Learning to love Aussie banks
08 April, 2015
We added ANZ and Westpac to our Australian portfolios in March. The first "S" in our stock-ranking STEEPP process stands for "Strengths", or characteristics that allow a company to earn superior profits over time. Typically bank profits follow general economic conditions, and are vulnerable to cycles in interest rates, income and inflation. So typically, banks would not meet our investment criteria.
How come we've added them then?
The four major Australian banks are far from typical. As a group they are super-dominant in areas critical to banking success. They represent 80% of banking sector assets, 80% of total deposits and 86% of sector profits. The four majors hold this share against 17 other Australian banks and 47 foreign banks!
The major Australian banks enjoy significant strengths. Their key advantage is their scale. They have large stable bases of deposit accounts, giving them a cheap and ready source of funds. This in turn supports their ability to offer borrowers loans at attractive interest rates, while still lending profitably and winning market share. Besides great lending businesses, they have diversified earnings by developing considerable wealth management, advisory and insurance enterprises. The big banks can also spread costs over larger operations, resulting in superior cost efficiency.
Recognising the quality of their risk management systems, regulators allow the large banks to lend more per dollar of invested capital, boosting profits and growth potential. As a result the major banks have earned significantly higher returns than competitors over time.
The major banks' strengths are in some ways also their risks. To some extent they have become victims of their own success as their dominant position and relevance to the economy has made them subject to significant regulatory oversight, and made their high profile brands vulnerable to reputational risk.
Nevertheless, we conclude that their key strengths explain the superior performance of this exclusive club. To enable our investors to participate in this success, we've selected those banks with the best earnings prospects and most attractive long-term returns for our Australian portfolios.