The major banks boast some of the best financial histories in Australia. They have been profitable and paying dividends for more than 20 years. However, there have been no recessions for more than 20 years either. In my opinion, such impressive track records are due to both favourable economic conditions and their internal strengths.
Growth in non-core income streams
The banks have become more than just domestic retail banks over the past twenty years and all four have businesses in New Zealand. All of them are investing heavily in their online and digital banking capabilities, including mobile banking. Collectively, around 30% of their total income is generated from non-core businesses.
Australia and New Zealand Banking Group (ASX: ANZ) has a presence in more than 30 countries with a focus on growing into Asia. It also has a funds management business with more than $60 billion under administration.
Not only is Commonwealth Bank of Australia (ASX: CBA) Australia's largest bank, it is also its largest retail fund manager. In addition, it owns Colonial First State, a life insurer and Commonwealth Securities (Commsec) an online stockbroker. Like ANZ, it is also growing its Asian business.
National Australia Bank Ltd (ASX: NAB) owns Clydesdale Bank and Yorkshire Bank in the UK and Great Western Bank in the US. It operates a purely online bank called Ubank, and has a major funds management business.
Westpac Banking Corp (ASX: WBC) owns St George Bank and has a large wealth management division called BT Financial Group.
Efficiency
I compared the ratio of operating costs to operating income for the last set of financial results for each of the big four Austalian banks, two American banks (Wells Fargo and Citigroup), and one from Europe (HSBC). All four Australian banks had a lower ratio than the three foreign banks. CBA, Westpac and ANZ had ratios of less than 45%, whilst Wells Fargo had the best of the foreigners at 58%. Rather than indicating greater efficiency, the result may suggest that the Australian banks enjoy a more powerful market position than their overseas counterparts.
Return on Assets
Return on assets is an important measure for banks because it indicates how much profit is made on each dollar it lends to customers. It should be noted that the connection is somewhat distorted by the additional businesses operated by a modern bank. Again, the Australian banks perform strongly on this score, with CBA, Westpac and ANZ recording around 1% return on assets last year with NAB lower at 0.6%. Of the three foreign banks only Wells Fargo outperformed them with an impressive 1.5%.
Valuation
CBA scored the best of the Australian banks in terms of both efficiency and Return on Assets and therefore justifies a higher price than the others. NAB fared the worst, with Westpac and ANZ somewhere in the middle. Looking at current price-to-earnings ratios (PERs) it seems that ANZ is one of the better value options on a relative basis at 14.3, compared to 17.5 for CBA, 16.7 for Westpac and 18.1 for NAB.
Further Considerations
Other important considerations for determining the quality of any bank are the liquidity and risk of its assets. This is because these factors determine how well it will cope in a recessionary environment. For example, a shortage of liquid assets can cause bankruptcy when alternative capital sources such as money markets dry up, as happened in 2008 in Europe and America. Similarly, risky loans may be serviceable in a low interest rate environment but things can quickly change when rates rise and people and businesses start defaulting.
It is also important to understand the banks' liabilities. For example, are its deposits (a key source of funding) short or long term? Does it pay high interest rates and is therefore more likely to retain its deposits? None of these questions regarding a bank's assets and liabilities is easy to answer, which is why I would not buy shares in any of the major Australian banks at current prices.
