Don’t bank on the Big Four

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Following the strong results of Australian banks, they are now trading on hard-to-justify valuations when compared to their international peers.

That’s according to Sydney-based specialist equity fund manager, PM Capital, which said that while Australian banks are sound businesses, they are currently fully valued and do not offer the same growth opportunities as offshore financial stocks. 

Paul Moore, CIO of PM Capital says, “There is no doubt that Australian banks are great businesses; they are a guaranteed oligopoly, they all produce the same product at the same price and if they were to ever get into trouble, the government is guaranteed to bail them out. That being said, they are well priced for that now and we don’t believe this is the place for new investment.”

Moore says current valuations were not factoring in the significant risk of the Australian mortgage market. He says that in terms of gross loans to equity, the banks are sitting at up to 8.4 times on the balance sheet. “The perception of home loans is that they are not problematic, but the reality is if we ever had an environment where home prices were to decline 20-30% on a permanent basis, there would be a significant issue.”

“Further to this point, there is an anomaly in Australia; the bank with the highest leverage has the highest P/E ratio. This highlights that people are forgetting how balance sheets work and assuming home loans will be fine forever, which is exactly what happened in 2008 in the US, and look how that turned out.”

AMP Capital chief economist Shane Oliver agreed that bank valuations were at the expensive end of their range, but said this should come as no surprise given the environment of record low interest rates.

“If you’ve now got short term interest rates and bond yields at or around record lows it’s not surprising that the earnings yield on shares is pushing in the same direction, and of course the inverse of that is that PE is pushed up to around record highs – so it’s all a reflection of the low interest rate environment that we’re in. That’s why it’s way too early to say this has run its course.”