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Are troubles coming for the banks?

Can ANZ  (ASX: ANZ)Commonwealth Bank (ASX: CBA)National Australia Bank (ASX: NAB) and Westpac (ASX: WBC) sustain their current share prices? Here are a few reasons why they might not.

Funding

Offshore wholesale funding provides 30% of Australian banking requirements. Current conditions, including the falling Aussie dollar, will make the cost of offshore funding significantly more expensive in the near and medium term. This has a negative effect on margins.

Housing prices

In a recent report (June 2013), the NAB residential property index forecast national house prices to rise by just 1.4% in the next year and 2.4% over the next two years. In addition rental returns are expected to be stagnant. This is contrary to the expectations of many recent housing investors, a good proportion of which are negatively geared. The fallout could be considerable should this report be over-optimistic. Australian retail banks are very exposed to residential housing, both investment and owner-occupied.

Business confidence

Simply put, business confidence is declining rapidly and not helped by the longest election campaign in our democracy’s history. As a sector, small and medium business is being particularly hard hit. Opportunities for business lending growth are limited in this environment.

Competition for deposits

Due to insecurities over economic crises investors piling into term deposits have been a boon for banks over the past few years and this is likely to reverse, increasing funding pressures. In addition the competition for domestic deposits will deepen, further squeezing margins.

International banking regulations 

The Basel Committee (international banking regulator) is presently examining the leverage ratios of banks. It is not generally realised that Australian banks are amongst the most leveraged in the world due to the high residential mortgage component on their books. This exposure varies from 50% in ANZ’s case to over 70% in Westpac!

Any changes in Basel’s allowable leverage ratios (last set in 1988) are likely to be phased in over a number of years. Note: declared profits would not be directly affected by any changes, however ratios such as return on capital would be. There might also be an effect on the extent of dividend payouts should capital requirements change dramatically; and share buybacks would be out of the question.

Foolish takeaway

Most value-biased Fools are happy to look through short-term market noise; however it is difficult to identify where medium-term lending profit growth is going to come from. Some of the looming challenges are structural. The more likely scenario is profit slippage. In terms of dealing with these pressures, ANZ is the best positioned, followed by NAB, Commonwealth and Westpac. In short, at current bank prices, better value opportunities lie elsewhere.

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Motley Fool contributor Peter Andersen does not own shares in any of the companies mentioned in this article.

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