AN INVESTMENT SUMMARY YOU CAN BANK ON

The key point is that right now a transformational shift in banks is underway due to the rapid tightening of monetary policy.

The banks’ return on equity will be greatly boosted from overnight rates climbing from 0.1% this time last year to 2.35% and next month in all probability to 2.85%.

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WHICH BANKS TO BUY

The big banks are trading on a running dividend yield of 5.6% and three are very good value.

In Blue Chip Issue #113 we tell subscribers which of the big four banks is overvalued and the three that our analyst team offer value right now.

Our Blue Chip Value Portfolio continues to be overweight in the banks, but is not adding to our position of owning the three best valued.

Although our Portfolio Manager believes that banks are good value, he is wary of the RBA’s Lowe being forced to take a tougher position on interest rates and raise them faster than expected, which would send shock waves through the sector.

After all, although he has been talking tough on increasing taxes, Dr Lowe knows that the only near-term remedy for reducing inflation, is interest rate rises.

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THE BIG NEWS (AND THE OTHER NEWS)

The biggest news this week was the US Federal Reserve lifting the overnight official cash rate 75 basis points to 3-3.25%.

Although this was expected, the surprise was the central banks determination to keep lifting them.

The rate is now forecast to climb as high as 4.6% next year.

This is an enormous increase on where the rate was this time last year, which was close to zero.

Chair Jerome Powell is playing it tough, much tougher than our own Reserve Bank Governor Philip Lowe. Global markets wobbled a bit but because he has been jawboning for some time, there isn’t much surprise.

On the other and if our own RBA starts hiking rates as quickly, this would indeed be a negative surprise for the market, and a big shock for the banks.

AUSTRALIANS RATED THE RICHEST IN THE WORLD

The other, less publicised news, was that the RBA came out with its report on the financial strength of the banks, stress testing them by assuming basically another pandemic, but without government support.

Economic growth in free fall and unemployment at 15-20%. In short our banks got the big tick. Anything other than this scenario and they would weather the storm.

Right now, Australians are rated the richest in the world on the basis of population per capita, economic growth is running at 3.6% and employment is drum tight based on our unemployment rate of 3.5%.

Our official cash rate is 2.35% and is forecast to lift another 50 basis points to 2.85% next month.

UNIQUE FEATURES OF AUSTRALIAN BANKS

The Australian banks have a number of unique features that differentiate them from other financial services businesses around the world. These make them a much more secure vehicle to invest in.

1. Franking credits

This benefits ASX listed companies with domestic earnings.

2. Loan security

Australian banks lend on the basis of an LVR (loan to value ratio) of 80%. When Dr Lowe says that he is comfortable with a 15% decline in house prices, so are the banks!

If a property is worth $100, banks can afford for it to fall $20. They only care if it falls lower and they don’t have mortgage insurance on it.

Further, their lending to customers is based on higher interest rates. The regulator APRA requires them to compute affordability off a higher interest rate, say 4% when existing interest rates are 2%.

3. Rising rates boost their profit margins

The big domestic banking oligopoly is the key here. The interest on overnight loans represents valuable income for the banks. Sure, they give it to depositors to some degree, but they always make sure they take out a healthy margin before this, such is the power of their oligopoly.

Companies with pricing power such as banks do well in an inflationary environment. They have two big weapons, their deposit rates and their loan rates. They have the freedom to set both.

4. Australian banks have a much more secure asset base than their US counterparts

When the banks lend on a mortgage, the loan attaches to the mortgagor (the banks customer) who is obliged to pay back the loan, whether or not they own the house.

The US system could be called “jingle mail” because there the banks only have recourse to the asset and don’t have recourse to the borrower beyond this. When the borrower can’t afford to pay the loan, that person is incentivised to simply give back the keys, walk away and find a cheaper house.

The Australian finance sector remains a growing market with increasingly attractive dividends. Learn more on how to time the market using greater insights to making a return.