‘Goldilocks’ period for banks, but can they exercise their pricing power?
Margins collapsed at the end of 2021, hit by fierce competition and a surge in discounted fixed-rate loans. Lately, however, the conversation has turned more optimistic, as money markets are betting that a series of RBA rate hikes will occur from June.
When National Australia Bank, Westpac and ANZ release their half-year results next month, some pressure on margins is expected, but markets feel the worst will soon be over.
In theory, banks benefit from RBA rate hikes because lenders are rapidly raising their mortgage rates, while continuing to hold a similar amount of interest-free or low-interest deposits. The result is wider margins.
A sharp rise in fixed rates, which began last year, should also encourage more people to borrow at variable rates, which are more profitable for lenders.
At a press conference this week, UBS analyst John Storey cited forecasts that rate hikes could boost Big Four revenues by about $5 billion over the next three years, on the basis of UBS’s relatively conservative forecast for a cash rate peak of just 1.25 to 1.5 percent. hundred. At the same time, banks are also benefiting from strong credit growth and historically low loan losses.
“It’s a bit of a Goldilocks period for banks,” Storey says.
But if the banking sector is as competitive as we are told, will the extra profits from rate hikes be a sugar shot or something more sustainable?
Some in the market are more skeptical on this front, saying aggressive competition for mortgage customers will eat away at banks’ rate hike windfall.
Macquarie analysts, for example, point out that banks continue to offer higher discounts on their new loans. They say the average new homeowner’s variable rate mortgage had an interest rate of 2.29% in the six months ending March, down from 2.55% six months earlier, citing broker data in Lendi mortgages. Analysts say higher rates should eventually help margins in 2023, but stiff competition will “limit margin upside.”
Even so, others believe the big banks are emerging from COVID-19 in a position of greater strength, and the RBA’s rate hikes will allow banks to use one of their most prized traits: power. price fixing.
Pricing power refers to a company’s ability to set prices for goods and services in the market, rather than letting them be dictated by competitive forces. It’s something that’s highly sought after in times of high inflation – and the recent strength in bank stocks suggests markets think banks still have plenty of it.
Jefferies analyst Brian Johnson, who describes the Australian bank as a “rational oligopoly,” points to some recent signs suggesting that banks may choose to avoid an all-out price war when rates begin to rise. He says Westpac, which slashed prices and margins after losing market share in the mortgage business last year, has recently chosen to grow at a slower pace and face less aggressive competition. .
Another advantage for the Big Four is their huge pools of cheap deposits to use as funding, Johnson says, in contrast to the rising funding costs faced by non-bank lenders. “I think everything favors the starters,” Johnson said.
What about the risk that higher interest rates will lead to more bad loans, after an increase in lending to highly indebted households during the recent housing boom?
Bankers are confident most borrowers can cope with higher rates: They point out that unemployment is at historic lows, most people are well ahead of their repayments and households are sitting on 250 billion dollars in COVID-19 savings.
But a lot may depend on how high the rates are. According to Barrenjoey analyst Jonathan Mott, if interest rates rise more than expected, customers who have borrowed a high multiple of their income could find themselves in mortgage trouble. He’s not rocking a bust, but says the large loans to highly indebted customers show the challenges facing banks as interest rates begin to return to more normal levels.
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