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Mortgage price wars to rage on through rate rises

The big four’s squeezed margins could benefit from a rising cash rate, but analysts have tipped it will be countered by fierce competition and increased impairments.

A KPMG analysis of the major banks’ results has confirmed the institutions have reported a combined cash profit after tax from continuing operations of $14.4 billion for the first half of the 2022 financial year, up 5.1 per cent year-on-year.

The big four’s profits had rebounded close to pre-COVID levels after disruptions in recent years, with the combined cash profit after tax 0.4 per cent lower than those seen in the first half of FY19.

Strong volumes in both mortgage and business lending had boosted the major banks, with the banks’ combined home loan books ticking up by 2.5 per cent over the half year, to $1.8 trillion, while business loans grew by 4.8 per cent to $1 trillion.

But in the low cash rate environment, net interest margins (NIMs) had declined and dragged on the banks’ performance, with the big four’s average NIM dropping by 13 bps year-on-year to 1.75 per cent.

Knocked NIMs across the lending industry had been the “primary brake” for the major banks’ growth, the KPMG report said.

Hessel Verbeek, banking strategy lead at KPMG, commented that the market dynamic had been dominated by strong competition and high demand for low margin, fixed rate mortgages.

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“This downward pressure has only partially been offset by lower funding costs from near-zero deposit rates,” Mr Verbeek said.

“The impacts of an extended period of low interest rates are deeply baked into net interest margins.”

However, the low rate era has already ended. The Reserve Bank of Australia (RBA) had confirmed last week’s cash rate rise would be the first of a number of increases in the coming months to combat surging inflation.

The big four banks moved swiftly to pass on the full rate rise of 25 bps to their customers.

The KPMG report has forecast that the incoming series of rate increases will support a recovery in NIMs for the banks, but it will likely be tempered by continued strong competition, the recent peak in fixed rate loans and the unwinding of the Term Funding Facility from the RBA.

Further, higher interest rates and household debt levels over time are expected to result in more mortgage impairments.

“We expect to see the dual impacts of both net interest margin relief and higher levels of mortgage book stress, as RBA interest rates are expected to increase several times,” Mr Verbeek said.

“However, these impacts will take their time to pull through as both margins and book quality have built up their momentum over a long period of low rates.”

The major banks released $218 million in loan provisions during the half year, bringing overall provisioning closer to pre-COVID levels.

Another analysis from EY held a similar outlook, noting that amid high levels of refinancing, retaining customers and margins will be key areas of focus for the big four. 

EY banking and capital markets leader for the Oceania region Tim Dring also pointed to ongoing volatility.

“Last week’s higher than expected rise in the official cash rate by the RBA and future expected rises offer top line revenue growth opportunities and earnings upside,” Mr Dring said.

“On the flip side though, rate rises coupled with strong inflation could also put pressure on asset quality and slow credit growth and continued mortgage competition may also reduce margin upside for the banks.

“In the current economic environment, the only real certainty for the sector is uncertainty.”

Last week, NAB chief executive Ross McEwan told analysts that he expects a rise in refinancing ahead, as the cash rate starts on its upwards trajectory.

“That’s something certainly in our mindset here to be all over. It’s going to be a competitive marketplace going forward, there are 160 players in this market at the moment,” he said.

However, both he and ANZ CEO Shayne Elliott expect the majority of borrowers will make adjustments and weather rising rates.

Westpac also published its half year results on Monday (9 May).

Meanwhile, the KPMG analysis reported the big four had maintained costs at a similar level year-on-year, with combined operating expenses down by 1 per cent to $4.9 billion and the average cost-to-income ratio down by 73bps to 49.6 per cent.

Mr Dring noted the banks will face a significant challenge in acquiring and retaining staff, with shortages for in-demand skills such as data analytics and engineering.

He also noted the big four will need to keep adapting amid economic pressures. 

“…Banks cannot afford to take their foot off the accelerator when it comes to their strategic cost management and operations transformation,” Mr Dring said.

“The banking sector is moving from an era of large multi-year transformation programs, to one of building capabilities to manage continual change and create more sustainable, future-ready organisations.

“In this environment, following through on simplification, innovation and digitisation strategies will be key to the banks boosting their efficiency, improving customer experience and remaining competitive against disruptive new players.”

[Related: Macquarie grows mortgage book by a third]

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