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The next stage in the mortgage refinance market

The next stage in the mortgage refinance market

One key factor of profitable banking is to lend long and borrow short with adequate control of pricing margins. However, replenishing the supply of liabilities is a much more important element, writes Peter Sheahan, director of institutional markets at Curve Securities.

Australia has taken steps towards developing a more sophisticated home and investor mortgage refinancing market on the back of our emerging low, flat, medium-term yield curve.

AMP announced on 19 June 2018 a fixed rate loan offer of 3.79 per cent for owner-occupied borrowers with up to 90 per cent loan-to-value ratio. This is extraordinary, being only 20 basis points higher than Bank of Sydney’s 3.59 per cent variable rate loan and 11 basis points over a swathe of lenders at 3.68 per cent like Gateway Bank and Credit Union Australia.

I expect the recent, strong demand for new liabilities by these ADIs will influence mainstream term deposit pricing well into the new financial year.

Australian mortgage borrowers are developing a real appetite to substitute their lenders at a cheaper cost. Major bank treasurers are likewise undertaking a similar substitution strategy looking for a better deal on their borrowings. They are progressively responding to the new US Corporate Tax policy by adjusting their foreign/domestic funding mix to immunise themselves against a diminishing pool of offshore depositors and a higher interest rate profile in Libor-based funding markets.

The clear indication of a domestic funding resurgence is the reconfiguring of the positive slope of the term deposit curve we had during the last few years of fine-tuning liquidity coverage ratio and net stable funding ratios. Terming out liabilities was encouraged via low short-term rates and far more attractive long-term rates. A steep differential was the bait.

Today, we have quite the opposite evolving. High yield, flat curves are the new norm as they encourage all investment profiles equally.

High rates for three months, which are either above or below long rates by 5 to 10 basis points, are one of the main discussion points in our client conversations. Both investors and borrowers are winning at present. Term deposit yields are more lucrative, coupon resets on floating rate products are improving for investors and term borrowings are pricing off a low, flat swap curve that shows no inclination to reinstate any term risk premium.

The presence of the major banks in the two- to six-month funding sector is materially changing price dynamics of low-cost funding, which has been the province of smaller ADIs.

At present, it seems supply of funding for the larger banks is far more crucial than finessing net interest margin. Guaranteeing sustainable supply is the clear and present danger and challenge to all ADIs.

The dynamics of scarcity and reduced liquidity are becoming more evident in many quarters. The speech by Rob Nicholl, CEO of AOFM, at the ABE luncheon on 29 May 2018 warrants a re-read to understand the structural change they are proposing to their modus operandi and its impact on cash markets. Guy De Belle’s speech from mid-March can also be viewed as a signalling statement that key risks may not be priced correctly if much tighter global financial conditions are looming.

Asset growth has to slow if liability growth is slowing. Credit rationing is already apparent. It is being commentated as a key reason in a weakening housing market. The major banks are being more discerning on client segment, loan size, location demographics and equity contributions by borrowers. Hence, borrowers are willing to explore new channels of supply.

A fringe credit spectrum evolving through fintech channels is the genesis of a private equity-based shadow banking system, too. Credit rationing will certainly be a catalyst for growth in this sphere.

If funding benchmarks such as the BBSW one-month, two-month and three-month rates (1.99 per cent, 2.03 per cent and 2.06 per cent) diverge too far away from the RBA official cash rate (currently at 1.5 per cent) and sustain those higher levels, then which of the following scenarios is most probable:

  1. Monetary policy remains unchanged until more compelling data emerges;
  2. Monetary policy is tightened to endorse the higher wholesale market price; or
  3. Monetary policy is eased to alleviate the elevated wholesale market price.

Where does the highest level of financial stability lie?

The next stage in the mortgage refinance market
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