Here’s why you should avoid shares in the Big Four Banks

Australia’s biggest banks have enjoyed strong earnings growth in recent years, generating record-breaking profit results and returns their international counterparts could only dream of. However, that run is quickly coming to a conclusion with analysts expecting a further slowdown in growth this year.

The banks have all benefited from the low interest rate environment, which his helped generate strong growth in loans and, importantly, a reduction in losses on those loans.

As highlighted by The Sydney Morning Herald however, Fitch Ratings predicts that trend will soon reverse course and, although it thinks the change will be “manageable”, it will ultimately act as a drag on their earnings.

In addition to higher impairment charges, the banks’ net profit margins (the level of profitability on their loans) have also been falling, reflecting the tough competition within the sector to win new customers.

The Sydney Morning Herald quoted Fitch as saying: “Profit growth is likely to slow due to ongoing asset competition, higher funding costs, and an increase in loan-impairment charges. Improvements in cost management are likely to be offset by increased investment in technology.”

Indeed, shareholders of the major banks have enjoyed incredible returns in recent years, both in the form of capital gains and fully franked dividend yields. As a result of that strong track record, most investors have most likely, at one point or another, been tempted to buy shares of Commonwealth Bank of Australia (ASX: CBA), Westpac Banking Corp (ASX: WBC), Australia and New Zealand Banking Group (ASX: ANZ) and National Australia Bank Ltd. (ASX: NAB).

Given their size and weighting in the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO), most portfolios own at least one of these companies, while many portfolios are likely made up almost entirely of their shares.

While they have generated huge returns in the past however, that trend is by no means guaranteed to continue. To begin with, the banks have come under the spotlight of the Australian Prudential Regulation Authority, or APRA, which now requires them to hold more capital against the loans they write as a safeguard against a potential economic downturn.

While I won’t speculate that we will fall into a recession, we are facing some tough economic headwinds which could impact the ability of some households or businesses to repay their debts on time (i.e. higher bad debt charges). It could also hinder their borrowing activities if consumer and business confidence levels fall.

The tougher regulations will also have an impact on overall shareholder returns, and could even lead to a reduction in dividends paid to shareholders. Personally, I think their share prices are still too pricey based on these risks, and think investors could do better by looking elsewhere for superior opportunities.

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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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