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Key points
- As inflation rises, and interest rates are expected to follow, many market watchers are looking to big banks
- However, T. Rowe Price's Nick Vidale believes investors should be "cautious" of the banking sector
- He worries about the sector's earnings and banks' ability to cash in on interest rate increases
It's been an interesting start to 2022 for ASX shares. With inflation rising and talk interest rates might follow, there's one sector many market watchers have firmly in their sights – S&P/ASX 200 Index (ASX: XJO) banks.
But T. Rowe Price investment analyst Nick Vidale isn't buying what the big banks are selling in 2022.
Here's why the expert is warning investors to be cautious of the major banks this year.
Are ASX bank shares a buy for 2022?
Many might be scratching their heads as to why a professional might be bearish on banks during a time of potentially rising interest rates. Particularly as ASX 200 banks have been performing notably well lately.
Over the past 12 months, the only big bank to underperform the ASX 200 is Westpac Banking Corp (ASX: WBC), which has fallen 3%.
The index has gained 4% in that period. Meanwhile, the share prices of National Australia Bank Ltd (ASX: NAB), Australia and New Zealand Banking Group Ltd (ASX: ANZ), and Commonwealth Bank of Australia (ASX: CBA) have gained 13%, 9%, and 7% respectively.
But Vidale has a number of good reasons as to why T. Rowe Price is keeping an eye on the sector.
The first: Banks' earnings. Many banks downgraded their earnings at the start of the COVID-19 pandemic, often due to net interest margin compression and impairments.
While much of their earnings have recovered, the expert isn't convinced of their stability.
"The earnings composition of the banks now, compared to 2 years ago, is much more driven by low impairments," said Vidale. "So, the quality of the earnings now is lower.
"And this leads us to be cautious because, if and when we move into an impairment cycle, the downgrades could be more pronounced than we saw previously."
Are banks ready for interest rate rises?
Rising interest rates normally spell good news for banks as it allows them to reprice loans. But Vidale worries ASX 200 banks might not be able to capitalise on increasing interest rates this time around.
"Much of the discussion around rising interest rates comes back to how the banks will benefit from that," he said. "But actually, we think this doesn't take into consideration what's happening with the major banks at an industry level."
Previously, 15% to 20% of Australian home loans were fixed-price loans, leaving banks able to reprice 80% to 85% of mortgages quickly when rates rise.
Over the course of the pandemic, however, borrowers have taken advantage of a low-interest-rate environment with more opting for fixed-rate mortgages. In fact, in the second half of 2021, 35% of Australian home loans were fixed-rate loans. Vidale continued:
This creates 2 problems. The first is, it reduces banks leverage to rising interest rates. The second is, it could potentially create customer churn 2 to 3 years down the track when customers come up to refinance their mortgage.
As customers look to refinance their mortgages in 2 years' time, we're going to get a lot of customer churn and we think that will put pressure down on net interest margins.
[F]rom industry structure perspective, even though rates are good for banks, is it possibly going to be negated by the competitive pressures that take place within the banking sector.
