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Banks’ mortgage price war will hurt dividends: JPMorgan
The Australian 12:00am October 20, 2016
Michael Bennet
The big banks must rely less on deep discounting of mortgages and instead target customers with selective pricing as part of efforts to protect dividends, according to a major report.
JPMorgan bank analyst Scott Manning said the banks should address “poor discipline” in managing mortgage books — including “spending” recent loan repricing benefits on discounts — by offering rates that differed by 2 percentage points depending on customers’ risk and loan purpose.
He found Commonwealth Bank, Westpac, ANZ and National Australia Bank’s return on equity from mortgages had slid to 25 per cent from 40 per cent between 2010 and 2015 amid higher capital requirements and greater customer “churn”.
The blow, however, occurred as returns from the banks’ other products sank to the same level as their cost of capital at around 10 per cent. “The mortgage contribution to overall profitability is becoming increasingly important because the rest of their business just isn’t firing,” he said.
“We may have reached a ‘line in the sand’ on mortgage profitability — mortgage ROEs can’t really ‘afford’ to go lower than they are today without having an impact on dividend sustainability.
“The market structure is the key issue, with 80 per cent market share and high intentions (from borrowers) to refinance; they are their own worst enemies if they pursue a price-led strategy.”
The findings are topical as investors fear NAB and Westpac may slice their dividends at their annual results, following ANZ’s cut six months ago.
The report also sheds light on the banks’ massive mortgage profits after they resisted providing ROE data at the House of Representatives economics committee inquiry into the big four banks earlier this month. The inquiry questioned their interest rate decisions after banks held back half the Reserve Bank’s August rate cut.
Assisted by analysis from Digital Finance Analytics, Mr Manning said the banks’ use of excessive discounts to maintain market share was “puzzling” because earnings were already being revised lower and they were mainly competing among themselves, thus eroding benefits from the “oligopoly”.
Mr Manning argued the banks should stop “rocking the boat” and restore mortgage profitability by using more nuanced pricing based on risk and product features, claiming the biggest players, CBA and Westpac, were already driving change.
Differential pricing re-emerged last year with investors stung with more expensive loans.
Mr Manning said banks should shed their focus on market share and offer discounts of 130 basis points for safer mortgages with low loan to value ratios, with higher LVR investor loans materially dependant on rental income priced at a “premium” of 100 basis points, opening up a more than 200 basis point differential.
First-home buyers may also suffer more expensive interest rates.
Prior to August, when CBA reined in discounts by up to 15 basis points, discounts on advertised variable home loans were said to be around 150 basis points.
DFA principal Martin North said refinancing had jumped to 30 per cent of loan approvals as consumers sought a better deal and parents released equity in their homes to give children a deposit, with more than half of consumers with a major bank staying with one of the big four lenders.
He said regional banks, building societies and credit unions were being “squeezed” by the major banks, as highlighted when Bank of Queensland this month reported a seven basis point slide in net interest margin amid declining loan growth.
Mr Manning said the major banks “are very well positioned; when they’re discounting they’re actually competing against each other and driving down the returns of the oligopoly”.
“They’re not actually defending against smaller banks or non-banks.”
Reporting an 11 per cent rise in profit before tax to $73.7 million, non-bank Liberty Financial on Wednesday also said the big banks’ appetite for discounting had “lessened” in recent months.
Mr Manning said that while the banks’ more than 80 per cent market share may ease, the loss wouldn’t be dramatic.
Mr Manning said the benefit from the banks’ recent repricing to offset higher capital requirements had been wrongly “spent” through discounting to win new customers.
“I think the banks have lost vision of what that repricing is actually meant to achieve; it’s actually meant to sustain ROE, not margin, and I think they’ve gone out and spent it,” he said.