Why market feels that Royal Commission is bad for bank equities?

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Australian Economy
  • Public hearings of the Hayne royal commission seem to enforce lower leverage and simpler business models in the financial segment that may have an impact on equities
  • Return on Equities (ROE) coming close to cost of equity is worth looking at for investments

What makes the question particularly difficult is the four big banks – Australia and New Zealand Banking Group Limited (ASX: ANZ), National Australia Bank (ASX: NAB), Commonwealth Bank of Australia (ASX: CBA) and Westpac Banking Corporation (ASX: WBC) caught in the cross-hairs of the Hayne royal commission, and coming under increasing attack for poor behavior. Many analysts are concerned that bankers could respond to the findings of the Hayne royal commission by raising their lending standards, particularly in the critical home-loan market. The problem comes on the supply of bank credit which could put downward pressure on housing prices, and in turn could harm the balance sheets of Australian households – many of whom have loaded up on debt to buy homes and investment properties.

In terms of equity, March was a month of misery for the country’s big four banks as they watched their share prices tumble significantly. But the banks’ woes have left many investors wondering whether the sell-off means the big four are coming as an interesting investment opportunity. For example, if you have invested money in the Balanced Fund in Australia’s Super fund Industry, they put around a quarter of your money into Australian shares. That will include shares in the banks. So, when Australian stock prices fall, your super savings shrink a bit.

While we do feel that banks like ANZ and NAB do stand a chance to be grabbed at low levels, many other financial sector stocks still look to be sitting in the potholes. For example, AMP Ltd, which seems to be in gross breach of their code of conduct, portraying the fall-side of the sector’s operations. Staff are even asked to be nonpolitical in their work while Australians have been told for decades that they are fortunate for their highly profitable-but-stable and ethical financial institutions. However, the recent dents in the system take a toll on investors who seem to be changing their style of investing now.

The key thing to ponder about is the reputational damage but at the wake of the Royal Commission, new or evolving business models may take a prevalence. With an impact on the stockbroking industry as well, many are eying the upcoming annual Stockbrokers and Financial Advisers Association conference at Melbourne discussing the changing market infrastructure and dealing with some of the misconduct unveiled by the royal commission.

However, we also note that the return on equities with the challenges laid out for banks have reduced from about 15%-18% to 10%-12%, over the last few years, which now looks closer to the cost of equity. This deleveraging would stem down to the impact on returns to shareholders.

On the other hand, while Royal Commission might seem to bring the strings down, the latest relief in the rise of the yield on US 10-year Treasury note, has helped many investors sticking to equities, in general. Though we do feel bank dividends are under the claws of the latest investigations, but stocks like ANZ can still weigh over many given the capital position. ANZ has fallen about 3.8% in last six months but rose by 5.7% in one month with support from its decent financial update.


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