In life, we're afforded very few certainties…
Night follows day…
Your train will run late…
Politicians talk a lot and do little…
These things, every Aussie knows for sure.
The list goes on…
House prices will not go up forever…
Big bank profits will rise and fall…
Those last two, are also true. It's just many investors choose to ignore it.
The problem for all the investors buying up bank shares now, however, is the average dividend yield has fallen considerably from what it once was and the risk of making a capital loss has increased dramatically.
But before I'm accused of scaremongering…
The simple chart every investor must see
The next chart I'm about to show you is intended for long-term investors only (i.e. those investing for 5 to 10 years or more).
It shows the net interest margin, or NIM, of each of the big banks over the past 18 years.
The net interest margin is one of the most important measures of bank profitability. It is the percentage difference between the interest a bank pays on deposits and what it receives on its loans.
Banks' NIMs over the past 18 years. Source: Big bank annual reports.
As can be seen, big bank net interest margins have been falling quickly.
There's a number of potentially plausible reasons why this could've happened…
- Competition has intensified dramatically.
- Banking regulation has increased.
- Banks haven't been able to consolidate cheap assets (think: CBA's purchase of BankWest)
Some might argue that low interest rates are the problem. That's wrong. Just look at U.S. interest rates. They've been 0.25% for some time, yet their big banks, such as Wells Fargo, boast net interest margins comfortably above 3%.
There's also the argument that the big banks are pushing into markets where the net interest margin isn't a reliable indicator of profitability. Profit from these areas is known as 'non-interest income' and includes things like superannuation, financial advice and funds management.
Whilst that is a viable growth path for the big banks, the crown jewel for the Big Four is the local property market, where they are believed to control well over 80% combined.
There is nothing wrong with a bank lending cash to home owners and property investors (so long as it's done prudently!), and a market crash is unlikely so long as unemployment remains at low levels, the Chinese economy remains strong and politicians do not implement significant changes to the tax environment (which mightn't be such a bad thing!).
However, you don't need an 'expert' on Sky Business to gaze into a crystal ball to know the equation is relatively simple.
Overpriced bank shares + falling profitability + rising unemployment + a lofty property market ≠ a good time to buy.
Foolish takeaway
In the future big banks will go on to post stronger profits than ever before, but none of them are a buy right now. They're currently sitting atop record-high valuations at a time when, arguably, they're facing more headwinds than ever. So unless you bought your bank shares at a much lower price than we're seeing today, it could be time to take profits off the table and look for better alternatives…
