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Although higher mortgage rates will generate more earnings for the banks, S&P has warned the mutual sector will still be slapped down by fierce competition and elevated funding costs.
Earlier this month, the cash rate made its first climb in more than 10 years, with the Reserve Bank of Australia (RBA) stating the 25-bp increase would be the first of a series of hikes to come.
Lenders are expected to keep passing on the increases, after the big four and smaller rivals swiftly moved to pass on the May increase.
But a new analysis from S&P has cautioned that while the coming rate rises will boost interest income for the banking sector, the benefit for mutual banks will be offset by fierce competition, a subdued lending market, and higher funding and credit costs.
“For Australian mutuals, the effect of the interest rate benefit will not be immediate,” the report from S&P credit analysts Lisa Barrett, Nico de Lange and Mark Symes stated.
“There will be a delay as the market reverts to floating-rate mortgage lending in the next two years.”
As S&P has noted, there had been record-high levels of borrowers opting for fixed-rate loans, while the cash rate had sat at its historically low level of 0.1 per cent.
System-wide, about 75 per cent of the current fixed-rate mortgages are tipped to expire by December 2023.
While the tide has shifted and new loans are beginning to lean towards variable rates, it will “take time for the fixed-rate loans to mature and reprice at higher rates,” the S&P report said.
“While the mix of new loans (variable versus fixed) has largely returned to pre-pandemic levels (80/20), most mutual lenders are stuck with a portion of loans at lower than the current market price,” the S&P analysts wrote.
“While some have hedged part of this risk, any unhedged portions will continue to impinge on margins until they reprice.”
Competition in mortgage lending is also expected to stay rampant – but, as “small fish in a big pond”, mutual lenders are at a structural disadvantage.
“The scale and incumbency of the major banks means mutuals must compete aggressively and consistent, with their philosophy, provide preferential member pricing to continue to grow their lending books,” the report stated.
Brokers were also noted as key, particularly as new data from the Mortgage and Finance Association of Australia (MFAA) has shown their distribution channel is dominating the mortgage market, originating around 70 per cent of mortgages.
Hence, the importance of brokers to gain new business, particularly for smaller lenders, will mean mutuals will need to stay competitive.
Further, the era of cheap funding is now slipping away, as the cash rate begins its climb.
In this environment, S&P expects the mutuals will aim to both finance new lending growth and refinance the term funding facility (TFF) of the RBA over the next two years.
“This will be at higher interest rates and will therefore crimp margins,” the report said.
“However, market conditions and the funding mix mutuals choose will determine the overall cost.”
But, credit losses are only expected to increase marginally, with households facing financial distress due to higher rates and costs of living only forming a small proportion of mutual lenders’ books.
“The loss rates of mutuals have historically been very low,” the report said.
“As a result, we consider that a rise in defaults and credit losses will only offset part of the improvement in mutual lenders’ gross earnings.”
[Related: NAB lowers its DTI]