With the tightening regulation regarding lending activity in Australia, investors would be right to be wary of the big banks. The bank levy alone is expected to impact profits by around 4%, while tighter restrictions on interest-only loans and investor lending could also lead to slower growth at 'Big 4' banks like Westpac Banking Corp (ASX: WBC).
On the other hand, banks could see an improvement in their profitability as their recent increase in interest rates for borrowers leads to wider profit margins and higher quality borrowers. Despite that, you still won't find me owning shares of Westpac. Not while the company has 50% of its loan book loaned to interest-only borrowers.
In my opinion, that makes these loans a major bet from borrowers on continued employment, sunny economic conditions, and rising house prices. They are a house of cards stacked on the premise that tenants and borrowers remain employed – already we've seen evidence of what happens when employment dries up in resource regions. House prices drop, rental yields fall, and bad loans soar.
What are the chances of a major economic slow-down in Australia happening in the next 12 months? I haven't got a clue. 5%? 10%? Slim. But I still wouldn't run that risk in a bank with 50% interest-only loans. I'd much rather buy CSL Limited (ASX: CSL), another blue-chip titan, albeit one with a better business than Westpac.
With its research & development portfolio of innovative treatments to rare conditions, CSL Limited is in a much better position to grow and maintain its profitability, regardless of what happens to the Australian economy. A strong global position sees CSL generate billions in cash every year which it reinvests in research and buying back its own shares, generating strong results for shareholders. Yeah, it looks expensive, and yeah, it only pays a 1.3% dividend. But forced to choose between the two, I'd buy CSL over Westpac any day of the week.
