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The 3 major reasons why the big banks are too expensive

When you have four monsters eating the same cake, they’re bound to leave a mess and this is likely to be the case with our big banks. They’re also adrift in the same housing loan rowboat, paddling away furiously, with the circles getting smaller and no convenient engine to get them away. Mainly due to:

Diminishing Margins

Yellow Brick Road Holdings Ltd (ASX: YBR) recently announced one of its residential loan products had been awarded a five-star rating by leading industry researcher Canstar. Of 328 comparable products only 31 received a five-star rating and of these 31 only five were directly sourced from the major banks.

As savvy borrowers recognise the considerable savings to be made over the life of a loan by going to non-bank lenders further squeezes on margins are inevitable. The two major banks most affected by housing margin compression are Commonwealth Bank of Australia (ASX: CBA) and Westpac Banking Corp (ASX: WBC).

Higher Capital Requirements

The banking regulator (APRA) has introduced higher capital requirements for banks and the transition period ends in 2017. Although Westpac will be unaffected (due to the favourable treatment of residential loans); National Australia Bank Ltd (ASX: NAB) and Australia and New Zealand Banking Group (ASX: ANZ) will need to raise more capital. Their likely options are: 1) reducing dividends; 2) discounted dividend re-investment schemes (dilutive); 3) raising equity capital (dilutive); 4) sale of assets (potential earnings effect).

The APRA requirement for banks to consolidate their wealth holdings divisions will affect CBA with its ownership of Colonial. However the favourable treatment of housing loans will again come to the rescue.

Lack of Structural Business Growth

Over the past 18 months the dividend growth of the four majors has exceeded business growth, presumably in an attempt to boost share prices. This is an unsustainable policy and is likely to impact future business performance. On this factor ANZ is the only major to have a longer-term plan with the move into Asia, however this is still in progress – scarily, the rest remain over dependent on the state of the Australian housing market – not a good place to be.

In my view, new investors in the four major banks should be prepared for their current share prices to fall 15% or more within the next 12 months and this could easily be an understatement.

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Motley Fool contributor Peter Andersen owns shares in Yellow Brick Road.

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