CRITERION: How investors can get better banking bang for their buck

The Big Four banks are trading on multiples 28 per cent higher than their five-year average
The smaller regional banks arguably present better value despite their funding disadvantages
Some analysts recommend looking beyond the entire bank sector for yield

While the supermarkets are maligned as inflation public enemy number one, the banks’ problem is not so much with Canberra (for the time being at least) but the growing rumbles that they are heavily overvalued.

It’s a paradox: they are becoming unloved because they are over loved.

Defying talk of recession and ratcheting loan delinquencies, Commonwealth Bank (ASX:CBA) shares have climbed 33 per cent over the last year to record levels.

While the nation’s leading bank is deemed as having the most extravagant valuation, shares in the hitherto plodding Westpac (ASX:WBC) have gained almost 50 per cent.

National Australia Bank (ASX:NAB) shares are 28 per cent higher, while Australia and New Zealand Banking Group (ASX:ANZ) shares have gained 18 per cent.

Wilsons Advisory describes the rally as “perplexing” and “difficult to reconcile with the fundamentals”.

The firm says in an absolute sense, the big banks are trading at an unprecedented earnings multiple of 19.9 times, around 28 per cent higher than the five-year average.

The CBA trades on a multiple of 24 times that of JP Morgan, which is “arguably the highest quality bank in the world.”

Given the pessimists have an annoying habit of being right, maybe investors should consider the smaller banks that trade on much lower multiples with similar yields?

They’re cheaper because they have lower credit ratings, which makes their cost of funding more expensive.

They also have higher costs, but on the flip side they are more customer friendly and nimbler in embracing tech.

The biggest of the regionals, Bendigo and Adelaide Bank (ASX:BEN) trades on a multiple of 14 times – in line with the historical sector average – and yields 5-6 per cent.

Self dubbed as “the only credible challenger to the major banks”, Bendigo is performing in a workmanlike way as it balances its quasi big bank credentials with being nice to customers.

The ranks of the second-tier banks are thinning, with bancassurer Suncorp Group (ASX:SUN) selling its bank division to the ANZ.

The Hobart-based MyState (ASX:MYS) plans to acquire the puny Auswide Bank (ASX:ABA) in a scrip merger.

MyState should benefiting from Tassie’s transition from lumberjacks to boutique whisky-sipping gourmands and art afficionados.

But its full-year results were a tad off the pace in terms of earnings and home loan growth. Auswide’s earnings plunged 55 per cent to $11 million because of “margin pressures in loan and funding markets”.

Given that, the merger looks like the right gambit for both banks, with expected cost savings of $20-25 million and “greater than” 25 per cent earnings per share accretion in the current year.

The underperforming Bank of Queensland (ASX:BOQ) reports its full-year results on October 16.

That could be interesting, considering the bank is undertaking a digital transformation and is reverting its franchised branches – once the fulcrum of its business strategy – to bank-owned outlets.

For those who think the banks have reverted to glorified building societies, Judo Capital Holdings (ASX:JDO) is making deft moves on the mat with its business banking focus.

Judo targets loans of $2.5-10 million, thus picking up clients the big banks and private creditors don’t bother with.

But with business lending everything is OK until it’s not, in which case the glorified building societies don’t seem so expensive after all.

Or perhaps investors should look further afield.

“We are not particularly positive on the smaller banks given revenue pressure from constrained lending volumes and margin pressures,” says Wilsons Advisory head of investment strategy David Cassidy.

“We generally focus more on growth that pure yield but yield plays we think have solid prospects are Telstra (ASX:TLS), both IAG Insurance Australia (ASX:IAG) and Suncorp in insurance and Aurizon Holdings (ASX:AZJ).”

This column does not constitute financial product advice. You should consider obtaining independent advice before making any financial decision.