The ongoing Banking Royal Commission has been a big drag on the share prices of our best loved banks at a time when these stocks should be performing strongly.
But given how the first two weeks of the Royal Commission is going, I somehow suspect we won't see the seasonal outperformance of our big four banks, which includes 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).
These stocks tend to be well supported during this period from dividend-stripping – a strategy where investors rotate into the different bank stocks to get the dividend and franking credits.
It is still early days into the year-long Royal Commission to gauge the full impact this will have on bank earnings, but I think it will be very difficult for banks to escape stricter controls on consumer lending – particularly in the area of Household Expenditure Measure (HEM).
HEM is the living expenses that new borrowers declare to their banks in their loan application. There appears to be outright rorting on this front with borrowers under-declaring expenses to get access to bigger loans and lenders not bothering to check.
This probably explains why Australian households are the most indebted in the world!
If banks are now forced (either voluntarily or by the regulator) to undertake proper assessments of loans, UBS warns that this could lead to a credit crunch where loans become much harder to get.
This is probably a good outcome for our economy and share market in the longer run, but the transition will be painful for just about everyone.
This isn't just bad news for the profit growth of our banks, which will be impacted from having fewer borrowers and rising costs from tougher compliance.
Less credit means less spending power. This in turn may impact on home builders like Mirvac Group (ASX: MGR) and Stockland Corporation Ltd (ASX: SGP) through falling residential property prices.
Retailers will also take the brunt of this change as consumers will have less to spend. Companies like electronics and furniture retailer Harvey Norman Holdings Limited (ASX: HVN) and its rival JB Hi-Fi Limited (ASX: JBH) will face challenging times ahead.
While UBS's base-case economic outlook is only predicting a modest tightening in credit conditions, I think the risks are much greater than this – particularly if you consider that we are in a rising interest rate environment as well.
It's almost unthinkable – but a year from now, our big banks may be forced to commit the cardinal sin of cutting dividends to protect their balance sheets.
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