Australia’s biggest banks have resumed their price competition, which could pose a threat to the industry’s prized dividends after a crunch in home loan profitability.
On the bright side, borrowers have emerged better off as lenders are offering them lucrative discounts of up to 1.5% off their standard variable interest rates. The renewed price war has also taught customers that switching banks can deliver big savings on loan payments, which has helped drive a surge in refinancing.
According to a new report from JPMorgan bank analyst Scott Manning, the big banks must rely less on the deep discounting of mortgages and instead target customers with selective pricing as a means of protecting dividends. Specifically, Manning said banks should address “poor discipline” in managing mortgage books—including “spending” recent loan repricing benefits on discounts—by offering rates that differed by two percentage points depending on the customer’s risk and loan purpose.
Manning said the Big Four’s return on equity from mortgages had declined to 25% from 40% between 2010 and 2015 amid higher capital requirements and increased customer churn. The decline, however, occurred as returns from the banks’ other products sank to the same level as their cost of capital at around 10%.
“The mortgage contribution to overall profitability is becoming increasingly important because the rest of their business just isn’t firing,” Manning said. “We may have reached a ‘line in the sand’ on mortgage profitability — mortgage ROEs can’t really ‘afford’ to go lower than they are today without having an impact on dividend sustainability.
“The market structure is the key issue, with 80 per cent market share and high intentions [from borrowers] to refinance; they are their own worst enemies if they pursue a price-led strategy.”
Increasingly, investors are fearing that NAB and Westpac may slice their dividends at their annual results, following ANZ’s cut six months ago.
JPMorgan’s report also sheds light on the Big Four’s massive mortgage profits after they resisted providing ROE data at the House of Representatives economics committee inquiry earlier this month. The inquiry questioned their interest rate decisions after banks held back 50% of the RBA’s August rate cut.
Manning, who was assisted by data from Digital Finance Analytics, said the Big Four’s use of excessive discounts to maintain market share was “puzzling” because earnings were already being revised lower and they were largely competing among themselves, thus eroding benefits from the oligopoly.
Collections: Mortgage News