After the party must come a bad hangover for banks
The major banks are set to pay the price for years of excessive lending to investors and interest-only borrowers as prudential restrictions placed on riskier lending start to slow the housing market.
After a bumper $31.5 billion in collective profit over the past year, the big four banks are set to feel the strain of slowing growth in home lending, which has traditionally been the most profitable part of banking.
Official data this week shows housing finance fell 3.6 per cent last month, dragged down as lending to investors fell at its fastest rate in two years.
Analysts are now questioning whether the latest round of earnings are a sign that retail banking — the bread and butter banking business of selling home loans — has already “seen its best days”.
The major banks are facing an uphill battle against increasingly strict limits on riskier forms of lending, such as writing loans for investors or borrowers seeking interest-only loans.
The Australian Prudential Regulation Authority in March told banks to limit interest-only lending to 30 per cent of new loans and to stay “comfortably below” the 10 per cent annual growth limit on investor lending.
Banks are also being forced to have more capital in their buffers, and it is expected they will face further penalties the more risky their mortgage portfolio is.
Westpac is particularly vulnerable due to its overweight exposure to mortgages, along with Commonwealth Bank, which is thought to already be losing market share.
“Over the last decade, retail banking has been an outperformer with an outsized contribution in both lending growth and revenue growth,” Citi analyst Craig Williams said. “But what happens when the retail banking contribution moderates?”
The Reserve Bank’s statement on monetary policy yesterday said housing credit had “eased a little” and “shifted away from interestonly and other riskier types of lending”. The central bank said the housing market had now “eased noticeably in Sydney” but “remained relatively strong in Melbourne”.
Bank profits have been underpinned by growth in home lending over the past decade, as borrowers took on greater debts as house prices boomed.
Australia’s household debt-toincome ratio is now the fourth highest in the world. Surging house prices have been pushed along by generous tax breaks for investors, such as negative gearing and capital gains discounts.
Investors take up about threequarters of interest-only loans, which don’t require payment on the loan’s principal for about five years. Interest-only loans also allow a borrower to access larger loans, which has helped drive property prices higher. The loan type is also far more profitable for lenders as borrowers remain indebted for longer.
Britain’s Financial Conduct Authority slammed the brakes on interest-only lending when it grew to an unprecedented 17 per cent of the mortgage market.
APRA, on the other hand, waited until interest-only loans accounted for 50 per cent of loans in the local $1.6 trillion mortgage system. APRA is worried borrowers may not be able to afford their loan when monthly repayments jump by around 40 per cent at the end of the interest-only period.
Although Commonwealth Bank, Westpac, ANZ and National Australia Bank complied with the 30 per cent limit by the end of the September quarter, the banks’ outstanding portfolios are still packed with interest-only loans.
About 46 per cent of Westpac’s loan book is interest only, compared to 39 per cent of CBA’s. Interest-only accounts for 31 per cent of ANZ’s book, and 30 per cent of NAB’s portfolio.
Speaking at parliament recently, ANZ chief Shayne Elliott said his bank started addressing the risks in its interest-only portfolio almost a year before the prudential limits were announced.
ANZ did this “well before the speed limit, because we assessed that the risk in that book was changing and that we needed to be mindful of that”, Mr Elliott said. As he unveiled an $8 billion profit this week, Westpac boss Brian Hartzer said his bank was “still fundamentally comfortable” with interest-only loans.
“When you’re running a bank, one of the biggest challenges with risk is to make sure you’re constantly looking at things through different lenses,” Mr Hartzer said.
“We try to look for concentrations … for things that are rising rapidly. Interest-only is one of the areas where we’ve looked at many times over time and came to the view, along with APRA, that we wanted to wind that back, but we remain still fundamentally comfortable with interest-only.”
The restrictions have forced banks across the sector to pull back from the market at the same time financial regulators are turning the screws on the banks over responsible lending standards. “The outlook into 2018 remains challenging as the housing market slows,” UBS analyst Jonathan Mott said.
“With an early federal election looking more likely, we believe it will be difficult for the banks to outperform during 2018.”
Shayne Elliott says ANZ addressed interest-only loans ‘before the speed limit’ was imposed