Here’s why shares of Commonwealth Bank of Australia are back in a bear market

Shares of Commonwealth Bank of Australia (ASX: CBA) have crashed 2.4% today to trade at just $76.18, and once again find themselves in official bear market territory.

A bear market is defined as a fall of 20% or more from the peak. The bank’s share price has crumbled 11% since it traded for around $85.50 at the beginning of the year, but almost 21% since peaking at about $96 a share in March 2015. By comparison, the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO) has fallen 7.6% since the beginning of the year and a little over 18% since March 2015 as well.

Indeed, shareholders of Australia’s biggest banks had become accustomed to fantastic returns, both in the form of fully franked dividends and capital gains. They performed particularly well in the six years following the Global Financial Crisis (Commonwealth Bank’s share dipped to a low of around $23 in early 2009) but have since fallen away.

In fact, all four of Australia’s major banks are currently in a bear market. Commonwealth Bank is faring the best of the bunch, while Australia and New Zealand Banking Group (ASX: ANZ), National Australia Bank Ltd. (ASX: NAB) and Westpac Banking Corp (ASX: WBC) have all plunged more than 30% since their peaks.

First of all, it’s important to note why the banks soared in the first place. Australia has not experienced a recession in nearly a quarter of a century, while booming house prices and rising household incomes also helped them generate eye-watering growth. More recently, that growth was boosted by falling interest rates (which are now sitting at just 2%), as well as record low bad debt charges.

While that has aided the banks towards record profits in recent years, however, some of those trends are expected to reverse course in the near future.

For instance, earnings growth has already slowed down and is expected to slow even further this year. That’s a result of intensifying competition among the banks to win over new customers (who wish to take advantage of low interest rates), as well as rising bad debt charges. Notably, they haven’t started rising just yet but are widely expected to in the near future.

At the same time, the Australian Prudential Regulation Authority, or APRA, has recognised the risk of the banks becoming too lenient on lending standards as they compete for customers. It has thus forced them to hold more capital against the loans they write, which will no doubt impact shareholder returns in the future.

The banks have already been forced to raise billions of dollars in fresh capital from investors, but it is believed they will need to raise tens of billions of dollars more to appease APRA’s standards. For some banks, that could result in cuts to their dividends to shareholders while the Returns on Equity of the others are also in jeopardy.

Commonwealth Bank’s shares might have fallen more than 20% or more from their peak, but that doesn’t make them a standout buy in today’s market. Given the risks facing the sector, and indeed, the economy as a whole, investors would be wise to ensure they are not overly exposed to the banks and think twice about the hazards before loading up.

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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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