Here’s why the big four banks are really falling in price

Despite another record half-year profit being announced by Westpac Banking Corp (ASX: WBC) yesterday morning, each of Australia’s major banks ended the day trading in the red and acted as a drag on the overall S&P/ASX 200 Index (Index: ^AXJO) (ASX: XJO).

Westpac’s first-half cash profit hit $3.77 billion which exceeded expectations of $3.64. It also increased its interim dividend by 5% to 90 cents per share. Despite the strong result its shares plunged 1.2% while Australia and New Zealand Banking Group (ASX: ANZ) also dropped early in the day, giving up 1.1%. Commonwealth Bank of Australia (ASX: CBA) and National Australia Bank Ltd (ASX: NAB) both started the day in positive territory but also ended the day down 0.3% and 1%, respectively.

You might be wondering why shares in the banks would all be giving up ground at a time where their profits are skyrocketing. Indeed, it is now looking almost certain that they will exceed last year’s combined $27.3 billion profit (Commonwealth Bank alone is tipped to report around $8.5 billion for its full year) and their dividends per share are still increasing.

There are actually a number of reasons behind this behaviour.

Excessive Valuations

First and foremost, it should be noted just how excessive the banks’ valuations currently are. Each of the big four are trading on a P/E ratio which far exceeds their 10-year average. Commonwealth Bank, for instance, is trading on a multiple of 15.3 times, compared to its 10-year average of roughly 13.1. These figures indicate that the market believes the banks will be able to continue growing their earnings for years to come.

Unfortunately, that is looking less and less likely. Low interest rates are driving bad debts downwards which is one of the key drivers behind the banks’ recent profit surges. When interest rates inevitably rise, so will bad debts which will apply pressure on their overall earnings.

Declining yields

The dividends are another key issue. Although ANZ and Westpac have both increased their interim dividends (NAB is expected to do so when it reports on Thursday), their yields have fallen dramatically as the share prices have risen. The bumper dividend yields have been another key reason behind their popularity with investors and they are becoming less appealing – particularly in light of the dividends that are otherwise being offered by companies like Telstra Corporation Ltd (ASX: TLS).

Speaking of dividends, the market normally reacts positively when it learns that more money will be distributed amongst shareholders. That wasn’t the case when ANZ increased its dividend last week. As UBS’s Jonathon Mott noted, a raised dividend is not taken well “when it comes at the expense of capital. The market was not impressed with ANZ’s common equity tier 1 capital falling 15 (basis points) to 8.33 per cent”.

Foolish takeaway

Given the pullback in share price over the last week or so, there is every chance that the banks could recover a few percentage points in the short-term. However, based on today’s valuations, they are by no means good long-term (or even medium-term) investments.

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Motley Fool contributor Ryan Newman does not own shares in any of the companies mentioned.

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