Is it time to get back into the Big Four banks?

The more things change, the more they stay the same… Now that last month’s final report from the Royal Commission into misconduct in the financial services industry is well and truly behind us, is it time to re-examine the ‘Big Four’ banks?

The market seems to think so.

In just over a month, the 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) share prices have all risen on average over 5.5% since the final report was handed down. Although the share market seems to be in a ‘forgive-and-forget’ kind of mood, can the banks be trusted to deliver for shareholders without forsaking customers going forward?

Of course, many investors love the ‘Big Four’ for their dividends. The banks are all paying a dividend between 5 and 8 percent (before franking). It is reasonable to expect that these yields are relatively sustainable, due to the banks’ grip on the Australian banking industry, their dominant pricing power and their brands (although this one has taken an obvious hit).

I believe the biggest threat to the banks’ future cash flow is the risk of Australia’s housing market undergoing a significant correction in the next year or two. The housing boom of the last decade has fuelled the profitability of the ‘Big Four’. Sharply rising house prices saw a rush of mortgage applications from FOMO-crazed property investors, particularly between 2012 and 2016. This sentiment has dried up over the past two years, but any further corrections in property prices would have a significant impact on the banks’ balance sheets if investors decide to cut their losses.

Furthermore, the proposed curtailing of tax concessions such as limiting negative gearing and cutting the capital gains tax discount, if implemented, would also add pressure on lending demand. Mortgage lending is a highly-profitable revenue stream for all of the banks, and as such, any significant changes in this environment would significantly impact free cash flow.

Foolish Takeaway

For these reasons, I would consider NAB and ANZ as a safer bet, as they have a larger exposure to business lending and less to residential property loans than the Commonwealth Bank and Westpac. NAB alone receives around 45% of its revenue from commercial lending operations. This represents a more diversified business model and means that NAB and ANZ are better positioned to weather adversity in the property market going forward.

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Motley Fool contributor Sebastian Bowen owns shares of National Australia Bank Limited. 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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