Why you should avoid buying the big banks like Australia and New Zealand Banking Group

Credit: NAB

Banks have been a mainstay for many portfolios of both individual and institutional investors, but I do wonder if it really is time to be actively buying bank shares today.

I believe there’s a whole host of reasons why buying shares in banks could potentially result in poor returns for the next several years, and this is despite the already-lacklustre returns experienced by the big-four banks so far this financial year (not to mention the opportunity-costs).

Inclusive of dividends, shareholders have endured the following returns since 1 July 2015:

Bank stock 1 July 2015 to 29 April 2016 TSR *
Westpac Banking Corp (ASX: WBC) 0.94%
Commonwealth Bank of Australia (ASX: CBA) (6.57)%
National Australia Bank Ltd. (ASX: NAB) (11.46)%
Australia and New Zealand Banking Group (ASX: ANZ) (21.33)%

* total shareholder return

These returns compare to the S&P/ASX All Ordinaries Accumulation Index which has returned 0.4% over the same period.

When one looks at returns like these, it makes one wonder whether it’s really a smart thing to be chasing high fully-franked dividends when the underlying security provides such poor total shareholder return outcomes.

However, I don’t think there’s any improvement on the horizon for bank shareholders.

I have relatives and well-meaning friends who tell me that bank shares have been good to them over time, and this is undoubtedly true over many years (the IPO of Commonwealth Bank of Australia at $5.40 in 1991 being a case in point).

Also, if you’re a long-standing shareholder with significant unrealised capital gains built up over a couple of decades it’s completely understandable that you may wish to hold on to your shares to postpone the realisation of capital gains tax.

For new investors wishing to invest in banks today though, you might want to consider delaying any new bank share purchases until the following headwinds have been somewhat lessened:

  • High property prices relative to take-home salary and wages (low affordability)
  • High household leverage
  • Legislative risk with regards to negative gearing
  • The likelihood that bank provisions for bad and doubtful debts will rise, hence affecting profitability, and
  • Regulatory requirements requiring banks to have higher capital adequacy ratios, which, again, affects bank profitability

On this last point, such higher capital adequacy ratios will make Australian banks stronger and safer, but this comes at the cost of lower returns on shareholders’ equity as capital set aside isn’t allocated for lending.

One final risk to consider is the effect the Fintech phenomenon will have on Australia’s traditional banks.

Fintech is an industry comprising of technology start-up companies that use technology to make financial services for traditional bank customers more efficient. A good example of a player in the Fintech industry is SocietyOne, an Australian peer-to-peer startup which has already reached $100m of loans on its digital platform, according to Roy Morgan Research. Such companies are able to cherry-pick Australian banks’ most lucrative and valuable customers potentially leaving them exposed as mere utilities selling commodity-like products.

The risk/reward trade-off in buying bank shares today is not skewed in favour of the buyer.

If you’re wanting to initiate a position in any of the big four banks, you may wish to wait until either the risks to the banks have lessened, or share prices have fallen to compensate for the risks. Either way, I think it’s best to show patience and wait for a better buying opportunity down the track.

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Motley Fool contributor Edward Vesely has no position in any stocks mentioned. 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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