The impacts of rising interest rates continue to work their way through the economy. Homeowners are facing a more than doubling of interest repayments.

While this increases loan loss risks for the banks Morningstar Senior Equity Analyst Nathan Zaia expects losses will remain small relative to the size of bank loan books.

More borrowers are in what is considered mortgage stress, where over 35% of gross income is eaten up by loan repayments. While negative for living standards, the majority in Zaia’s view can make cuts to discretionary spending to meet repayments.

Another option is available with homeowners with wiggle room is to move from principal and interest to interest-only repayments. Zaia says this trend is not notable in bank results to date.

The impact of cuts to spending are being felt as the Australian Bureau of Statistics reported on Thursday that the volume of retail goods and services fell by .5% in the second quarter. This followed falls of .8% in first quarter of 2023 and .4% in the fourth quarter.

Going forward the economic backdrop will be crucial, as population growth and low unemployment (even if rising) are expected to support house prices and ability to service debt.

Bank margins bounced back in first-half fiscal 2023, but competition to retain customers as fixed rates mature and credit growth slows, plus depositors chasing higher rate savings products, are seeing margins ease.

Current pricing for loans and deposits is likely to deliver poor returns, especially for smaller-scale nonmajor banks; hence, we would expect they follow repricing undertaken by wide-moat-rated major banks.

The removal of cash back offers from most major banks, and some lifting in advertised rates by more than Reserve Bank of Australia rate increases, are potentially early signs the focus is shifting from volume to margin.

Zaia has not made changes to his fair value estimates for the banks under his coverage universe. He thinks Westpac (ASX: WBC) and ANZ Group (ASX: ANZ) reflect best value among the wide-moat-rated majors trading at material discounts to our respective fair value estimates.

National Australia Bank (ASX: NAB) is modestly undervalued, while Commonwealth Bank (ASX: CBA) remains an expensive outlier.

Among the no-moat-rated nonmajor banks, MyState (ASX: MYS) and Bank of Queensland (ASX: BOQ) are cheapest relative to our fair value estimates. Bendigo (ASX: BEN) and Adelaide Bank trade at a less material discount to our fair value.