An analysis performed by Moody’s Investors Service has found that interest income as a share of average outstanding mortgages fell 0.2 percentage point year-on-year from 4.2 per cent in 2017 to 4 per cent in 2018. The figure was 8 per cent in 2008.
The ratings agency attributed the decline to a combination of the Reserve Bank of Australia’s “easing” monetary policy, subdued growth in owner-occupied and investment home loans, and tighter lending criteria, which Moody’s said has increased competition for lower-risk mortgages.
Price competition in the mortgage market is expected to further intensify after the Consumer Data Right, which will require increased loan pricing transparency, comes into effect.
“This development will reduce the current opacity in pricing that has resulted from discretionary discounting of headline mortgage rates, and has the potential to create further downward pressure on home loan interest rates,” Tanya Tang, analyst at Moody’s, wrote in a new report.
Moody’s said smaller banks, including mutuals, will be most impacted by interest income pressures as mortgages contribute more than half of their total lending interest income (between 64 per cent and 87 per cent, as at December 2017). For major banks, home loans account for around a little over half, or around 58 per cent, of their lending interest income, according to APRA data from December 2017.
“Price competition has been primarily driven by the major banks, as they looked to preserve market shares as they tightened loan underwriting standards. The major banks held three-quarters of the total housing loan assets in the Australian banking system at the end of 2018. Other domestic banks and mutual ADIs held 10 per cent and 2 per cent of system assets, respectively,” Ms Tang wrote.
“As a result, the three groups of domestic lenders, despite their different sizes and business models, now report returns on their housing loans that are essentially the same, testifying to the homogeneity of their products.”
The big four banks also have “greater flexibility” than its smaller rivals, according to the ratings agency, when it comes to income diversification, reducing costs, funding and scale, having demonstrated their ability to “adjust deposit pricing and operating costs to substantially mitigating falling housing loan pricing” in the past.
“Overall, the major banks are in a better position to cope with falling home loan rates than other lenders because they have a higher share of non-housing loans on their loan books, a higher share of fee income, more diversified and lower-cost wholesale funding, and better cost efficiency,” Ms Tang wrote.
She noted that from 2015 to 2018, interest income from mortgages dropped by 14 basis points a year, but deposit costs also shrunk. This resulted in “the spread between housing loan yields and deposit expenses narrowing by only three basis points.”
“Looking ahead, weaker loan growth will reduce bank funding needs and allow for a further moderation in deposit price competition,” Ms Tang wrote.
A possible drop in the Reserve Bank of Australia’s official cash rate, as hinted in February, could present an opportunity for banks to recover some margin, according to Moody’s.
Additionally, based on its stress testing results, the ratings agency concluded that if the housing loan interest income continues on its 10 basis point decline, as seen in 2018, then the banks’ profit before tax will fall by 4 per cent. However, there will be “minimal” impact on their Common Equity Tier 1 ratio.
“To fall below the minimum regulatory requirements, a drop of 160 basis points would be needed,” Ms Tang wrote.