over the past five years, mainly because of regulatory risks and the threat of industry disruption from fintech firms. The prospect of lower interest rates eating into bank net interest margins was another concern.

I published a favourable view on CYBG Plc (now Virgin Money) in this report, on demerger grounds, in 2016, and a positive article on ANZ Banking Group late last year and again last month. ANZ still offers the best value of the big-four banks for long-term investors.

The bearish view on banks paid off. The S&P/ASX 200 Banks index has an average annualised total return of -7% over five years, S&P data shows.

Over one year, the total return for bank stocks ranges from -14% for CBA, -32% for NAB, -35% for ANZ and -39% for Westpac, shows Morningstar data. Nobody could have imagined this bloodbath.

I have resisted adding several bank stocks to the COVID-19 ideas list in this column, until now. It is telling that bank stocks have mostly trading sideways during the market rebound from March 23, lagging the recovery, amid rampant uncertainty and fear towards the sector.

To briefly recap other ideas, as the crisis erupted in early March, I suggested tech stocks, which are a rewarding view so far.

In late March I added five industrial stocks, most of them with defensive business models (Telstra, ASX, APA Group, Woolworths Group and ANZ). In early April, Domino’s Pizza Enterprises and Collins Foods were added to the ideas list. Last week’s column added the infrastructure plays, Transurban Group and Atlas Arteria.

In addition, I suggested last week that investors should have 75 per cent of any available cash back to work in the share market now, leaving some aside for opportunities, such as the banks.

 

Reasons for bullish view

Six main reasons underpin my bullish view on Australian banks stocks.

First, I am less bearish on the economy over the next 12 months than some forecasters and do not believe banks are underestimating likely loan impairments or that bad debts will soar beyond expectation. Yes, there will be a recession and many businesses and home-owners, sadly, will go bust, driving bad debts sharply higher. Many Australians will be unemployed, possibly for longer than they ever expected, but do not discount our economy roaring back to life in 2021.

Second, bank valuations appear to be factoring in an overly severe economic downturn, at current prices. Morningstar, for example, values Westpac at $25 a share, compared with the current $15.69. Its fair value for NAB, also $25, compares to the current $16.29. Even if those valuations are too positive (several brokers have lower price targets) the banks still provide a sufficient margin of safety to buy at current prices.

Third, COVID-19 could ease regulatory pressure on the banks after the Banking Royal Commission and even partly restore their battered image with the public. Like or loathe them, the banks have mostly stepped up during COVID-19 and it is possible that regulators might delay or reduce future regulatory impositions as banks recover from the crisis.

Fourth, emerging competitors, such as fintech firms, could have their wings clipped by COVID-19, particularly if they struggle to raise capital this year. There could be opportunities for banks to buy promising fintech firms and boost their digital presence.

Fifth, the optimist in me says COVID-19 will, longer term, spark a new and much-needed wave of reform in taxation, industrial relations and red-tape. This is a flimsy argument to buy banks now (and probably naive) but crises can force warring parties to work together to drive change, and early results from the National Cabinet is cause for hope.

The sixth reason is sentiment. Newspapers are full of bad news stories about banks and negativity could peak this week and next with NAB, Westpac and ANZ reporting. It feels as if there is unreasonable negativity about the banks (relative to their share price) and that is invariably a buying opportunity for long-term investors.

 

What to buy

Westpac and NAB are added to the ideas list this week, joining ANZ. Each has underperformed the Commonwealth Bank during the COVID-19 crisis and offers value.

An easier approach is to buy the banking sector through an exchange-traded fund (ETF). The VanEck Vectors Banks ETF (MVB) provides exposure to the big-four banks stocks, Macquarie Group, Bendigo & Adelaide Bank, and Bank of Queensland.

Bought and sold like a share, the ETF is a simple way to gain exposure to a recovering bank sector, rather than having to pick individual stocks. The annual fee is 28 basis points.

ETFs are useful when investors want to buy the market or buy a sector during a crisis, rather than punt on individual stocks.

 

Chart 1: VanEck Vectors Banks ETF

The BetaShares Australian Financials Sector ETF (QFN) is another option, although 30 per cent of its underlying index weighting is in insurance and diversified financial stocks.

 

Chart 2: BetaShares Australian Financials Sector ETF

 

About the Author
Tony Featherstone , Switzer Group

Tony is a former managing editor of BRW, Shares, Personal Investor, Asset and CFO magazines and currently an author at Switzer Report. He specialises in small listed companies, IPOs, entrepreneurship and innovation and writes a weekly blog for The Sydney Morning Herald/The Age on small companies and entrepreneurs.