Jane Searle | Australian Financial Review | October 6, 2011
The depth and frequency of discounts below the standard variable mortgage rate have hit a peak as lenders jostling for market share weigh up further price cuts against maintaining profitability.
That’s the finding from analysis by JPMorgan and Fujitsu, as housing credit growth treads at 20-year lows.
Major banks have lifted their discounting below advertised rates to about 0.9 of a percentage point, which is above average discounts of 0.7 of a percentage point before the credit crisis and compares with discounts of up to 0.3 of a percentage point a year ago.
JPMorgan analyst Scott Manning said small changes in mortgage pricing were magnified on banks’ return on equity (ROE).
On this basis, he noted that discounts of more than 1.2 percentage points on variable mortgages through a bank’s branches would be uneconomic.
“We’d say banks want mortgage ROE at the 20-25 per cent level so the discounting [now] is as good as it’s going to get with that return hurdle being met,” he said.
Mr Manning said improving deposit returns for banks, where excess deposit growth had enabled them to cut interest rates, meant that this dynamic subsidised mortgage discounting.
But he warned that the need to renew expensive wholesale funding was likely to mean a change in deposit pricing, and consequently, less funding support for deep mortgage discounting.
Despite rampant competition, Mr Manning said adequate risk pricing did not appear to have been compromised.
“The credit scorecards of Australian banks are robust in relation to global peers with an average loss rate of 0.02 percentage points and a peak of 0.05 percentage points, while they are now sitting around 0.01,” he said. “So there isn’t clear evidence that standards are slipping but what would we be cautious about is [writing loans] at absolute low levels of interest rates.”
Fujitsu Australia & New Zealand’s executive director of industry group, Martin North, said discounting was also only available to select customers, especially those with large loans or lower loan to value ratios.
Mr Manning said the falling yield curve had enabled banks to offer three-year fixed mortgages at what were often more attractive rates than standard variable loans.
But the lower cost of funding for fixed loans meant they earned a better return on equity, he said.
Overall, mortgage profitability has declined slightly over the year, with lower margins and fees offsetting operational efficiencies and longer loan durations.
Mr Manning said the trigger for intensifying price competition may have been National Australia Bank “picking a fight” to restore its share after a decade of losses and a sharper focus on its business bank.
Of the two largest mortgage lenders, Westpac Banking Corp and Commonwealth Bank of Australia, he noted Westpac’s decision to reduce broker-originated loans might affect its market share growth over the coming two years.
“For CBA, given the funding task they have, we’d like to think they prefer profitability over volumes but 18 months of share declines is heavier than they would have liked,” he said.
In terms of distribution, the report found that Australia and New Zealand Banking Group and Westpac had the most effective branch footprints.
It found that CBA and NAB were under-represented in some profitable segments, such as suburban mainstream, and over-represented in certain unprofitable areas such as rural.