Is the dream run of Australia’s Big 4 coming to an end?

By Michael O’Neill – Portfolio Manager | 01 December 2017
Is the dream run of Australia’s Big 4 coming to an end?

With the Royal Commission announced this week, many shareholders in Australian Banks will be wondering how it will affect their investment. Investors Mutual has, over the past few years, been relatively cautious around investing in the big 4 banks. This article seeks to explain to investors the thinking behind our view. 

The continued success and profitability of Australian banks over the last few decades, as well as recent large capital raisings, means that Australia’s big 4 banks are now valued at over $400 billion by market capitalisation and they account for over 26% of the S&P/ASX 300 index. As a result, Australian bank stocks are widely held by many Australians either directly, or through their super funds.

Do Australian Banks warrant such a high weighting in investors' portfolios going forward?

The foundation for extraordinary growth

The last three decades have been a dream run for Australia’s big 4 banks. Strong earnings growth translated into strong share price appreciation, as well as reliable, fully franked dividends - exactly what all investors were looking for over the long term.

The foundations for this extraordinary run began as far back as the mid 1980’s, a time when median house prices were two times disposable income, while household debt to disposable income sat at around 50%. This relatively low level of consumer indebtedness provided a low base from which the banks could grow.

Bank deregulation really kick-started this growth in 1987 (see Chart 1), with the removal of interest rate controls and the reduction of mortgage capital requirements. This deregulation allowed Australian banks to compete more aggressively for home loans and deposits, while at the same time they were required to hold far less capital on their balance sheet to support underperforming loans, relative to other classes of lending like business loans.

This resulted in commercial lending being crowded-out ever since the 1980’s by more-profitable residential lending, with double digit growth in this sector helped along by the rise of third-party mortgage brokers like Aussie Home Loans (1992) and RAMS (1995). These and other mortgage brokers provided the big four with an expanded, and far more incentivised distribution capability, which also provided more flexible customer service and document processing – resulting in a far better conversion rate than the banks were achieving through their branch network.

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