Banks take another hit, adding to headwinds

The big four banks face higher funding costs, another problem to add to their already long list, which could see earnings fall and drag share prices and dividends with it.

Wholesale funding costs have risen to near two-year highs according to Fairfax Media, turning a tailwind into a headwind for Australia and New Zealand Banking Group (ASX: ANZ), Commonwealth Bank of Australia (ASX: CBA), National Australia Bank Ltd (ASX: NAB) and Westpac Banking Corp (ASX: WBC). Low funding costs over the previous few years had allowed the banks to increase their margins, but that appears to be over.

The big four raise most of their funding from deposits, but around a third comes from wholesale borrowing. As an example, CBA last week raised funding at 115 basis points over the benchmark – compared to 108 basis points just three months ago and 90 basis points 12 months ago according to Fairfax.

Watermark Funds Management analyst Omkar Joshi has told Fairfax that the spread between government bonds and AA rated corporate bonds had widened by around 15% since November – which means a higher premium for credit for big borrowers such as the banks.

Mr Joshi told Fairfax that the big banks would probably need to absorb the higher costs in their profit margins, as they would be unlikely to be able to push them through onto customers, following a number of rate hikes last year.

That’s one view of course, and the banks are likely to try and recoup those costs either by cutting deposit rates or perhaps small interest increases to borrowers. But increasing loan rates makes the banks less competitive – which could cause another problem – customers leaving the bank and going elsewhere in search of cheaper rates.

It’s just another problem the banks and their shareholders face. New capital measures could see the banks forced to raise even more capital – on top of the billions they raised last year. Recommended reforms from the Murray Inquiry could also still have an impact, while a slowing property market will likely mean lower credit growth and potentially rising bad debt provisions – which are at cyclical lows.

Foolish takeaway

The tailwinds of the past have receded and the banks look headed into a storm of headwinds. Investors appear to have forgotten how risky bank shares can be and that they are subject to market cycles. This one appears to be turning – which might shock many retail investors with heavy investment in the banks.

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Motley Fool writer/analyst Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga

Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. 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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