Bank profits boom after being pumped full of free cash

It is a wonderful time to be a banker – which is almost always the case anyway, but the banks are enjoying the pandemic.

The old joke in broking used to be that you can chop and change stocks all year long or instead, just buy the banks and play golf to achieve the same result.

Well, the past year has been a wonderful one to take that advice, which could be why golf is also enjoying a popularity rebound.

While we haven’t seen all of the bank results yet given their different balance dates, it isn’t too hard to take the Commonwealth Bank (ASX: CBA) profit, and National Australia Bank’s (ASX: NAB) quarterly guidance, as a guide and extrapolate against the rest of the sector.

What a wonderfully profitable picture that reveals, with the banks overstuffed with capital, brimming with profits and happily taking virtually free money from the Reserve Bank and lending it back out at a healthy margin.

Dividends and buybacks galore

For Commonwealth that produced a profit close to $9 billion, a $2 dividend for the half year that takes shareholders right back to the pre-pandemic era and a $6 billion share buyback which virtually guarantees rising earnings per share in the future.

Arguably, the Commonwealth will still be overstuffed with capital, but it never pays to be too careful, particularly with the pandemic still raging around the world with only the opaquest of end games within sight.

It is enough to make you go out and buy some new golf clubs and double up and buy some more banks shares, even as the Commonwealth share price moderates as brokers warn that surely this is as good as it gets.

Conditions are tailor made for bank profits

They may well be right – it is hard to imagine the Reserve Bank of Australia repeating such a massive pump priming exercise in the near future – although the remnants of this free money era will be ploughing through the banks profit and loss accounts for many years to come.

By forcing interest rates down towards its official rate of 0.1%, the RBA has now locked in a long period in which bank deposits will also earn minuscule returns, helping to maintain bank profitability well into the future.

The really good news for everyone with these bank results is that the billions of dollars that were put aside to cope with an anticipated pandemic rush of bad loans were hardly touched – indeed, with the property market rising strongly and the banks enjoying a profitable boom in loan refinancing, the prospect of bad loans seems more remote than before.

Bad loan provisions barely touched

Obviously, there are plenty of pain points amid the wreckage of the hospitality, arts and film theatre industries but overall, the bulk of the bank’s loans remain healthy and intact.

For Commonwealth, the $2.5 billion that was put aside for loan losses has been replaced with a bad loan provision of just $554 million – singlehandedly puffing up its profit result substantially.

It is never good to waste a crisis and the Commonwealth did better than most, growing its home loan portfolio at 1.2 times the overall bank rate of growth – again, helping profitability well into the future.

Business lending was triple the rate of system growth, locking in more gains for the future given the higher margins on business lending.

Brokers downgrade but great conditions continue

It is true that the banks may have to use some of their loan provisions in the future as the pandemic continues to turn state borders into genuine free trade impediments and lengthy lockdowns continue to spring up unexpectedly.

That is the reason why the Commonwealth share price took a breather last week as some bearish broker reports caused some of the wind to spill out of the very full bank sails.

Citi and Credit Suisse both downgraded Commonwealth’s shares to the polite equivalent of a sell rating, cutting the price target to $94.50 (Citi) and $95.00 (Credit Suisse).

Costs on the rise but so are fees

Bell Potter remained bullish with a buy rating and a price target of $118, which is a healthy premium to Friday’s $104.03.

The bearish argument is that near term earnings will be lower due to higher costs, although Bell Potter argues that higher non-interest income and continuing strong lending growth will keep the profits rolling in.

It will take some time until we see if banks are really basking in a particularly pleasant moment in the sun for themselves and their investors or if things continue to improve.

One thing is for sure though, there are still times when the buy banks and play golf rule pays off and the past year has certainly been one of them.