The V-shape residential market recovery has sent ASX bank share prices rallying, but Citigroup believes you should be banking on their smaller ASX rivals instead.
This is because ASX big bank shares aren't as leveraged to the housing market as non-bank financial institutions (NBFIs).
That's grim news for ASX banks as the sector has outperformed on the housing rebound.
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ASX banks' outperformance is coming back to bite them
The Commonwealth Bank of Australia (ASX: CBA) share price, Australia and New Zealand Banking GrpLtd (ASX: ANZ) share price, National Australia Bank Ltd. (ASX: NAB) share price and Westpac Banking Corp (ASX: WBC) share price have beaten the S&P/ASX 200 Index (Index:^AXJO) over the past year.
Their big rally leaves them more vulnerable to bad news even though their operating environment appears bullish.
Rising house prices are usually a tailwind for the sector. But this time is different as the rebound is driven by record low mortgage rates, noted Citigroup.
Why emerging lenders are better buys than ASX banks
"Despite recent investor fears, lenders have plentiful cheap funding to maintain these record low rates, but housing affordability is set to slow house prices," said the broker.
"Loan demand is broadening. However, this spells trouble for Major Bank revenue growth, which is expected to be lower than previous cycles.
"NBFIs, fuelled by rising borrower demand and falling funding costs, can drive ~7% revenue growth, to lead the sector."
In contrast, Citi is forecasting around a 5% increase in revenue for ASX bank shares, which is lower than previous cycles.
ASX NBFIs trading at an unwarranted discount
Despite the superior revenue growth profile for NBFIs, these ASX shares trade at a discount to ASX banks. Citi believes this presents a unique opportunity for investors.
"The NBFIs are expected to be the ultimate beneficiaries of the recent up-cycle in house prices," said the broker.
"At an average ~12x PE [price-earnings], below the Major Banks (~16x) and Regional Banks (~14x), the NBFIs are not currently reflecting their mortgage revenue growth prospects."
Shares to buy over ASX banks
Citi's two favourite NBFIs are the Liberty Financial Group Ltd (ASX: LFG) share price and Australian Finance Group Ltd (ASX: AFG) share price.
The broker upgraded its FY22 and FY23 cash earnings estimate for both ASX shares by 5% to 8%, each.
This isn't to say that the outlook for ASX bank lenders is grim. If anything, the Macquarie Group Ltd (ASX: MQG) share price is a standout due to its strong deposit base.
However, Citi pointed out that the Macquarie share price is looking fully valued at current levels.
