Australia's major banks have enjoyed a stellar run since the depths of the financial crisis. In that time, they have smashed the gains made by the broader S&P/ASX 200 Index (Index: ^AXJO) (ASX: XJO) whilst also delivering income-hungry investors with bumper dividends and franking credits. But that could all soon come to an end.
The chart below reflects the astounding returns from the last five years. While the Index has risen 45.1%, the banks have each gained an average 82.7% with Commonwealth Bank of Australia (ASX: CBA) jumping an incredible 114% in that time. Those figures aren't even including distributions to shareholders (those have been generous enough on their own).
However, it seems that investors might be getting a bit ahead of themselves. While each of the banks are amongst the nation's strongest and most well-run corporations, they have still become overpriced. Indeed, they recorded record profits last year (a combined $27.3 billion) and are more than likely to exceed that this year (Commonwealth Bank could record $8.4 billion on its own), but those earnings could come under pressure in the years to come.
The profits are being largely supported by low bad debts thanks to the low interest rate environment. While this will support earnings in the short-term, they will both inevitably rise in the medium-to-long-terms. John Abernethy, chief investment officer at Clime Asset Management said, "People's capacity to service interest and pay back debt can change dramatically if interest rates go up, even slightly." The banks' over-exposure to the housing sector largely increases this risk.
Another issue is the new rules which will require the banks to hold more capital in reserve against their lending as a safeguard against any economic downturn, which will reduce their return on equity.
Considering these issues, the premiums the banks are trading on are too high. Currently, Australia and New Zealand Banking Group (ASX: ANZ) and National Australia Bank Ltd (ASX: NAB) are trading on a P/E ratio of 14.3 and 13.6 times respectively, while Commonwealth Bank and Westpac Banking Corp (ASX: WBC) are both trading on a multiple of 14.9 times (each of which are well-above their 10-year averages). At this stage, it is looking unlikely they will be able to deliver earnings growth on these levels.
Foolish takeaway
The banks could well continue to climb in the short-term, particularly if their profits come in as strong as the market is anticipating for this financial year. The problem is the long-term – at today's prices, they stand little chance of outpacing the market, meaning you would be wise to seek more attractive opportunities.
