One reason to avoid buying bank stocks

Falling interest rates and a hot property market are putting pressure on margins.

a woman

Australia’s banks are great businesses but, according to some analysts, it seems the end of our country’s two decades of consecutive growth will take its toll on earnings. The earnings slowdown could be attributed to the reduced investment (particularly in the resources sector) or the historically low interest rate environment.

Over the past 10 years our big banks have competed fiercely over mortgages thanks to booming demand from both investors and homeowners. In that time, high interest rates were curbing demand and banks could make huge profits thanks to a healthy amount of deposits. However, now with interest rates so low, the demand is ramping up again but many lenders’ margins will come under pressure.

The Australian Prudential Regulation Authority has grown concerned that banks may start to change their standards to tap into the rising demand for loans. “Slow credit growth increases the pressure on authorised deposit-taking institutions to compete for business on price and, of concern to APRA, by relaxing lending standards”.

However Mel Evans, head of home ownership at Westpac (ASX: WBC), told The Australian that “there’s very little appetite to lessen serviceability standards in the home loan space simply as a result of growth not potentially being as high as it was in the decade previously”. However she declined to comment when asked if Westpac had changed its levels or “buffers” to calculate whether or not customers could repay loans.

Of the big banks, Westpac has the second biggest share of the market, behind Commonwealth Bank (ASX: CBA). The CEO of Aussie Home Loans (which is controlled by Commonwealth), Ian Corfield, said despite a rising demand for loans it won’t deter the banks’ lending practices. “I don’t think you’ll get cut-throat competition until there’s enough volume in the market (that) people want to cut their margins”.

Finding the best deal for customers usually requires a visit to a broker to compare and select loans. According to Macquarie (ASX: MQG) this is where the competition and lower margins will originate because banks have to remain competitive to grow their portfolios. As a result Macquarie has cut its earnings forecast for CBA for the next two years by 0.6% and 1% respectively.

Goldman Sachs also said the mortgage competition would “drive the major banks’ net interest margins down 12 basis points between full-year 2013 and 2016.”

Foolish takeaway

The fierce competition for mortgages means our biggest banks’ earnings may fall whilst interest rates are so low. ANZ’s (ASX: ANZ) Asian strategy remains a good prospect for the next 5-10 years and could see it offset any losses from its retail banking in Australia. However this Fool thinks that although the banks are good businesses that pay huge dividends, at current prices, they are not worthy of a new spot in portfolios.

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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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