Deutsche Bank name Westpac and NAB as their top bank stock picks

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Westpac and National Australia Bank are Deutsche Banks’s top picks in the Australian banking sector with total returns on the two stocks expected to run in the teens in 2017.

Westpac is well positioned, with strong market share in high returning segments such as mortgages, plus a focus on cost cuts, while NAB’s strength in small business banking should offset margin pressures in home loans, Deutsche Bank said.

While the entire Australian banking sector has lagged a rally in global bank shares amid prospects of higher US bond yields, the two banks are cheaper when compared to long-term PE relative to industrial stocks.

Deutsche said the banking sector was poised for a stronger 2017 compared to the previous year. It forecast earnings per share to climb 2% and that combined with a 6% dividend yield will offer a 8% return in line with 2015. The forecast is based on a strong loan growth, only a “modest” decline in net interest margin, lower bad debt expenses and a recovery in fees and commissions.

Regulatory changes should also be manageable for the lenders with higher capital rules only likely to result in additional 50 basis points of core capital ratio that can be met through retained profits and dividend reinvestment plans, where investors swap all or part of their dividend for new shares.

Net interest margins, while forecast to be about 2 basis points lower, could surprise given competition has eased and lenders have put up their mortgage rates this month. Lower deposit and credit spreads may reduce banks funding cost.

Deutsche Bank expects cost growth to slow from job cuts and fewer one-off items. Westpac is seen as the sector leader with just a 2% cost growth in 2017.

The analysts still cautioned that slowing loan growth, risks from the overheated housing market and competition from disruptors were risks though these were long-term challenges and not for the current year.

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