Big bank shares have hidden perils

Given the volatility of the share market and a slowing economy, share investors have sound reasons for being concerned about participating in the spate of big bank new share issues.

The problem for many is that with the recovery in share prices following the global financial crisis, existing bank share holdings already make up a high proportion of their share portfolios.

Especially for investors whose portfolios are already overweight in Australian shares, the incentive to pass up the new investment opportunity is strong.

Investors in the National Australia Bank new issue have seen the share price retreat since the issue. Similarly, ANZ Banking Group share price fell considerably after a raising from institutional investors. Small investors are now being offered a share purchase plan to acquire up to $15,000 of new shares at the now lower share price.

The question for eligible shareholders to consider is whether the share price could fall further if, for example, the new issue reduces future per share earnings and dividend payouts.

Whereas a decision not to participate in a share purchase plan provides no immediate benefit to shareholders, the Commonwealth Bank of Australia (CBA) renounceable rights issue provides some compensation for investors who choose not to participate. Because the rights are renounceable, the entitlement can be sold on the share market and the investor pockets the cash received after paying brokerage and any relevant income tax.

The CBA offer also assists smaller investors by selling any entitlements not taken up and paying the net proceeds to relevant shareholders. Unless the CBA share price tanks below the discounted new issue price, there is at least some return to investors who do not participate in the new issue.

The pressure from the Australian Prudential Regulation Authority (APRA) on the big four banks to increase their capital resource has focused investor attention on the likely impact of their future profitability.

The purpose of the higher capital is to ensure the big four have the financial capacity to absorb losses.

Among other things, this has led to bank share analysts questioning how long the historically lowprovisioning for bad debts will continue. With burgeoning mortgage books in a time of buoyant house prices, the risks of bad debts are increasing, which is presumably behind APRA's pressure to increase capital reserves.

While the prospect of a high franked dividend yield is tempting, when deciding to participate in banks' new share issues, investors need to be aware of the difficulties facing the banks in maintaining and enhancing their profitability.

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Daryl Dixon

Executive Chairman

Daryl Dixon is one of Australia’s foremost investment experts and a well known writer and consultant. He has provided trusted advice to thousands of personal clients over more than 25 years and is an acknowledged expert in the areas of tax, superannuation (including public sector superannuation), social security and investments.

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