With the banking sector changing under our feet and global trade in slowdown, it should come as little surprise geopolitical tensions are high and shareholders are questioning the longevity of company earnings. Specific to the major banks, we have witnessed one of the strongest and longest periods of loan growth in history which has pushed household debt levels to record highs.

As a general rule, none of this would typically portend to be beneficial for banks in a forward looking context. However, balancing the questionable long-term outlook is a potential tailwind from rising inflation expectations, which have the ability to increase net interest margins and thereby profitability.

The Long-Term Backdrop for Traditional Banking is Ominous

One needs to ask themselves how much scope for future growth is available in the major banks given high existing debt levels. One way to illustrate this is to provide a global perspective, which shows Australian banks growing household lending at a very healthy rate of 6.2% against the headwind of the highest existing debt levels in the world. This lending has increased in importance as it accounts for approximately 60% of total lending – as opposed to commercial lending (data is at 31 October 2016).

This creates a sense of nervousness for people that explicitly focus on the dividend yield and forget about the cash-flow that finances the dividends. It is worth considering how much more leveraged Australian households can get, especially as the average household is getting older.

The secondary consideration is value. Below is an extract from our November 2016 edition showing the valuations of the broad financials index excluding property. We can see the sector appeared modestly overvalued on the metric below, however would need to be balanced with alternative valuation methodologies.

 

 

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