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Australian house price falls could send your bank shares tumbling

As crazy as it first sounds, a hard landing in the property market may actually be what the big banks need to regain favour with investors.

Just to be clear, I am not forecasting a residential market slump nor am I advocating for one, but the idea is an interesting one worth pondering on as I read a Bell Potter report downgrading Westpac Banking Corp (ASX: WBC) to “hold” from “buy” following the bank’s quarterly update last week.

Shareholders in Westpac are enjoying a some respite as its share price recovered from its morning sell-off to trade 0.4% higher at $27.76 in after lunch trade as the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index added 0.3%.

The bank recently caught investors and analysts off-guard when it reported a sharp drop in net interest margin (NIM) to 2.06% from 2.17% due to higher funding costs and weaker performance from its Treasury Markets operations.

The saving grace was the bank’s Common Equity Tier-1 (CET-1) ratio, a key measure of balance sheet strength, and that’s one of the few things going in favour of Westpac and its fellow big banks.

Bell Potter noted that Westpac’s CET-1 ratio of 10.4% puts it in the top quartile of the major global banks.

What’s more, Westpac’s CET-1 ratio only dropped slightly from 10.5% in the previous quarter despite the bank paying an interim dividend and a $566 million conversion of preference shares.

“Our cash NPAT estimates are lowered by 4%, with NIM decline of up to 8bp in the medium-term offset by slightly better loan impairment outcomes,” said the broker.

“Taking into consideration potential political and resulting economic uncertainties in the next 12-18 months, we have reluctantly lowered WBC’s valuation and price target by 6% to $30.00 (previously $31.90).”

While brokers are largely divided on the outlook for the big banks, which include Westpac, Commonwealth Bank of Australia (ASX: CBA), National Australia Bank Ltd. (AX:NAB) and Australia and New Zealand Banking Group (ASX: ANZ), no one is disputing their ability to weather a reasonably hard fall in the housing market.

The same can’t necessarily be said of their smaller rivals and rising competition is one of the reasons why some analysts are warning investors to avoid the sector.

I am not saying that banks stocks won’t tumble if the property market falls more than expected, and it’s a fine line between a “hard enough” landing and a “too hard” landing that sends our economy in a tailspin, but what’s obvious is that the big banks will be the only ones able to pick themselves up after the storm.

In the meantime, there’s just too much uncertainty to go overweight on the sector – at least until we become more confident that the property slowdown has turned a corner. The problem is we may not see signs of this for a few months yet.

Banks are in the “too hard” basket when there are more attractive blue-chip stocks paying good dividends to focus on.

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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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