Westpac to address asset quality, big mortgage switch

Australian Financial Review May 6 2018 4:36 PM

Jonathan Shapiro

Westpac is under pressure from investors to show that its lending margins are not being squeezed by the regulation-imposed switch away from lucrative interest-only mortgage loans and rising short-term funding costs.

Westpac rounds out the half-year earnings for the major banks, which have been overshadowed by the upheaval of the royal commission and the prudential regulator's scathing attack on Commonwealth Bank's culture and management.

The Sydney-based lender is forecast to deliver a half-year cash net profit after tax of about $4.2 million and pay an interim dividend of95¢.

So far the Melbourne lenders, ANZ and National Australia Bank, have delivered a mixed set of results with respect to asset quality, cost controls and margins.

But the mortgage-focused Westpac's results will be watched closely for several reasons.

Of specific interest to analysts covering the Westpac result will be the outlook for the bank's net interest margin, as more borrowers switch from interest-only loans to principal and interest loans.

Westpac is more focused on mortgages than ANZ and NAB, and is the the nation's largest lender to landlords.

These loans have become more lucrative after macro-prudential lending limits led to the banks being able to charge higher rates on these products.

Sensitivity to rising costs

While the caps on investor loans have been lifted, the banks are under pressure to refinance more borrowers out of interest-only loans into principal and interest loans.

The Reserve Bank estimates $120 billion of interest-only mortgages are due to be refinanced annually over the next three years. That could put some strain on the mortgage market and potentially reduce the bank's margins.

The evidence is that both ANZ and NAB have had their margins cut by the switch so the impact and outlook for Westpac is likely to be a key talking point.

Westpac is also the most sensitive of the big four banks to a sharp rise in short-term funding costs that appear to have been triggered by US policy changes.

A persistent widening of short-term borrowing costs relative to the cash rate is expected to hurt the banks with both ANZ and NAB forecasting their margins will take a two-basis-point-hit if conditions don't ease.

If the so-called BBSW/OIS spread remains at 50 basis points, Westpac's future earnings could fall by 2.6 per cent, according to Macquarie analysts.

Loan quality concerns

So far, the banks have that have reported have shown that asset quality is still a good news story for the banks, despite the headlines.

But the loan quality of Westpac's mortgage book quality is likely to attract the attention of investors when the bank fronts analysts on Monday.

Westpac was the subject of a bearish UBS research, which cut its recommendation to "sell" on concerns about the bank's mortgage quality.

The downgrade came about following disclosures of a sample of 420 loans assessed by PwC as part of a "targeted review" by regulators into lending standards.

The report, made available as part of the Hayne royal commission led UBS to conclude that the bank's lending standards was worse than previously assumed. The other banks fared better in that 2016 assessment.

Westpac moved to allay the markets concerns with the statement to the exchange and said it would provide a more detailed response when it delivers its results.

The banks, and the Reserve Bank, have said tighter lending standards that will inevitably result from increased scrutiny is likely to slow lending growth and analysts are predicting that the big four banks will struggle to keep their pace of loan growth in line with the broader system.

In a slower-growth environment the ability of the banks to demonstrate cost control has become more important than ever.