Tough times ahead for bank stocks

Australia’s big banks — Westpac (ASX: WBC), ANZ (ASX: ANZ), Commonwealth Bank (ASX: CBA) and NAB (ASX: NAB) — have all grown profits in the past year but some doubt their ability to continue to do so.

After two decades of growth, our country has avoided the hardship of many other countries. Now, the mining boom over, consumer confidence is low, China is slowing and property cannot go too high because if residential prices go higher, household income will also need to rise to avoid a bubble.

Compared to much of the world, Australians are conservative. Although this is normally a good thing, it means the RBA’s rate cuts aren’t working as quickly as it would like. This puts pressure on the big lenders’ earnings because they need us to borrow more aggressively to maintain the bottom line.

The next few years will be tough for investors who buy banking stocks at current prices. They will find themselves paying higher multiples of earnings if the share price drops in response to lower profits. Of course there will be a floor on the share price because of the high dividends they pay — this is especially important when interest rates are slow low but investors cannot rely purely upon dividends.

Throughout the GFC, good liquidity positions and little exposure to bad loans enabled our banks to retain their credit ratings. Coupled with strong foreign investment into our economy, the banks were able to produce strong results. Since 2004, Commonwealth bank grew its annual net profit from $2.535 billion to the incredible $7.677 billion in the past year. These growth rates cannot continue.

ANZ and NAB have sought to counter this trend by doing more business banking, focusing on maintaining their market share of mortgages and actively looking abroad for opportunities. NAB’s recent performance can be attributed to savings rather than growth whilst ANZ’s Asian strategy has experienced reduced margins. Credit Suisse Analysts said in a note to clients, “Earnings appear to be more optimized than ever at this juncture, leaving limited scope for positive earnings surprises near term”.

Foolish takeaway

Regardless of what investors believe share prices will do in the short term, our banks are highly leveraged to our economy and the end of the mining boom will take its toll. More political certainty at the next election will be key for the economy and markets moving forward. This Fool believes that at current prices the banks are expensive because future earnings will struggle; therefore they do not represent good buying opportunities.

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Motley Fool contributor Owen Raszkiewicz does not have a financial interest in any of the mentioned companies.

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