Is Commonwealth Bank of Australia and the big bank rally about to get derailed?

The seasonal rally that usually pushes bank stocks right to the front of the market is at risk of getting derailed by the Banking Royal Commission, which kicked off this week.

The Royal Commission is putting the spotlight on “liar loans” and investors have yet to fully understand and appreciate the risk of these loans on the bottom lines of our country’s biggest mortgage lenders.

This uncomfortable spotlight on the big banks comes at a time in the year that is typically great for the sector with investors clambering to buy into bank stocks to ride the dividend train.

This is why the big banks have historically performed well right through to April with the sector normally leading the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) higher.

But the dividend train hasn’t come up against a Royal Commission before and could get derailed this time as the focus on “liar loans”, where borrowers exaggerated their income and were given loans they could not afford, will force investors to reassess the liabilities of the $1.7 trillion residential mortgage market.

While the ABC reports that these loans make up two-thirds of bank lending, it is one of the least investigated areas of the financial industry and a survey by UBS found that a third of 1,000 new mortgagees have lied about their income.

If that doesn’t quite concern you, a federal court ruling against Australia and New Zealand Banking Group (ASX: ANZ) at the end of last month could prove to be the canary in the proverbial coal mine.

The court ruled that ANZ had breached responsible lending laws when it failed to properly verify the income of car loan borrowers. It appeared that the bank replied too heavily on payslips, which are easily doctored.

The circa $5 million penalty to compensate 320 customers is a rounding error for the bank but UBS is warning that this could set a dangerous precedent when it comes to home loan borrowers.

It is usual practice for banks to ask for three payslips when processing home loans. I suspect they don’t do much or any counterchecks, so if the latest federal court ruling were to be applied, banks could be liable for a very big compensation bill.

It is also worthwhile noting that household income data collected by the Australian Bureau of Statistics (ABS) is lower than the income reported by our mortgage lenders.

Further scrutiny on liar loans will be a drag on the share prices of the big four, which includes Commonwealth Bank of Australia (ASX: CBA), Westpac Banking Corp (ASX:WBC), National Australia Bank Ltd. (ASX: NAB) and ANZ Bank.

The good news is that I am still feeling upbeat about the rest of the market in the short-term to May. If you are looking for blue-chips that are better placed to outperform the market, you will want to hear what the experts at the Motley Fool have to say.

They have picked their three favourite blue-chip stocks for 2018 and you can find out for free what these stocks are by following the link below.

Top 3 ASX Blue Chips To Buy In 2018

For many, blue chip stocks mean stability, profitability and regular dividends, often fully franked..

But knowing which blue chips to buy, and when, can be fraught with danger.

The Motley Fool’s in-house analyst team has poured over thousands of hours worth of proprietary research to bring you the names of "The Motley Fool’s Top 3 Blue Chip Stocks for 2018."

Each one pays a fully franked dividend. Each one has not only grown its profits, but has also grown its dividend. One increased it by a whopping 33%, while another trades on a grossed up (fully franked) dividend yield of almost 7%.

The names of these Top 3 ASX Blue Chips are included in this specially prepared free report. But you will have to hurry. Depending on demand – and how quickly the share prices of these companies moves – we may be forced to remove this report.

Click here to claim your free report.

Motley Fool contributor Brendon Lau owns shares of Australia & New Zealand Banking Group Limited, National Australia Bank Limited, and Westpac Banking. The Motley Fool Australia owns shares of National Australia Bank Limited. 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 Scott Phillips.

Two New Stock Picks Every Month!

Not to alarm you, but you’re about to miss a very important event! Chief Investment Advisor Scott Phillips and his team at Motley Fool Share Advisor are about to reveal their latest official stock recommendation. The premium “buy alert” will be unveiled to members and you can be among the first to act on the tip.

Don’t let this opportunity pass you by – this is your chance to get in early!

Simply enter your email now to find out how you can get instant access.

By clicking this button, you agree to our Terms of Service and Privacy Policy. We will use your email address only to keep you informed about updates to our website and about other products and services we think might interest you. You can unsubscribe from Take Stock at anytime. Please refer to our Financial Services Guide (FSG) for more information.