The Australian real estate bubble has peaked on Friday, and the median house price reached the 1million mark. What has been interesting is the relationship between our currency, the housing bubble, and interest rates.
The RBA this month had kept the cash rate at 2%, however the rise in interest rates for housing investors by ANZ and CBA will mean they could cut the cash rate again, given slower loan growth. This is particularly interesting as it against logic – as the interest rates rise, the cash rate is expected to fall. Banks are attempting to improve margins and return on equity as regulators impose lower leverage. ANZ last Thursday had raised the variable interest rate for property investors by 0.27 percentage points. CBA did so by that exact amount in less than 24 hours later.
It should have been expected that eligibility criteria for investor loans are tightening, though understandably it is the timing and magnitude of the pricing action last week that is the biggest surprise to the market. This is because banks historically are constrained from adjusting variable mortgage rates outside of the cash rate moves.
Nonetheless the banks’ choice to raise rates shouldn’t be controversial as the recommendation of the financial system inquiry that led to APRA’s decision to increase housing risk weights to a minimum of 25% from July next year was to change the competitive landscape between the majors and smaller banks. The rise in mortgage rates by the major banks can facilitate this.
Banks are showing willingness to reprice mortgage rates with limited downside risk. This should be good news for bank shareholders and the central bank. Major banks are expected to reprice all housing loans by between 0.55-0.65 percentage points which would maintain group return on equity that otherwise would be lost from APRA’s decision last Monday to increase housing risk weights to minimum 25% from July next year. For bank shareholders, the repricing is positive as net interest margins are key drivers of bank profit. They are fattened up after being squeezed in recent years from competition.
Another positive outcome that comes out of this is that despite it being contradictory, the ability of banks to increase rates without the RBA increasing the cash rate means the RBA can focus on depreciating the Australian dollar. Otherwise, the RBA would be torn between two goals: low Aussie dollar and to slow the property price bubble, of which would cause low rate financial stability concerns.
However investor lending approvals are still 22% higher than in 2014 and more than 50% of new home loan approvals are being used for investment purposes.
Also, because the banks are already growing investor lending at around 10 per cent, their ability to attract customers from one another is severely limited, as new customers will push them over the 10% speed limit. So if peers do not follow ANZ’s lead, they will likely gain more share and once again exceed the 10% cap. This means the ability for better market share for smaller banks has been curtailed by these caps set by APRA. (The consequence of being over 10% is more capital and the increase in margins will only cover the increase in required teir 1 capital.)
The bank repricing gives flexibility to the RBA to cut the cash rate up to 75 basis points to weaken the dollar without affecting the housing bubble. This is positive for stocks with offshore earnings, and leads to a lower Australian 10 year bond price. Westpac and regional banks are also worthy stocks to hold given their overweight position to investment lending.
ANZ’s repricing of its domestic variable rate investor lending book will increase cash earnings by 2%. However to offset the valuation impact of this additional $13 billion to $24 billion of common equity tier 1 capital, the major banks would need to increase their margins by 12 to 22 basis points. CBA earnings should increase by 2-3%, and if the others follow suit: NAB 1-2% and Westpac 3-4%. Combined profits of the big 4 banks could improve by $800 million. For regional banks the returns would be even larger: Bendigo and Adelaide bank 4-5%, Bank of Queensland 5-7%. Interest rates therefore are expected to continue on the upward trend.
Australian Financial Review, SMH, Reuters