In a difficult economic environment, the banks have held up well.
After Westpac announced its full-year profit last week, the reporting season for the big four banks was complete and the consensus among analysts is that the results are solid in challenging conditions.
The black spot was National Australia Bank (NAB), which reported a fall in profit because of the poor performance of its British banks, while the other three reported relatively modest profit growth. The annual underlying profit of the big four has passed $25 billion. But with the combined profit of the big four up less than 4 per cent in the past year, it is the smallest increase for many years.
There was a rise, overall, in provisions for bad debts, but most of that was due to the provisions NAB made for its loss-making British banks. Some banks warned of signs of increasing bad debts, particularly from businesses in sectors exposed to the high Australian dollar, such as manufacturing and tourism.
Despite weaker profit growth, the share prices of the big banks have risen strongly this year as investors seek businesses with sustainable profits. Even at today's prices, bank shares offer attractive cash yields of between 6 per cent and 7 per cent.
"Banks have been a dividend play for some time and, as a result, have performed very well," the chief executive of Lincoln Indicators, Elio D'Amato, says. With their predictable earnings, there is a strong argument that investors are better off buying bank shares than depositing their money with the banks, D'Amato says.
However, for investors wanting shares in companies that will increase profits strongly, D'Amato says there are better opportunities elsewhere. The banks face challenges to improve earnings, as consumers have become more cautious about taking on debt since the global financial crisis, he says. "However, we rate all the big banks among our preferred income stocks."
Most big bank shares are trading at prices that are higher than the valuations that Lincoln Indicators has for the shares. "But the market is comfortable paying up for the certainty of dividends and there is a case to suggest that the premiums [paid for the shares] are justified," D'Amato says.
D'Amato's preferred big bank is ANZ. He likes the "head start" ANZ has in Asia with its banking interests there, which provides the bank with better growth prospects than the other three banks. The Commonwealth Bank is his second preference. It is Australia's biggest and most profitable bank and has the largest mortgage book, D'Amato says.
The head of Australian equities at fund manager Aberdeen Asset Management, Rob Penaloza, favours the Commonwealth. "It is well diversified across Australia," he says. While its shares have never been the cheapest of the big banks, investors are prepared to pay extra for quality. ANZ is his next preference, because of its better growth prospects. ANZ's shares are also cheaper compared to the valuation Penaloza has on the shares relative to the other banks.
For income investors, the head of banking research at Morningstar, David Ellis, likes Westpac because it offers the best yield for the lowest risk. For those investing more for capital gains, Ellis says the ANZ is his preferred pick.
Ellis says the big banks are generating surplus capital. With modest credit growth, they are unlikely to be splashing out on acquisitions. He says dividends could even be higher in the 2012-13 financial year, and particularly in 2014, as the banks seek to return capital to shareholders through share buybacks, special dividends and raising their dividend payout ratios.