The banking sector was historically the darling of investors, with stocks offering steady income and high secured yields universally. However, the 2008 Global Financial Crisis laid bare the risky dealings by individual banks and the lack of regulatory oversight made leeway for such practices. Or, as Warren Buffett put it, "You only find out who is swimming naked when the tide goes out."
In the melee that ensued, Australian Banks, with their stringent regulations and traditionalist lending ways, turned from being the narrow-minded cousins (for opposing risky businesses) to the poster boys of fiscal dependability. Since Dec 2012 -- 4 years since the crisis set in -- 4 of Australia’s biggest banks, Australia & New Zealand Banking Group Limited (ANZBY - Snapshot Report), Commonwealth Bank of Australia (CBA.AX), National Australia Bank Limited (NABZY - Snapshot Report) and Westpac Banking Corporation (WBK - Snapshot Report) still carry a Standard & Poor rating of “AA-“ and are among the top 50 dividend payers listed around the globe.
The AU banks likely learned lessons from the top U.S. banks – JPMorgan Chase & Co. (JPM - Analyst Report), Bank of America Corporation (BAC - Analyst Report) and Citigroup Inc. (C - Analyst Report) – and European counterparts – Deutsche Bank AG (DB - Analyst Report) and UBS AG (UBS - Analyst Report). The Aussies managed to bring radical changes in funding sources, reinforce balance sheets, lower risky assets and post healthy earnings. The reinforcement of investor confidence was a natural outcome.
Down Under is the Stop
Investors hunting the globe for yield would be prudent to stop in Australia, which has a dividend yield just more than 5%, the highest in major global equity markets. Further, apart from reporting rising earnings over the last decade, the Aussie banks also boast the best risk-adjusted returns and highest dividend yields.
The Big Four down-under – Australia & New Zealand Banking Group, Commonwealth Bank of Australia, National Australia Bank Limited and Westpac – currently disburse dividends between $4.0 billion and $5.4 billion annually, earning their place among the top 10 international banks. The average yield for these banks is roughly 6.4%.
Notably, in a booming economy with more than 2 decades of almost no domestic recession, Commonwealth Bank’s market value has exceeded that of the U.S. biggies like The Goldman Sachs Group, Inc. (GS - Analyst Report) and Japan’s largest bank Mitsubishi UFJ Financial Group, Inc. (MTU - Analyst Report).
Australia’s fairytale returns are mainly attributable to domestic economic stability. Not only does the Aussie government have little debt, the country enjoys healthy macroeconomic growth and a bright earnings outlook. The Telecom, Utilities and REIT industries have consistently been the key growth drivers in the past few years.
Recession? What Recession?
Since 1991, the Australian economy has functioned without any major economic downturn, an achievement unrivalled by any other highly developed nation. Further, the AU regulatory authority – The Reserve Bank of Australia – maintained the highest inflation rates among the developed countries to keep away inflation.
However, the global financial crisis did have it impact on the Aussie banking sector. After climbing to a record high in Nov 2007, Commonwealth Bank’s shares plunged almost 61% within 14 months as asset values deteriorated. Moreover, a decline in asset quality through 2008 resulted in the slowed earnings growth at Commonwealth in 4 years.
However, most of these banks have bounced back. Australia & New Zealand Banking Group, Westpac and Commonwealth clocked record profits in the first five months of 2013. Further, higher dividend payout ratios and low bad debts stimulated a 10% gain in Australian bank shares through the end of May. This lured many overseas investors after bond yields sank in a gloomy macro economy.
Yields Look Attractive: Is There a Hidden Downside?
Westpac, Australia’s second-largest bank in terms of market value pays almost 85% of its earnings to shareholders through dividends. Commonwealth Bank has a dividend payout ratio of roughly 75%. However, any sort of elevation in bad debts would weigh heavily on profits.
Even without an economic crisis or drop in the housing market boom, earnings growth is under pressure. The biggest challenge for the Aussie lenders is growing revenues in a still muted global economy.
Australia’s recession-free status prompted consumers and businesses to borrow greatly. Household debt is around 150% of disposable income, at almost similar levels to Canada but much higher than the U.S. Additionally, home prices in the island country are overvalued by almost 70%.
However, the tale of long-term growth for the banking sector is presently on edge. Banks look overpriced, but that’s sustainable by low interest rates and extraordinary quantitative moderation in various parts of the world. As long as these continue, Aussie banks will prevail with healthy dividend yields. But the economy always in a state of flux, nobody can predict for how long.