Blood in the streets – investment lending

investment lending collapse

The prudential regulator has shaken the branches when it comes to investment lending in fact I haven’t seen this level of lender reaction since the GFC and maybe not even then.  Let’s look at the results so far lender by lender on investment lending only:

  • AMP have withdrawn completely from investment lending
  • ANZ increased rates on new and existing loans reduced LVR 90%
  • CBA increased assessment and interest rates on new and existing loans including fixed rate loans while tightening servicing
  • Heritage max lending 80% LVR
  • ING increase all interest rates reduced max 80% LVR  and tightened servicing
  • Macquarie increased rates on new and existing loans
  • NAB increased rates on new and existing loans
  • Suncorp something but too obscure to figure out what
  • Westpac reduced discounts and tightened servicing

As for the other lenders on panel – well nothing much has changed.  We can still get 95% investment loans on interest only and we can get interest rates as low as 4.04% variable and 4.29% fixed so the question is; how long can this situation last and how much damage will be done to  the lenders above?

Initial response from clients has been anger.  If the situation persists I can see some second tier lenders doing very, very nicely out of this.

More level playing field for smaller banks

Level the playing field for lenders

The Australian Prudential Regulator ( APRA ) has announced the the four major banks and Macquarie will be compelled as of 1st July 2016 to increase their risk weighting for home loan lending to 25 percent up from the current 16 percent.   This will bring them a little closer to the 35 percent that applies to other non-IRB accredited lenders which basically represent the rest of the market.

The move will be welcomed by the regional/second tier lenders who have argued for several years that the risk weighting has been biased in favour of the major banks.  This will to some extent level the playing field as the major banks will be required to fund their lending with between $10 and $12 billion dollars of extra capital.  Meanwhile there is still a possibility that APRA could lift the 25 percent figure further, depending on the outcome of the Basel Committee on financial regulations later this year

This will probably result in increased interest rates or more likely reduced discounts, which have recently been seen as high as 1.35% off the standard variable.   Where as ten years ago discounts were closer to 0.60% to 0.80%.

ABC reports Westpac CFO Peter King said that, while Westpac had started increasing its capital position, customers and shareholders would be forced to bear the costs.

“We are well placed for this change, having already taken a number of significant steps to boost our capital position,” he said. “While Westpac is well-placed to meet these changes, increased capital does come at a cost. The cost of holding higher capital will inevitably be borne by customers and shareholders.”?


More out of cycle rate movements due to funding costs

Rate cuts by the Reserve Bank are important however the good intentions seem to be a futile attempt as lenders fail to pass on cuts imposed by the central bank.

Latest report by the KPMG reveals that despite the continued good performance of Australia’s major banks on the global banking stage, they are still affected by the interconnection of new regulatory environment demands’ structural changes and the global funding markets. This could mean that there will be more out of cycle rate hikes happening in the future.

The Major Australian Banks Half Year 2012 report by the KPMG shows a healthy profit acquired by the major for the 2011-2012 half year although the acquired healthy profit lacked growth.

Andrew Dickinson, KPMG’s head of banking, stated, “The major banks’ profit clearly shows we have a strong banking system, however it must be viewed in light of the increased capital that the banks now need to hold. Return on equity (ROE) remains around 16 percent for most banks and shareholders will need to accept that this level of return is all they can expect for the foreseeable future.”

A total of $16.8 billion statutory profit before tax was recorded for 2011-2012 half year where as a total of $16.3 billion was recorded in 2011’s second half. “The banks’ biggest challenge is adapting their business model to cope with the competing strains of constrained lending growth, ongoing funding pressure, ever higher regulatory hurdles, and a transition to new mobile delivery channels and competitors,” shared Dickinson.

The major banks are still facing the challenge brought by the high cost of funding’s impacton margins. KPMG’s Head of Financial Services, Michelle Hinchliffe, stated, “Sustainable cost reduction remains a challenge for the major banks. While they are implementing a number of cost reduction measures, the full impacts are yet to flow through to the results. They need to make structural, long term changes that will sustain a lower cost base.”

KPMG believes that the condition of Australia’s major banks is still very much affected by the global markets’ economic uncertainty and by the funding costs.

Dickinson mentioned, “The global crisis in access to funding has forced the majors ‘back to the past’ where they are wooing domestic deposits to boost their funding. This means deposit competition is intense, and depositors are now being paid 2 percent more (relative to RBA rates) than before the GFC. It is these increased deposit rates which are now having the strongest impact on bank funding costs.”

Hinchliffe however stated that, “Australian banks are well capitalised, continue to maintain strong liquidity positions and are well placed to respond to new global capital and liquidity rules.”

Cash rate down 50 points

In what many believe is a belated reaction the RBA has virtually admitted that they misread the economy and have announced a reduction in the cash rate of 50 basis points down to 3.75 per cent.

The question will now be, how much will the lenders pass on to borrowers.

There can be no doubt that the home market throughout most of the country is very flat with both home buyers and investors very hesitant to commit.  Let’s hope this rate reduction will bring back some confidence and stimulate some home loan activity.

May rate cut more certain due to low inflation

The latest inflation figures released by the Australian Bureau of Statistics (ABS) should lead to a rate cut, with some economists even forecasting a cut as much as 50 basis points.

It may be an ambitious forecast but the 0.1 per cent increase in the March quarter of 2012’s consumer price index (CPI) has led many to think of the 50 basis point cut having a 62 per cent possibility.

The release from ABS stated that overall the CPI, “rose 0.1% in the March quarter 2012, compared with no change in the December quarter 2011” and, “rose 1.6% through the year to the March quarter 2012, compared with a rise of 3.1% through the year to the December quarter 2011.”

The result was way below the Reserve Bank of Australia’s (RBA) 2 and 3 per cent target level. Since late 2009, the result is also the lowest recorded annual inflation rate.

Pamela Bennett, president of the Real Estate Institute of Australia (REIA) believes that the RBA now has now no excuse for not doing the much-needed interest rate cut, “The latest figures are well within the RBA’s target zone of 2-3 per cent and should provide a clear message to the RBA to reduce official interest rates at its meeting next week.”

“With inflation well within the RBA’s target zone and a clear message from the Government that there will be a focus on reducing expenditure in the 2012/2013 Budget, it is appropriate to have a cut in interest rates, “ added Bennett.

A Commsec economist, Savanth Sebastian, stated, “Inflation is well and truly contained and the Reserve Bank is all but certain to cut interest rates on May 1st. Not only was the headline inflation rate virtually flat, but the closely-watched underlying measures also recorded decidedly subdued readings”

Shane Oliver, AMP’s chief economist shared in an article in The Adviser, “A 0.6 per cent rise would give you an annual rate of 2.1 so that would be at the low end of the target [of 2.5 per cent]. So numbers around there will be considered benign. Alternatively 0.7 would probably still be okay. If you get to around 0.8 it becomes a bit more debatable. If we do get a 0.8 per cent number then you can’t rule out a rate cut, but the chance of it occurring would be substantially less.”

With the certainty of the rate cut shining brighter, the question in everyone’s head moved to the possibility of a rate cut more than 25 basis points on the RBA’s Board meeting on May 1.

A currency trader at Arab Bank, David Scutt, mentioned, “The question now is, is there room for the RBA to cut interest rates by 50 basis points.”

The CEO of the Real Estate Institute of Queensland (REIQ), Anton Kardash, believes that Australia’s economy badly needs stimulation, “The producer price index yesterday fell 0.3 per cent when most economists had predicted a rise of 0.5 per cent and the Reserve itself is starting to question the reasoning behind recent rate hikes by lenders. All of these signs point to an economy that is certainly not firing on all cylinders, a fact the Reserve noted in its April meeting when it lowered its expectation for growth. The Reserve must act next week and must act decisively.”

Since lenders have been moving rates independently, many are calling out for a 50 basis points cut.

Harley Dale, HIA’s chief economist shared, “The housing industry and wider Australian economy needs a further 75bps of interest rate cuts and there is nothing standing in the way of a 50bp move to get the ball rolling next Tuesday. That would, admittedly, be a bold move for the RBA, but it would be entirely appropriate given the pulse of the Australian economy is not beating as fast as the Bank earlier expected. The banks need to follow suit and pass any rate cuts on in full rather than hide behind the fallicious argument that higher funding costs somehow justify them holding some interest rate relief back.”

An article from The Australian revealed that Citigroup is one of those forecasting a 50 bps cut. Citigroup’s chief economist, Paul Brennan, said, “The case for a 50 basis point in May is reinforced by higher lending rates.”

In the same article Annette Beacher, the senior analyst of TD Securities, shared that the independent moves by retail banks on interest rates would be a major consideration by the RBA. “It’s become a game of chicken between the banks as to who is going to blink first.”

Kardash also believed that the RBA must do something on the lenders’ unjustified moves and help support the recovering Queensland property market stating, “It’s unfortunate that the major lenders insist on achieving profit margins more in tune with the good times rather the current economy reality. In this game of cat and mouse that lenders seem to play with the Reserve and their own customers when the central bank reduces the cash rate, the Reserve must now take back some control and reduce rates by at least 50 basis points on Tuesday.”

The 50 bps cut however seems too unlikely to happen for some as Beacher shared in The Australian, “I don’t think the RBA will cut by 50 basis points because that would be too much of a surprise and the RBA doesn’t have a history of doing that unless there is an emergency. If the RBA order two cuts of 25 basis points they’re also forcing the banks to make two decisions rather than just one.”

Su-Lin Ong, the chief economist of RBC Capital markets declared that the banks independent move is not helping the RBA’s aim which is to stimulate the Australian economy, and that the banks’ moves could force the Reserve Bank to cut 50 basis points. Ong shared, “It’s not out of the question given the policy dilution by the major lenders. But we think that a move like that would look a little panicky and be an admission of policy error.”

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