Af­ter the party must come a bad hang­over for banks

The Weekend Australian - - BUSINESS - MICHAEL RODDAN

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.”

KYM SMITH

Shayne El­liott says ANZ ad­dressed in­ter­est-only loans ‘be­fore the speed limit’ was im­posed

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