Mortgage re-pricing and robust mortgage volume growth have supported banks’ earnings in recent years but that may be coming to an end. Macquarie Securities estimates that banks’ ability to continue to re-price mortgage is diminishing and, increasingly, banks need to identify other sources of earnings growth.
Macquarie has downgraded its earnings forecasts for the big four banks in the 2017/18 and 2018/19 financial years.
Banks have re-priced mortgages by as much as 63 basis points over the past 12 months, which should increase earnings by as much as seven per cent in the current financial year.
But Macquarie is concerned that mortgage re-pricing is turning into a zero sum game; as rates have gone up the interest burden on highly indebted households has become more serious. “We see limited scope for further re-pricing,” Macquarie says.
Current historically low interest rates should give households a buffer against debt stress and at an aggregate level household debt servicing capacity remains sound.
However, the growth in debt has been concentrated rather than evenly spread. Thirty per cent of households are responsible for 85 of household debt. Household debt reached 130 per cent of GDP last year – an all time high
And as a result of ongoing mortgage re-repricing Macquarie estimates that the average mortgage rate is close to the 10-year average of six per cent, which suggest the low-rate buffer is not as great as people assume.
The impact of higher rates on household incomes is likely to be reflected in reduced borrowing capacity. Macquarie sees mortgage volume growth falling to low single digits towards the end of the 2017/18 financial year.
Further, while a possible fall of five to 10 per cent in house prices is unlikely to lead to large losses in banks’ housing portfolios, it would impact consumer sentiment.
The recent tightening of credit standards by the Australian Prudential Regulation Authority, combined with the increasing vulnerability of highly indebted households, is likely to reduce the banks’ earnings outlook over the medium term.
In March APRA directed lenders to limit interest-only loans to no more than 30 per cent of new residential mortgage lending (they are currently around 40 per cent)
The regulator considers interest-only loans more risky than principal and interest mortgages for a couple of reasons: the borrower is exposed to the full value of the loan if rates rise; and there is less incentive to continue paying a mortgage in difficult circumstances when none of the principal has been repaid.
APRA’s latest move follows an instruction it gave to lenders at the end of 2014 to limit growth in new investor loans to 10 per cent a year.
Macquarie has downgraded its earnings forecasts for the big four banks in 2017/18 and 2018/19. It expects ANZ’s earnings per share to fall 0.5 per cent in 2017/18 and 1.3 per cent the following year.
Commonwealth Bank’s earnings per share are expected to fall by 0.8 per cent 2.3 per cent over the two years, National Australia Bank’s by 0.8 per cent and 1.6 per cent, and Westpac’s by 1.1 per cent 2.7 per cent.
CBA and Westpac are expected to experience bigger EPS falls because they have bigger shares of the mortgage market.
“In the short term banks are continuing to offer a relatively defensive earnings profile, supported by re-pricing initiatives and low bad debt figures. With our change of view, we do not see justification for banks to continue trade at current price-earnings multiples, which are at a premium to historical levels,” Macquarie says.