4 reasons why bank shares have been smashed in 2016

The disappointing performance of the big four banks since the start of the year has been one of the major talking points amongst investors.

As the comparative chart below highlights, all of the major banks have significantly underperformed the  S&P/ASX 200 (Index: ^AXJO) (ASX: XJO), with the National Australia Bank Ltd. (ASX: NAB) being the worst performer overall.

Source: Google Finance

Source: Google Finance

The lacklustre performance of the financial sector would surprise some investors considering the big four banks offer some of the most attractive, fully franked dividends on the ASX. With interest rates at historical lows, it would be logical to think that these high-yielding stocks would trade at much higher valuations.

Unfortunately for investors, a number of headwinds are currently facing the banks and this is having a big impact on sentiment and, consequently, their share prices.

Four of the biggest issues that I think are having a negative impact on the banks right now include:

  • The possibility of further capital raisings: As highlighted here, some analysts believe that the banks may be forced to go through another round of capital raisings to meet progressive regulatory requirements. This is bad news for existing shareholders as it means their current holdings will become diluted if they do not participate. This would be even more dilutionary than the previous round of raisings considering all of the banks’ share prices are considerably lower today than they were in 2015.
  • Possibility of contagion from European markets: Australian banks are in a far stronger position than many of their counterparts overseas, but this doesn’t mean they can’t be impacted by a banking crisis abroad. The Italian financial sector could once again be facing a banking crisis and this could flow into other countries in the region. Unfortunately for Australian investors, the big four banks would be hit hard if this was to occur.
  • Earnings growth will become more difficult with lower interest rates: The banks face the prospect of even lower net interest margins if interest rates fall even further because the spread between its loan rates and deposit rates will be squeezed. This will make it even harder for the banks to grow earnings in an environment of subdued credit growth.
  • Current dividends are not guaranteed: All of the banks, except Australia and New Zealand Banking Group (ASX: ANZ), maintained their dividends in the last round of dividend payments, but investors are less certain this will be the case over the next 12 months. There could be a scenario where further capital raisings, a rise in bad debts and a further slowing in credit growth could negatively impact profits, and ultimately, dividends.

Foolish takeaway

There is no doubt that investors could make a strong case that many of the potential headwinds facing the banks have now been sufficiently priced in and that the dividend yields on offer are attractive enough to offset any further downside risk.

Despite this, I would still be cautious on the short-to-medium term outlooks of the big four banks and suggest investors shouldn’t focus solely on their dividend yields.

The big four banks aren't the only shares that investors might want to avoid right now.

3 Rotten Shares to Sell, and 1 to Buy Today

After a double-digit rally for the ASX since 2016 lows, investors should be on high alert. You'll find a full rundown below of 3 shares we think you should avoid today plus one top pick worth buying, even if the market turns south and the RBA keeps rates at an "emergency low." Simply click here to uncover these stocks.

Motley Fool contributor Christopher Georges 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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