What is the best bank share to buy?

We give you the best of the big four banks in Australia to buy with our favourite stock.


The high-profile failure of Silicon Valley Bank and the forced takeover of Credit Suisse by UBS has lowered the confidence in the banking industry as a whole throughout the world, increasing costs for the sector and introducing the likelihood of tighter regulations due to concerns around contagion, reducing returns.

Australian banks do share these concerns, but in the case of our bigger banks, it is materially lower, which means that the sell down provides opportunities to buy the bank stocks of Commonwealth Bank (CBA), Aust and New Zealand Bank (ANZ), Westpac Banking Corp (WBC), National Australia Bank (NAB) and Macquarie Group (MQG) for investors.

The question is, which are the best bank stocks?

AUSTRALIAN BANKS operate under arguably the strongest regulatory framework in the world.

Whereas pre-GFC the majority of bank funding was wholesale, now it is from much stickier retail deposits. Plus, there has been a mandated increase in the amount of capital a bank needs to hold relative to its asset base.

Australian banks have de-levered their books by reducing their borrowings and importantly, reducing wholesale borrowings.  This does not provide as much comfort as in the past, however.

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Digital banking

Unlike previously, where a run on a bank would be associated with people queuing to take out their money, a bank run will happen digitally, where funds are electronically taken out and deposited somewhere else. It would take 10 minutes at most. But think about this hypothetical example.  If everyone took their deposit out of the Commonwealth Bank, they’re not going to put it under a mattress; they will transfer it to another domestic bank. This enormous amount of liquidity or funds would be deposited by those banks into the RBA, which in turn would lend it to the Commonwealth Bank to prevent a liquidity problem becoming an existential threat. In Australia we are protected by having a relatively enclosed financial system when it comes to customer deposits.

Which Bank?

The big Australian banks are essentially giant building societies. Most of the assets are home mortgages because that’s where they get the best return on capital, but there are important variations.

Have a look at the valuations in the table above, which highlights where the value is.

The four banks that I quickly want to focus on are:

  • Macquarie Group (MQG),

  • ANZ Bank (ANZ),

  • Westpac (WBC) and

  • Bendigo & Adelaide (BEN).

MQG is much smaller in terms of its mortgage asset base, but has been growing very aggressively. We cover this stock in the previous issue in late March 2023 and pointed out that with $12bn of excess capital, it can afford to.

ANZ was also mentioned last week and has the best momentum on lending and cost reduction. This remains our favoured exposure to the sector.

Read our latest stock research and find which ASX banks we trade in our portfolio.

Westpac Banking Corp is interesting because it has been most aggressive in lending to investment properties; plus its management has arguably been the biggest underperformers. We argue that this bank has potential because its return on equity is lowest and improvement is therefore easiest. BEN is the highest risk, which applies to all regional banks where there are perennially funding problems, but never more so than when there is increasing economic uncertainty.

The four majors and MQG raise funds at AA rating, while the regionals are lucky to raise funds at single A rating.

The regionals are much more at uncertain if employment deteriorates. The depositors will get their money, but the shareholders might not. All banks do not have the likelihood of huge write-offs while employment stays robust. Yes, unemployment is the key indicator for investors to watch, when it comes to all the banks.

Interest rate: RBA bucking international trend

The Reserve Bank of Australia is once again bucking the international trend and pausing rate hikes, this month taking time to assess the impact of 10 consecutive rate rises and giving people a respite. But it is noteworthy that there is no clear communication whether they will resume going up and it doesn’t sound like they are coming down from the current overnight rate of 3.6%, which is lower than that of comparable central banks such as the US (4.75-5%), Canada (4.25%), the UK (4.25%) and New Zealand, which last week lifted its cash rate a further 0.5 percentage point to 5.25%.

We continue to think that our overnight rate is headed above 4%, but the bigger point is how long interest rates stay elevated, rather than how high they actually go. The big factors Australia has in its favour is a low unemployment rate (3.5%) and a high level of savings.

Offset against this, of course, is the second highest consumer debt in the world, driven by the rise and rise of house prices.

The big banks are where the rubber hits the road in the economic sense, being the boiler room of any economy because it’s where credit is provided, or not. Before I get into detail on where the banks stand, it’s important to point out that the Australian housing market has stabilised, which makes sense with our high savings and employment rates. Certainly, the impact of interest rate rises is flowing through to consumers’ spending patterns, but the big transition from fixed rate to variable mortgage rates has not yet fully occurred. A good percentage is about to take place. Maybe a quarter of people won’t be able to refinance and will be stuck with higher rates. There is little sign of distressed selling right now, but that can change. Certainly, we were encouraged when Westpac Bank CEO Phil King’s commented earlier this year that his bank “understood the cash flow issues” and would assist household mortgage holders as much as possible. The point is that the deterioration in the banks’ giant book of mortgages is highly unlikely.

What does all this mean?

We advise being stock specific and ensuring that your portfolio is weighted to the quality end of the spectrum, which means owning companies that have strong balance sheets and sticking to themes that work. Invest in what makes sense now, rather than trying to imagine a better future.

The Seeds of Uncertainty: Silicion Valley Bank & Credit Suisse

In order to look at where each bank stands now, it’s important to look at the causes of current business uncertainty, which has shaken markets. Although it happened after Silicon Valley Bank, Credit Suisse has been a bank under pressure since the early 2000s when it went up the risk curve and got burned on high profile lending initiatives such as the failed factoring group and scandal plagued Greensill Group.

SVB is definitely more important, but can still be regarded as special case due to its extreme concentration towards servicing the venture capital and technology space. When the tech sector raised money, they placed their money on call deposit, which was invested by SVB in US 30 year bonds using a simple, low cost (at the time) barbell strategy.

When the Federal Reserve raised the overnight rate at the fastest pace in living memory, from 1.5% to 3.5%, those bonds fell heavily in value, albeit only nominal. The VC depositor base got wind of this and started a run on the bank. In the end the US$16bn loss realised by its bond sell down was the same level as the capital base, causing a default. The main worry has been that this would be spread. How many other banks have large capital losses that have not been revealed? Systematically important banks are required to reveal their capital position, but under the Trump administration, SVB was able to hide its position, which interestingly it did not initially do.

The threat of contagion is exaggerated for the overall sector. More than 80% of the US banking sector is well capitalised. The US Federal Reserve also provides important backing. Even if securities are under water, such as was the case with SVB, the Fed will take the securities on its own balance sheet and lend them back to the banks at par, which means losses are not crystalised. The big issue in the financial sector is with non-bank lenders, which raised cheap funds and lent that money out. The possibility is of loan default, but the big point is that this is not regarded as systemic, rather it’s at the margin.

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Richard Hemming

Richard Hemming

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Richard is a leading market commentator and expert on ASX Small Caps

www.undertheradarreport.com.au provides investment opportunities in Small Caps that you won’t get anywhere else.

Under the Radar Report is licensed to give general financial advice only (ASFL: 409518). The author does not own shares in any of the stocks mentioned.

Under the Radar Report is licensed to give general financial advice only (ASFL: 409518). The author does not own shares in any of the stocks mentioned.

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