This has resulted in Australian major banks trading at what appears to be much less than their intrinsic valuation, with current prices not reflecting their true long-term value. Recent market volatility has presented excellent buying opportunities for investors that are prepared to look past the short term doom and gloom.

The Australian banks operate in an economy that is actually growing, providing solid earnings growth potential, low fundamental risk and high fully franked dividends. No Australian banks have gone into default and they have very low exposure to the sovereign debt of the troubled European PIGS (Portugal, Ireland, Italy, Greece and Spain). However the Australian bank’s share prices have been dragged down by the weak sentiment of global banks. 

Australian bank balance sheets are strong and exceed minimal capital requirements. The banks are highly profitable, with solid earnings per share growth, despite the current economic climate. 

The banks have also seen an increase in customer deposit growth as many Australians seek to increase their level of savings. This strong customer deposit growth reduces the need for wholesale funding, in particular offshore funding which reduces the banks risk.

The banks home loan quality is good, with average Loan to Value (LVR) ratios of major banks mortgage portfolios at 45-55%. Often a big headline grabber in the media is that default rates are on the rise, however much of that default accounts for lenders outside the top four major banks.  

Another indication of the strength of the Australian banks is the fact that our top four have an AA-credit rating, pacing them in the top 10 globally. 

We all know that the banks offer investors a fantastic dividend yield. Based on current prices, the top four Australian banks are yielding around 7% per annum.  Including the benefit of franking credits, this figure is up around 10%. Over the past two decades, the average dividend yield of the top four banks has been 5.8%. This data poses two questions – either the bank’s earnings are too high and are likely to fall, or the share price is too low and a rise in price is required to see the dividend levels return to more normal levels. We think the latter.

When comparing the banks’ dividend yield with the interest received from bank accounts or term deposits, dividend yield looks compelling. A high interest bank account would give you an income return of around 5-6% per annum. For investors that can handle the short term volatility of the share market, they can pick up a fully franked dividend yield of around 10% on a bank share.

Investing in shares carries greater risk, however has potential for higher returns. Investing in Australian banks at current prices provides  investors with a superior income return when compared to a yielding bank account or term deposit, as well as the potential for capital growth.