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Should you hold your bank shares?

Australian bank stocks have had a great run in the past decade and continue to pay large and reliable dividends. Consistent earnings and modest growth have made them the envy of much of the developed world.

Growth in the mining sector and a firm but relatively stable regulatory environment has enabled the banks to make well-timed acquisitions and tap into the Australian resources boom. However it now appears investment in mining related activities could drop by up to two-thirds in coming years. We need only look as far as the mining services sector to see the effects.

The RBA hopes lowering interest rates will counteract the fall in investment. However National Australia Bank (ASX: NAB) and ANZ Banking Group’s (ASX: ANZ) recent comments paint a bleak picture of what we can expect from the economy in coming years. “The big picture remains intact with the economy expected to underperform over the year ahead, more so for domestic demand, leading to rising unemployment,” NAB said.

ANZ recently said that while it remained confident the economy would continue to grow above 3% in 2014 and 4% in 2016, the unemployment rate could start to rise in 2015.

What does this all mean for bank shares?

Currently, bank stocks aren’t cheap and the economy is slowing, this rules them out as a standout buy. We’ve only got to look back two years and realise what we’d be buying today, isn’t a bargain. Two years ago Commonwealth Bank (ASX: CBA) shares traded for as low as $45 (that’s nothing compared to its price 20 years ago!) and had a dividend yield of 9% grossed-up.

I say they’re expensive for two reasons. Firstly, unemployment and bad debts are low. Secondly, competition for customers is growing and net interest margins have fallen to their lowest levels in years. Currently Westpac has a net interest margin of 2.1% — it boasted 2.6% in 2009.

So although we’re seeing a stronger property market and lower unemployment, interest margins aren’t significantly improving. In my opinion the banks, with the exception of ANZ, are lacking any significant growth strategies moving forward and judging by their return on equity and other margins, they have been growing profit largely by reducing costs.

Foolish takeaway

In the next year, the only big bank expected to grow earnings more than 10% is ANZ. Its relative underexposure to Australian mortgages (when compared to Westpac and Commonwealth) and its clear strategy in Asia make it the most likely to outperform its peers.

Although many advisors would be quick to instruct customers to sell their bank shares, they are well regulated and although they may not grow anywhere near as fast they have in the previous two decades, if you’re content with their stable dividend stream it mightn’t be such a terrible idea to have some exposure.

However I would not instruct investors to buy any bank stock at their current prices, because doing so would mean we expect to never encounter another financial crisis or recession – whereby bank stocks drop significantly in value making them much more enticing. There are plenty of other dividend stocks available that are cheaper, and more leveraged to growth.

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

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