Australian Banks: Are the Big Yields Worth It?

Australia is exposed in several ways, but its banks are sturdy

By Will Ashworth, InvestorPlace Contributor

Pragmatic Capitalism’s Cullen Roche recently pointed out an amazing statistic: Australia’s banks are now bigger than the all of the eurozone banks combined. Of course, we’re talking market capitalization — not assets or revenues — but it’s still quite staggering to see how the mighty have fallen.

Intrepid investors will look at this stat and contemplate adding a European bank or two, while conservative investors will take the other side of the coin and explore the juicy dividend yields provided by the stable Australian banks.

Aussie Investments That Offer Top Dividends
Aussie Investments That Offer Top Dividends

Considering yield-chasing is a big deal these days, let’s explore the ins and outs of investing Down Under.

InvestorPlace editor Jeff Reeves thinks Australia is a good place to invest right now, as the country is delivering strong economic growth (GDP grew 4% in Q1) while consumers continue to spend. Unfortunately, storm clouds are on the horizon.

The Reserve Bank of Australia moved its benchmark interest rate to 3.5% in June — the lowest rate in three years — because of international economic uncertainty including China’s slowdown, which would have serious consequences in Australia, its largest trading partner. How this affects the banks remains to be seen, but it likely won’t be good.

According to PricewaterhouseCoopers’ 2012 first-half analysis of Australian banks, the big challenge is going to be growing revenues in an increasingly stagnant global economy. Australia hasn’t had a recession since 1991, prompting consumers and businesses to borrow excessively. Any “hard landing” in China will seriously damage the resource sector, which has borrowed heavily since 2008 in the expectation of commodity prices continuing to rise. As for consumers, household debt is around 150% of disposable income, similar to the level in Canada and much higher than in the U.S. Furthermore, some experts suggest home prices in Australia are overvalued by as much as 70%.

If both of these situations came to a head in the next 12 to 24 months, you can be certain Australian bank stocks would take a beating. Whether that will come to pass isn’t as certain.

At the end of 2011, only 11 banks worldwide had an S&P rating of AA- or higher. All four major Australian banks were on the list, along with three Canadian banks and four others. Australian banking regulations are very similar to those in Canada, where the “Big Six” are touted as some of the world’s best. However, Australian banks might actually be better run if you believe in financial metrics like return on equity and others.

In the first half of 2012, the four major Australian banks averaged a return on equity of 15.9%, 120 basis points higher than the big Canadian banks. Furthermore, the four largest Australian banks averaged an expense-to-income ratio over the past five years of 46.9%, 1,240 basis points lower than the Canadian banks.

So, what you have in Australia are banks that are well run and relatively undervalued. The only question is which stock(s) to own.

If yield is your primary concern, your best bets are either Westpac Banking Corp. (NYSE:WBK) at 6.6% or National Australia Bank (PINK:NABZY) at 6.8%.

If return on investment is also important, the Commonwealth Bank of Australia (PINK:CMWAY) has the highest return on average equity at 19.2%, while providing a still-shining yield of 5.4%.

Others like to see a high net interest margin. Of the four, the Australia & New Zealand Banking Group (PINK:ANZBY) is highest at 2.38% for the first six months of fiscal 2012, and its current yield is 5.7%.

As far as I can tell, there’s not much difference between the four companies, making the choice a tough one.

For this reason, I’m right behind Jeff in suggesting the iShares MSCI Australia Index Fund ETF (NYSE:EWA), which holds all four aforementioned banks in its top 10 holdings. Although it’s a much broader take on Australia, financials represent 48% of the overall holdings.

If you believe Australia will keep chugging along and you like its banks, the fund’s 30-day SEC yield of 4.43% should be more than adequate. Furthermore, the fund has $2.4 billion in net assets, making it very liquid should you want to sell in the future. Sure, you can squeeze out a couple of extra points by investing directly, but you also expose yourself to significant company risk.

Having said that, they’re all good businesses with great yields — and that’s a big deal in this low-rate environment.

As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.

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