Original article written by John Abernethy, Chief Investment Officer, Clime. The following article was published by The Australian, December 1, 2015. 
The four major banks are oversold and a significant rally is likely. While all our leading banks are now discounted by the market, for my money, the choice among the big four is ­National Australia Bank.
Though there has been much negative coverage of bank stocks in recent months, there are two reasons why these leading financial stocks are in a better position than most investors realise.

  • Improving growth in the non-mining economy;
  • A general undervaluation of the major bank shares — ANZ Bank, Commonwealth Bank, NAB and Westpac.

Against a background of stable rates and in the absence of a negative offshore shock, a recession is not on the horizon. The Australian economy is growing and does not need further monetary support at present, ­indeed this is why I have no problem with the stance of the RBA just now.
Separately, the non-mining ­recovery is slowly becoming ­entrenched. We see a gradual ­acceleration as the economy navigates the challenges of lower commodity prices and falling mining investment, while benefiting from the double stimulus of extended low interest rates and currency ­depreciation.
Australian cash rates remain at 2 per cent, while the Australian dollar has fallen from $US1.10 in July 2011 to levels of about US71c.
The economy is not about to enter another boom, but the ­balance of risks to GDP forecasts is shifting moderately to the ­upside and this will soon start to appear in bank economic commentary and guidance.
The large banking stocks that now represent a significant portion of the total market valuation on the ASX were never big lenders to the resources sector during the mining boom, but they do lend widely across the non-mining economy and will benefit from the economy’s transition to non-­mining growth. Employment has surprised on the upside all year. In the last reading (ABS October jobs data) unemployment slipped back below 6 per cent, which suggests bank loan impairment expense will remain low.
Putting these factors together, I suggest Australian banks are oversold and represent good value on a two-year view.
The recapitalisation of bank balance sheets is 80 per cent complete. Compared with international peers they are strong banks, and well-managed and regulated.
At the time of these calculations (November 20) our top four ASX banks were undervalued on a two-year view, indicated in the table by the positive value-to-price ratios. As you can also see from the table, ANZ would appear to be the bank most heavily ­discounted from its intrinsic valuation, while CBA is trading most strongly of the major banks.

Bank Share Price (20/11/15) 2017 Valuation Value to Price Ratio
ANZ Banking Group $27.74 $33.60 +21%
Commonwealth Bank of Australia $80.07 $86.00 +7%
National Australia Bank $29.93 $33.75 +13%
Westpac Banking Corporation $31.89 $35.89 +13%

In my view, portfolio weightings to NAB, under new chief executive Andrew Thorburn, and CBA, led by Ian Narev, should be greater than for ANZ and Westpac. I prefer NAB for its exposure to the acceleration in business lending and boost in normalised return on equity from asset divestment, and CBA for its diversified loan book, which is less risky than those of ANZ and Westpac.
During the tenure of chief executive Mike Smith (soon to be replaced by Shayne Elliott) ANZ’s Asian strategy has diluted return on equity and will be partly unwound as the bank seeks to take market share in Australian mortgage lending after the top of the cycle — not a good move.
Separately, Westpac’s $3.5 billion equity raising was too small and preceded a dividend payout of most of the equity just raised.
Westpac will be under the most pressure to keep raising equity, especially after its aggressive growth in Sydney and Melbourne residential lending towards the peak of the recent house price cycle.
Clime Asset Management (Clime) owns ANZ.AX, CBA.AX, NAB.AX & WBC.AX on behalf of various mandates where it acts as an investment manager.