Banks have underperformed other high-yield sectors throughout the past year, said BetaShares chief economist David Bassanese, which has resulted in the S&P/ASX200 banking sector index price-to-book valuation trading below the 2.1 average seen since 2003.
“The S&P/ASX 200 banking sector index as at end-October was trading at a price-to-book valuation of 1.7, or 20 per cent below its average,” Mr Bassanese said.
Mr Bassanese noted that price-to-forward earnings ratios for the financial sector were trading “no higher than its long run average”, where resources and other sectors were.
Rising bond yields could also benefit banks, as higher long-term rates would give banks the opportunity to improve net-interest margins through increased loan interest rates, Mr Bassanese said.
“While helping support credit demand, RBA rate cuts over the past year have also placed downward pressure on local bank net-interest margins, due to the banks inability to push already low deposit rates closer to zero, or even negative territory,” he said.
“Provided it does not overly crimp credit demand, an eventual modest lift in local official interest rates may help banks restore some of the recent erosion in interest-margins.”
Additionally, Mr Bassanese said that while regulatory demand for banks to hold more capital could theoretically hurt returns on equity and dividends, this is not guaranteed.
“To the extent the downward pressure on bank returns on equity are reflected in a downward adjustment in price-to-book value – as has been evident in the past year – then it’s possible for banks to preserve still relatively attractive dividend yields going forward,” he said.
Given these factors, Mr Bassanese said the financial services sector was quite attractive comparatively with other sectors of the market.
“Banks on a price-to-book value basis might now be closer to ‘fair-value’ than cheap, even though valuations by this metric are now somewhat below their long-run average.
“Relative to other sectors of the market, however, banks are arguably better value, especially compared to ‘defensive yield’ sectors such as listed property, utilities and telecommunication in an environment of rising bond yields.”
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