Each of Australia's major banks have come off an incredible 2013 and are perhaps entering the new year with the most optimism since the GFC. In part due to the belief that demand for loans could increase by up to 5% over the coming 12 months. However, the question on many investors' minds is whether or not their strong performances can actually be continued.
2013
When combined, Westpac (ASX: WBC), ANZ (ASX: ANZ), NAB (ASX: NAB) and Commonwealth Bank (ASX: CBA) posted an annual profit of more than $27 billion in financial-year 2013. This was largely the result of the low interest-rate environment and low bad debt levels.
We saw a pick-up in consumer and business confidence and share prices soared to record or multi-year highs as a result of the increased profits as well as the bumper dividends on offer. The rampaging shares actually saw Commonwealth Bank overtake mining heavyweight BHP Billiton (ASX: BHP) as Australia's largest corporation by market capitalisation.
2014
In terms of maintaining profitability, it is expected that none of the big banks will go backwards. While interest rates hit a record low of 2.5% in 2013, a number of analysts expect further rate cuts and the demand for loans is tipped to continue increasing.
At the same time however, the level of bad debts is expected to climb in the coming year. They have remained low as borrowers have taken advantage of the low interest-rate environment to pay back their dues. This was one of the key drivers behind the record profits, but if conditions in the resources sector continue to deteriorate, the level of bad debts could start to increase.
Meanwhile, tougher regulations also mean the banks are required to hold greater amounts of capital in case of an economic downturn. Due to this, Hyperion Asset Management chief investment officer Mark Arnold believes that "earnings-per-share growth from the big banks is unlikely to move above the mid-single-digit level for the next five years."
Although some analysts do not believe that the tougher regulations will impact on dividends, there is still the risk that distributions from the banks could be impacted – particularly the occurrence of one-off special dividend payments.
Foolish takeaway
While the banks' profits are likely to remain strong in 2014, their share prices have become inflated and stand little chance of delivering market-beating returns in the long-run. Despite strong forecasts, investors would be better off waiting for the banks' shares to fall in price. There are alternative businesses which possess greater growth potential.
Get the full report on our top dividend stock for 2014 — FREE!
