The big four S&P/ASX 200 Index (ASX: XJO) bank shares have all underperformed the benchmark index in 2023.
Since the opening bell on 3 January, the ASX 200 has gained 1.8%.
Here's how the big bank stocks have performed year to date:
- Australia and New Zealand Banking Group Ltd (ASX: ANZ) shares are down 1.1%
- National Australia Bank Ltd (ASX: NAB) shares are down 12.9%
- Westpac Banking Corp (ASX: WBC) shares are down 8.9%
- Commonwealth Bank of Australia (ASX: CBA) shares are down 5.4%
The underperformance of these ASX 200 bank shares comes amid the rapid interest rate increases rolled out by the Reserve Bank of Australia to tame soaring inflation.
The central bank has boosted interest rates 12 times since May 2022. The official cash rate now stands at 4.10%, up from the historic 0.10% 13 months ago. And investors can likely expect more hikes to come from the RBA in 2023.
Gradual increases in the cash rate can be good for the banks, as it enables them to increase their net interest margins. But the rapid rate increases from all-time lows could deliver some painful write-downs for ASX 200 bank shares if stressed mortgage owners find they can no longer make their monthly payments.
ASX 200 banks shares and $267 billion in 'risky' home loans
Rock bottom interest rates saw the big four ASX 200 bank shares write $267 billion in new home loans to "risky" borrowers from the 2020 financial year through to the end of the 2022 financial year, the analysts at Barrenjoey report.
According to APRA, borrowers holding loans with a debt to income (DTI) ratio of six or more times their income are considered risky.
"With mortgage rates now well through the serviceability buffers used during the pandemic boom, we believe many borrowers are entering a period of severe stress," Barrenjoey banking analyst Jon Mott said (courtesy of The Australian Financial Review).
Indeed, average repayments on a $750,000 mortgage have increased by some $20,000 a year since the RBA began tightening last May.
Add in concerns about a looming recession and rising unemployment, and ASX 200 bank shares could see a surge in defaults.
Mott believes Australia is likely to enter a recession, with unemployment potentially reaching 5%.
According to Mott:
This will have a significant impact on many mortgagors who borrowed their maximum. Many of these customers are likely to fall into delinquency as serviceability buffers have been exceeded, real wages have fallen, and additional work is likely to become harder to come by…
The banks will have to deal with elevated levels of 'zombie mortgages' which are likely to be restructured to interest-only or extend-and-pretend.
Potentially dragging on the dividend outlook for ASX 200 bank shares, should the Aussie economy enter a recession, Mott forecasts 2024 impairment charges could leap to $7.7 billion, crimping the banks' profits.
As for the big banks' own modelling of expected losses from mounting bad debts, Mott called those "overly optimistic".
"All models are only as good as their assumptions, and banks have an incentive to provide a more optimistic view," he said.
AMP chief economist Shane Oliver shares some of Mott's concerns. According to Oliver:
On the RBA's analysis, 15% of households with a variable rate mortgage – which means about 1 million people – will be cash-flow negative by year-end at a 3.75% cash rate – and we are now well beyond this.
Don't run for the hills yet
Not everyone believes ASX 200 bank shares are facing a potential surge in bad debts from rocketing interest rates.
According to Hugh Dive, chief investment officer at Atlas Funds Management (quoted by the AFR):
This will be very unpleasant for the people involved with high DTI loans – but will this result in foreclosure sales [by banks], that will impact on bad debts and bank profits? Given where house prices are – most borrowers are in positive equity – are bank shareholders going to take massive hits? Probably not.
Also bear in mind that the big four ASX 200 bank shares scored as the most capitalised in the world, as gauged by their common equity tier 1 (CET1) ratios. The CET1 ratio measures the core equity capital of the ASX 200 banks compared to their risk-weighted assets.
So, they've got some healthy buffers to help insulate them from a likely increase in non-performing loans. Which is good. Because it looks like they might be needing those buffers.
