Interest rate cuts great for borrowers, not for banks

A confluence of factors - most of which emerged this week - may have put the brakes on falling house prices and improved the prospects for Australian banks - or at least - eased their performance headwinds.

The near certainty of an interest rate cut (or two) over the coming months, a regulatory winding back of lending curbs, and the removal of the spectre of negative gearing and capital gains tax changes should loosen the grip of the credit squeeze and tempt investors back into the housing market.

Thus it should be good news for bank lending volumes. It is largely because banks make better margins when interest rates are rising. Their margins get squeezed when rates fall.

Add to this the fact that big bank shares had a massive runup already this week and there is a view among some analysts that the good news has already been factored in - and possibly overdone.

Even the traditional bank bears over at UBS suggest the downside risks to banks have significantly reduced. But its bank analyst Jonathan Mott remains cautious about the industry's prospects - pointing to a higher spend on technology and compliance, a structural reduction in fees and an expectation for elevated capital requirements in New Zealand to remain as headwinds

Citi's analyst likens the proposal by the Australian Prudential Regulation Authority to remove the 7.25 per cent interest rate floor in assessing mortgage serviceability and replacing it with a 2.5 per cent interest rate buffer to a de facto interest rate cut.

And when added to the two prospective rate cuts, it greatly improves the addressable market of new borrowers. Citi analyst Brendan Sproules says the prospect of interest rates on new principle and interest loans falling to 3 per cent is expected to have a dramatic impact on borrower's debt appetite and "animal spirits", resulting in a pick-up in the housing market. He believes the expected RBA rate cuts and the regulatory easing is a gamechanger in the property market.

"The APRA announcement this morning should provide further support for the fragile property market and hence is positive for the banking sector.

"While banks have been arguing that the slowdown in lending was predominantly driven by demand rather than the supply of credit, we believe a restriction in credit availability has been a contributing factor." But Macquarie notes the re-rating of bank stocks early in the week and suggests that interest rate margin pressure and decline in fees remain.

"In this context we see limited upside to the sector from current levels, although recognise that in the near-term investor repositioning may impact relative share-price performance."