I hope you’re feeling nice and refreshed after the long weekend.

Of course, you don’t need me to tell you that Easter is a great time of the year to spend with the kids and family.

In between Easter egg hunts and events with loved ones, you may have even taken the opportunity to kick the feet up for a well-deserved rest.

As many investors do, you may have also taken advantage of the extended break to do some additional research, and to digest the latest news hitting the market.

As it turns out, there was plenty to digest after Thursday’s session…

The S&P/ASX 200 (ASX: XJO) suffered its first weekly decline for the month last week.

It dropped 58 points or 1.1% on Thursday alone in a rout led by the banks and the miners.

Indeed, the miners have had a rollercoaster ride so far in 2016…

Commodity prices were plummeting earlier in the year, only to recover in spectacular fashion in recent weeks.

Unfortunately, they appear to have run out of steam again – for now at least – and the miners are once again paying the price.

BHP Billiton Limited (ASX: BHP) ended the week more than 6% lower, and it’s down nearly 13% since hitting a peak of $19.44 just three weeks ago.

BHP’s fellow iron ore miner Rio Tinto Limited (ASX: RIO) looked worse for wear on Thursday as well, shedding 3.6%.

If one thing is clear, it’s that the volatility is not over for the resources sector – not yet, anyway.

But while the miners were a drag, it was the banks doing most of the damage…

The End of an Era?

For years, the “Big Four” have generated huge gains for investors.

Take Commonwealth Bank of Australia (ASX: CBA) as the best example.

Over the past five years, shareholders have recognised a capital gain of almost 46%, or nearly 83% when you include dividends (without the franking credits).

Given the low interest rate environment, it is clear that investing in the bank has been far more lucrative than simply putting money in the bank…

During that period, the banks have each reported record earnings results, with profits even the biggest banks in the world would envy.

One of the key factors driving that earnings growth has been diminishing bad debt charges…

Indeed, lower borrowing expenses have made it easier for consumers and businesses to repay their debts.

Some have taken full advantage by getting ahead on their repayments, limiting the losses recognised by the banks.

What investors can tend to forget, however, is that the banks operate in a highly cyclical industry…

Bad debt charges won’t stay low forever and will eventually reverse course.

In other words, what has acted to boost earnings growth will eventually hinder it…

There have been numerous signs recently that have suggested we could be nearing the turning point.

Back in February, for instance, the Australia and New Zealand Banking Group (ASX: ANZ) noted (my emphasis):

Our exposure in Asia is predominately short tenor, investment grade lending nevertheless the slowdown in the region and increased market volatility are seeing credit conditions become more difficult in the second quarter.

As a result, it estimated for “a little above $800 million” during the half in impairment charges – which was already above the market consensus of $735 million.

Strike 1.

As it turns out, even that $800 million estimate wasn’t quite enough…

On Thursday last week, the bank said it now expects to add at least another $100 million to that charge.

This time, it’s due to the bank’s exposure to a number of Australian and multi-national resource-related businesses.

Strike 2.

According to The Sydney Morning Herald, the vast majority of the additional charge relates to its exposures to Arrium Ltd (ASX: ARI) and Peabody Energy.

The latter is thought to be on the brink of bankruptcy, while Arrium has also expressed its doubts as to whether it can continue as a going concern for much longer as well…

Now, an additional $100 million in bad debt charges isn’t a huge deal in the big scheme of things – at least not for a bank the size of ANZ.

What is more troubling, however, is that this could be the beginning of a trend that effects the entire sector.

After all, while some of the issues facing ANZ are company-specific, each of the other banks have exposure to the resources sector.

Based on Macquarie estimates (as reported by The SMH), ANZ Bank and Commonwealth Bank both have about $20 billion each in exposure to the resources sector…

Meanwhile, National Australia Bank Ltd. (ASX: NAB) and Westpac Banking Corp (ASX: WBC) are thought to have $12 billion and $15 billion in exposure, respectively.

Beyond the Banks

Despite its focus on Australia’s greatest companies, Scott Phillips, who runs our Motley Fool Share Advisor service, has avoided the major banks so far.

That’s not to say they aren’t great businesses – I myself would happily add the banks to my own portfolio…

But only for the right price.

Indeed, the banks’ shares have all fallen heavily since they peaked almost 12 months ago.

But while their shares may have fallen, it is also reasonable to suggest they had become overpriced at that time, especially considering the headwinds that were also facing the sector.

Well, it seems as though some of those risks are now being recognised, and investors are finally starting to pay attention…

So much for the banks and their fat, fully franked dividends being a ‘safe bet’.

 

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