Bank shares will prove to be a good investment over the next five years, say experts / Craig Greenhill

Their share prices plunged between 54 per cent and 65 per cent in just 15 months and a disturbing number of doomsayers predicted at least one of them would follow many of their overseas counterparts and collapse.

But today, the banks are back, with analysts, advisers and stockbrokers tipping a prosperous five years ahead for the companies everybody but their shareholders love to hate.

It will be a bumpy ride, they say, but the big four Commonwealth Bank, Westpac, NAB and ANZ are set to flex their financial muscle even more.

Strength in adversity

Strong financial sector regulation, good management and no reckless lending practices helped our big banks tough out the financial crisis.

Research last year found all of the big four were in the world's 30 largest banks ranked by share market capitalisation not bad for a country that represents less than 2 per cent of the global economy.

"Australia's banks have been very conservatively managed during the global financial crisis and have emerged in a stronger-than-ever position,'' says the state chairman of RBS Morgans, Legh Davis.

"The banks, particularly the Commonwealth Bank and Westpac, have made enormous gains in housing finance market share,'' he says.

Baker Young Stockbrokers managed portfolio analyst Toby Grimm says the big four banks now account for 87 per cent of the mortgage market.

"A lot of overseas players have left,'' he says.

"Their exit from the marketplace has seen our banks benefit. It's given them greater pricing power and is a very big positive for them over the next five years or so.''

The banks' share prices didn't escape the carnage. NAB dropped 65 per cent, ANZ fell 63 per cent, CBA sank 61 per cent and Westpac dropped 54 per cent.

"The global financial crisis was propagated by credit markets, which was very close to home for the banks,'' Mr Grimm says.

Australian Stock Report head of research Steven Dooley says investors need not worry it will be the same next time.

"What we saw over the last 24 months was quite unique it was a global financial crisis,'' he says.

"Ten years ago, it was a global technology crisis. In 1987, it was leveraged entrepreneurs. People shouldn't think it means the banks will be hardest hit in any other share market crash.''

Risky or not?

The crisis opened a debate about whether banks are a defensive stock such as healthcare and supermarket companies or a cyclical stock similar to mining and energy shares.

Bell Potter Securities state manager Ashley Kelly sees the banks as cyclical.

"They're not the defensive stocks that they were seen to be,'' he says.

"The sector is seen as more defensive than other banking sectors around the world because we are well-regulated.''

Mr Grimm still sees "an element of defensiveness'' in the big four.

"They are largely exposed to the domestic market in Australia, they're well-funded, and with the Commonwealth Bank's recent upgrade, we know we are not talking about peaking or stabilising bad debts, we are talking about declining bad debts.''

Last month, CBA forecast a 44 per cent rise in cash profit to $2.9 billion for the six months to December 31.

The bosses of the two biggest banks, CBA's Ralph Norris and Westpac's Gail Kelly, have both suggested that bad debts have peaked.

Bad debts improving

The winding back of bad debt provisions is expected to benefit all the big banks.

"CBA gave us a heads-up and it was good news. If your bad debts are coming down, it's going to be positive for profits,'' Mr Grimm says.

Mr Davis agrees: "All banks have benefited from conservative, prudent bad and doubtful debts provisions. Those provisions probably in most cases will see some profit being written back on to the bottom line.''

The future

Share prices have bounced back strongly in the past year, but Mr Davis is still bullish about the outlook.

"Margins are still improving, particularly for NAB and ANZ because of their greater exposure to the business sector, which has been on the soft side. We expect business lending to pick up,'' he says.

"We expect a strong rebound in earnings and dividends over the next two years.

"For example, ANZ paid $1.02 in dividends in the year to September 30, 2009. We see it lifting the dividend to $1.26 in 2009-10 and $1.46 in 2010-11.

"We see NAB lifting its dividend from $1.46 in 2008-09 to $1.85 in the current year and $1.99 in 2010-11.''

Mr Dooley says despite the downturn, most banks have still beaten cash returns.

"Compare what would have happened if you had money in a Commonwealth Bank term deposit at the start of the decade or CBA shares at the start of the decade,'' he says.

"Even after what we have seen over the last 24 months, you would be much farther ahead with the shares.''

Which bank?

Different stockbrokers will give you different answers about the best buy in the sector.

Mr Dooley's top pick is CBA, followed by Westpac.  Mr Grimm also favours the Commonwealth Bank and Westpac.

Mr Davis prefers ANZ and NAB because of their exposure to business lending growth.

Bell Potter Securities has "buy'' ratings on CBA and Westpac and "neutral'' ratings on NAB and ANZ.

Stick with them

The big four banks comprise more than 20 per cent of the All Ordinaries index of 500 companies and Mr Dooley says this should make them a key component of a share portfolio.

"Bank shares have tended to perform well because of Australia's love affair with property and they have the deposit market cornered as well,'' he says.

"What you want is access to the Australian banking industry, if for nothing else but to try and get some of your fees back.''

Investors wanting bank shares should not rush into them in one hit, but instead spread their buying over a year, Mr Dooley says.

"There's a possibility of weakness as we go into the middle of the year,'' he says.

Mr Davis says after BHP Billiton, the four major banks are the next four largest companies on the ASX in terms of market size.

The author owns bank shares.