The big banks are a core part of many SMSF or mum and dad investors' portfolios thanks to their defensive nature and steady stream of term-deposit-thumping dividends.
However, the banks' share prices have been in reverse for the last 18 months and there's no shortage of reasons why including today's release of the Hayne Royal Commission's recommendations of reforms for the financial services sector.
There'll be plenty of recommendations all of which are likely to involve rising compliance or legal costs for the banks, while any restrictions on sales strategies could hurt their top-line growth too.
All will be revealed this afternoon and worryingly for bank investors the Royal Commission is far from the only headwind facing performance.
Below are six more reasons why bank shares and dividends could stay under pressure in 2019:
- Melbourne and Sydney's residential property prices are falling relatively quickly and these two capital cities represent around half of Australia's residential property value. By far the big banks' most profitable business is home loan lending and as the value of the assets (home loans and equity in residential property) on their balance sheets falls so does their book value and investor confidence.
- Aside from the Royal Commission the banks are already facing increased regulation due to past misdemeanours. Commonwealth Bank of Australia (ASX: CBA) for example is facing shareholder class actions, AUSTRAC proceedings, and an ASIC investigation. All that before the Royal Commission hands down its recommendations this afternoon. While the CEO of National Australia Bank Ltd (ASX: NAB) seems so overwhelmed by his bank's problems he's had to take an extended summer holiday in a move that doesn't inspire confidence in the bank's leadership.
- New regulatory demands are creating a credit squeeze as the banks calculate borrowers' expenses more strictly to result in lower borrowing limits. The less a bank can lend profitably on a risk-adjusted basis the lower its profits.
- Rising wholesale funding costs are a consequence of rising benchmark lending or Fed funding rates in the US. As benchmark lending rates in the US rise so do Australian banks' borrowing costs and banks turn a profit by making more on what they lend than they pay on what they borrow. Therefore they have to pass rising borrowings costs on to home loan borrowers or likely see profits, profit margins, and dividends all fall.
- Changing capital adequacy requirements out of the Basel Banking Supervisory Committee continue to restrict banks' ability to lend or over-leverage as they must keep a certain amount of idle capital as a backstop against the risk of faulty loans assessed on a risk weighted basis. The more idle capital a bank carries the lower its return on equity and profitability.
- One lever the banks have to protect profits is to pull out costs, however, this looks increasingly tough given the aforementioned regulatory and public pressure on them to have squeaky clean compliance and product sales processes.
The above are just some of the problems the banks face in 2019, but for shareholders much of the bad news is priced into their valuations already, therefore it wouldn't make sense to sell now in panic or in anticipation of a crash.
For example there's as much chance as the banks' share prices rallying in relief tomorrow as falling and the big banks' vice-like grip on home loan lending and other core banking activities won't be broken by the Royal Commission. As such I expect over the long term they remain a reasonable bet for conservative income seekers.
