Up, up and away. Why are mortgage rates on the rise?
Written by admin on November 27, 2016 – 8:56 pm
Australia’s property investors and debt slaves were in shock on Friday, when Westpac joined the ranks of smaller banks, significantly hiking mortgage rates out of cycle, on its fixed term loans.
Westpac’s five year fixed investment loan will jump 60 basis points or 2.4 times the standard Reserve Bank increase to 4.79 per cent come Monday. Two and three year investment loans will rise 30 basis points, while two and three year owner occupier mortgages will increase 24 basis points. It follows earlier rises by Westpac’s RAMS and a 60 basis point rise from the Bank of Sydney.
Over the past fortnight, another ten smaller banks had increased rates. Investors were too naive and complacent to see it coming, but they should have. Banks are facing pressure on a number of fronts.
IRB Risk Weights
Australian banks not the safest in the world – far from it – 8th December 2014.
Have the Big 4 just flunked APRA’s stress test? – 16th November 2014.
As we have reported over the years, Australia’s big banks or IRB (internal ratings-based) banks – Westpac, Commonwealth, ANZ, NAB and Macquarie, have been abusing their size and status. As silly as it sounds, regulators thought these banks knew what they were doing, so they were given the power to risk rate their own mortgage books. As you can guess, in a bid to enhance profitability at the detriment of financial stability, the IRB banks rated the risks on their mortgage portfolios so dangerously low so as to not have to hold as much expensive loss absorbing capital. After all, the taxpayer would be at hand if they needed to be bailed out. A stress test conducted by the Australian banking regulator in 2014 found that the five IRB banks were insolvent, if they were unable to access further capital, after a moderate housing and commodities crash. Something had to be done.
Effective 1st July 2016, APRA has raised the average risk weights for the IRB banks to a minimum of 25 per cent. This will require the IRB banks to hold extra loss absorbing capital to assist with solvency in a banking crisis. The banks have two options, reduce the level of profitability, or hit up mortgage holders. The later is preferable, as at some stage the banks may have to – go cap in hand – to shareholders to shore up balance sheets when default rates materially rise.
“Regulated banks” i.e. all our other banks, have a minimum risk rate of 35 per cent, so the big banks are still unfairly advantaged.
Net Stable Funding Ratio (NSFR)
As part of the International Basel III accord designed to make banks more resilient, banks will have to start relying more on domestic deposits for funding, rather than the risky overseas wholesale markets. A global shock (brexit, Italy, Europe, China etc) could cause liquidity problems for rolling over short term debt. As Australia’s household debt rapidly grew, Australian banks relied more heavily on short term wholesale debt markets to get the much needed cheap funding to satisfy Australia’s craving for perpetual debt.
APRA says big banks at risk from short-term, wholesale debt addiction – The Sydney Morning Herald, 16th September 2015.
Australia set to lose AAA credit rating
S&P fires first shot across bows – AAA rating placed on credit watch negative – 7th July 2016.
As we reported in July, Australia is on a credit rating outlook of negative with ratings agency Standard and Poor. S&P, at the time, said “There is a one-in-three chance that we could lower the rating within the next two years if we believe that parliament is unlikely to legislate savings or revenue measures sufficient for the general government sector budget deficit to narrow materially and to be in a balanced position by the early 2020s.””
Since the warning, Prime Minister Malcolm Turnbull and Treasurer Scott Morrison has more or less sat on their hands when it comes to budget repair. Only this week, former RBA board member John Edwards has suggested cutting negative gearing subsides to secure our AAA credit rating, but the Prime Minister has ruled out the change to prevent any backlash from Liberal backbenches who heavily depend on the negative gearing gravy train. The problem facing the soft Prime Minister, is he can’t find any cuts that won’t effect someone. Today, even former coalition Prime Minister, Tony Abbott has called on Turnbull to harden up!
Australia’s over extended and risky banks are seen only as safe as a government bailout, and hence cannot have a credit rating that exceeds the government. The loss of the government credit rating is expected to make any overseas wholesale funding more expensive.
Former RBA board member John Edwards backs negative gearing change to secure AAA credit rating – The ABC, 25th November 2016.
The Trump Effect
A future with Donald Trump, leader of the free world, is the hardest to predict, but has attracted most of the blame for rising interest rates. Trump policy is largely expected to be inflationary with pro-growth, large infrastructure builds in the wings. His election win earlier this month has caused pandemonium in world debt markets, but there is some evidence to suggest bonds have been out of favor since August. Whether the bond market sell-off started in August, or November with the election of Trump, bond yields are heading in one direction, up, and is considered a good proxy for future interest rate moves.
Janet Yellen, United States Federal Reserve chair, is expected to move on American interest rates in December.
Should we panic?
Australia’s banking regulator has repeatedly maintained banks should have a serviceability floor of 7 per cent for when interest rates inevitably go up. Provided banks didn’t flout this requirement, there should be some scope for rising interest rates over the next 12 to 24 months.
But then, who is confident the banks screened mortgage applicants with a 7 per cent floor? Certainly not me!