5 BIG reasons to avoid the Big Four banks

Australia’s banks have come under enormous selling pressure in recent months, with all four of the majors falling into an official bear market, defined as a fall of 20% or more from the top.

Although they have all recovered somewhat from their lows, Commonwealth Bank of Australia (ASX: CBA) remains 19.5% below its peak, while National Australia Bank Ltd. (ASX: NAB), Westpac Banking Corp (ASX: WBC) and Australia and New Zealand Banking Group (ASX: ANZ) all remain between 23% and 29% below theirs.

Notably, ANZ is faring the worst, likely due to its heavy exposure to Asian credit markets, while NAB is also struggling to regain ground.

While some investors believe it is simply a temporary setback for each of the banks, and one to take advantage of, there are a number of strong arguments that suggest that will not be the case.

Here are five reasons it could pay to avoid investing in the Big Four bank shares today…

  1. Capital Restrictions

Financial regulators are cracking down on the quality of the loans written by the Big Four banks and requiring them to hold more capital in reserve as a safeguard against a potential economic downturn. Indeed, the banks are considered “too big to fail” and have already been forced to raise tens of billions of dollars from asset sales, dividend reinvestment plans and, of course, rights issues.

Unfortunately, all four are still short of the mark meaning further capital raisings may become necessary. This is diluting shareholder ownership and flattening their returns on equity (ROE) which have traditionally been much higher than those boasted by international counterparts.

  1. Dividends

So far, the banks have passed additional costs onto customers in the form of higher mortgage rates. However, there is still a chance they will look to retain more capital by reducing their dividend payments, or at very least reducing their payout ratios (i.e. dividend growth mightn’t be as strong as earnings growth).

  1. Earnings Growth

Speaking of earnings growth, the banks have enjoyed an extended period of record profitability, thanks largely to booming house prices, low interest rates and, of course, record low bad debt charges. While that has provided a huge tailwind, the trend will inevitably reverse course and will soon act as a headwind on their earnings growth.

  1. Competition

Competition amongst the majors is intensifying, which is constricting net interest margins (the level of profitability on their loans) and is, in turn, hurting earnings growth as well. However, the banks also face competition in the form of digital disruption (for instance, Apple Pay) and peer-to-peer lending which could see their market share fall in the long run.

  1. Wrong time to buy

Bank profits are extremely cyclical. While they have boomed in recent years, for reasons mentioned previously, there are strong headwinds now facing the Australian economy which could threaten growth, and see the shares decline even further than their current prices. Although the banks all offer tantalising dividends (at least on a trailing basis), those gains could be offset by capital losses with the very real possibility of recognising underwhelming returns in the coming years.

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Motley Fool contributor Ryan Newman has no position in any stocks mentioned. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. You can follow Ryan on Twitter @ASXvalueinvest.

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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