The major banks’ mortgage rate hikes have sent them down a risky path, opening the door to a repeat of the competition that crunched home loan margins in the 1990s when mortgage brokers stormed the market.
“While upward housing loan repricing initially feels good, the preservation of super-high housing product return on equity is not without risk,” CLSA analyst Brian Johnson said in a lengthy report to clients yesterday that detailed his underweight view of the sector.
The report said the big four banks — Commonwealth Bank, Westpac, National Australia Bank and ANZ — were still about $31 billion short of top-tier capital despite their recent share raisings, and that “mid-cycle” dividends could decline up to 25 per cent.
The findings add to the debate about the banks’ controversial increases to variable mortgage rates independent of the Reserve Bank to offset the blow from stricter risk weighting rules and the $18bn in equity they raised from shareholders.
Apart from NAB, which introduced higher rates on November 12, customers of CBA, ANZ and Westpac on Friday began feeling the sting of the big banks’ decision last month to raise rates by 15-20 basis points.
It was the latest in a series of repricing initiatives by the big banks this year, including holding back some of the RBA’s official rate cut in May and increasing mortgage rates for property investors in July.
“The housing repricing initiatives far exceed the dilutive impact of higher housing risk weighting,” Mr Johnson said, adding that despite the political heat, the “far bigger strategic issue” for the banks was the risk of losing market share to “disrupters”.
According to CLSA, the big banks generate “super high” ROE of up to 49 per cent on mortgages to owner-occupiers and up to 64 per cent from landlord customers. While several other banks have piggybacked on the big lenders’ move and also raised borrowing rates, Mr Johnson said many non-banks had not and small lenders were advertising variable rates as low as 3.99 per cent, versus the majors around 5.6 per cent.
He said Westpac was most at risk after lifting mortgage rates a larger 20 basis points, warning “above peer pricing is a bit like wetting your bed — initially its warm but then it’s just wet”.
Also, the big banks were walking a fine line politically “between a tolerable oligopoly and a cartel, and a uniform uplift in housing pricing will heighten sectoral oversight”.
The warning comes amid fears the banks were setting themselves up for the sort of pain being felt by Woolworths, which was once one of the most profitable supermarkets globally after propping up margins to benefit shareholders, but is now reeling after letting Aldi and Coles steal customers.
Replicating the success of Aldi in banking and grabbing 10 per cent of the $1.5 trillion mortgage market would be a $800 million profit prize, according to UBS.
To date, most “fintech” disrupters are targeting more easily accessible segments of banking like personal loans. But several have spoken about one day taking up the fight in mortgages, while established non-banks, such as Pepper Group, compete hard.
“With housing product ROE so high, the Australian banks are inviting competition from suddenly competitive regional banks and new technology-driven disrupters in the same way that the advent of securitisation funding/broker origination allowed Aussie Home Loans to discount home loans,” Mr Johnson said.
He said the banks were forced to cut home loan margins in half to 200 basis points in the late 1990s. The banks have dismissed the comparison to Woolworths, but are alert to the threat of new fintech companies and believe they can partner with them or develop similar technologies. They have also brushed off the threat to dividends absent a major spike in bad debts and argued customers had to share the “cost” of higher capital requirements.
But there is concern higher mortgage rates will weigh on the health of the property market, where Mr Johnson said prices were “bubblish”. Moody’s yesterday warned the banks’ rate hikes “will further increase delinquency and default risks” for mortgages in a market where deteriorating housing affordability was already putting stress on loans.
Mr Johnson said rather than a national collapse, the biggest risk was specific housing price corrections, particularly in WA, similar to what Queensland experienced in 2008-09.
According to CLSA, the major banks would suffer a $6.5bn hit to earnings.
This article first appeared in The Australian Business Review.