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Are underperforming banks set to rebound in FY19?

Hopes of a quick rebound in property prices could see some of the biggest blue-chip laggards in FY18 surge ahead in the new financial year.

A report by property analytics firm CoreLogic and credit ratings agency Moody’s is predicting that the ongoing housing slump could be shallow and short-lived, according to the Financial Times.

If this comes to pass, you can expect our biggest mortgage lenders Commonwealth Bank of Australia (ASX: CBA), Westpac Banking Corp (ASX: WBC), National Australia Bank Ltd. (ASX: NAB) and Australia and New Zealand Banking Group (ASX: ANZ) to make a big comeback in FY19.

The share prices of the big banks are underperforming the broader market with the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) up around 10% over the past 12 months as the index hit a new 10-year high.

In contrast, CBA is the worst performer as it has slumped 10%, while the other three of its peers are also miles away from matching the top 200 stock index.

That could very well change over the next 12-months though as strong employment, the accommodative Reserve Bank of Australia (RBA), falling numbers of house sellers and the relaxing of some lending standards will help turnaround the market in 2019, according to the CoreLogic-Moody report.

Their analysts are forecasting Sydney prices to fall a mere 5% in 2018 before edging higher next year, and apartment prices will hold up better than many are expecting.

If the prediction comes to pass, it will also see a re-rating in the share prices of underperforming home and apartment builders like Mirvac Group (ASX: MGR) and Stockland Corporation Ltd (ASX: SGP).

But I think it’s too early to become optimistic on the Australian residential market as the supportive factors outlined in the article don’t address the key concerns I have about the slumping house prices.

To be sure, it isn’t employment or interest rates that have triggered the fall in the property market, so the ease of getting a job won’t save it from further falls.

The RBA’s stand on interest rates is also unlikely to stop mortgage rates from rising given the outlook for global bond yields, which tend to be positively correlated to the funding costs of our banks.

The drop in supply of homes for sale is also a natural occurrence whenever the market peaks. Sellers tend to temporarily withdraw from the market in the hope that prices will stabilise and recover, but if that doesn’t happen, supply will come rushing back into the market – particularly given that there is around $360 billion in interest only loans that will be converting to interest and principle (P+I) loans over the next three years.

Reverting to P+I loans could force mortgage repayments to jump by around a third even if the interest rate stays the same. Compounding the problem is our record high household debt.

For all our sakes, I hope I am wrong. But regardless of the outcome, it’s hard to see how property can beat equities in terms of returns in FY19 – although I would stay away from apartment builders.

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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.

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