Is it time to invest in smaller banks?

Australia’s biggest mortgage lenders by market share are Commonwealth Bank (ASX: CBA), Westpac (ASX: WBC), NAB (ASX: NAB) and ANZ (ASX: ANZ). Their robust balance sheets and strict lending criteria throughout the GFC meant they were able to continue to increase their share of mortgage market while others faded away.

In the past six years, the big four have gone in different directions. The two biggest banks have snapped up subsidiaries to do their bidding. ANZ and NAB have focused on developing business strategies and international expansion whilst still remaining competitive in the mortgage market.

However Westpac, which controls St George, and CBA, which has BankWest, are using their different brand names to offer loans throughout Australia to would-be homeowners, many of whom are likely unaware they are negotiating with a ‘big bank’. So far this strategy has paid off.

RateCity’s Alex Parsons said although the big four control the “lion’s share” of the mortgage market it “is slowly shifting as more people realise that smaller lenders, in the main, are offering better rates.” By comparison some small banks are offering 4.55% for variable loans whilst the average variable rate among the big four is 5.24%, according to The Australian Financial Review.

The big banks have countered the swing by upping the commissions they pay to mortgage brokers and by raising the loan-to-value ratio. This is something many property investors will be welcoming, particularly with interest rates so low and property prices rising. According to the Australian Finance Group, investors make up around 40% of the market.

Although lending for new houses has stalled in the past six months, the demand for mortgages could grow in the short term, especially if the RBA cuts rates again. HIA senior economist Shane Garrett said, “The patchiness we are continuing to see in areas of the home loans market means that another interest rate cut from the Reserve Bank before the end of 2013 is important in order to ensure that the market recovery fires on all cylinders.”

Foolish takeaway

Australian banking stocks remain priced to perfection for shareholders but not investors. With interest rates so low, margins are likely to be put under pressure for both big and small lenders. Regional banks such as the Bank of Queensland (ASX: BOQ) and Bendigo and Adelaide Bank (ASX: BEN) have performed exceedingly well in the past 12 months and continue to pay great dividends which could reward investors who are investing for the long term but, at current prices, they are not ‘bargains’.

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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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