How will banks behave if the housing market cools?

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This story introduces the COMMONWEALTH BANK OF AUSTRALIA and other companies. For more information SHARE ANALYSIS: CBA

Does the outlook for banks depend on the implementation of tightening measures to cool lending to homebuyers?

-Measures to curb the housing market could be underway by the end of the year
-Initial action likely to be modest and likely involve limits on DTI and LTV loans
-The main benefit for banks will be measures allowing a revaluation of mortgages

By Eva Brocklehurst

As Australia’s house price spike puts lending under scrutiny, are regulators now gently massaging expectations of tighter terms heading into 2022? Several brokers suspect that certain measures could be considered to cool the market.

Any macroprudential action is likely to dampen housing and Macquarie expects credit growth and potentially house prices to moderate accordingly. If these measures are effective, they would limit the potential risk of rising bank profits associated with credit growth.

A statement from the Board of Financial Regulators (CFR) also raised alert levels for brokers, with a warning that a period of credit growth that significantly exceeds household income will increase the medium-term risks to which the economy is. confronted.

Still, brokers agree that regulators don’t appear to be in a rush, and although the Australian Prudential Regulatory Authority (APRA) plans to release a document within the next two months, it doesn’t look like a major tightening is imminent.

Commonwealth Treasurer Josh Frydenberg reinforced the CFR’s statement, commenting on the need to restrict borrowing, especially the amount of high debt-to-income ratio (DTI) loans.

Although he was taken aback by the treasurer’s comments, as he had been keen to ease lending standards after the bank tightening previously, Jarden now thinks it is. a clear signal of the risk of a tightening on the horizon. The broker expects 2022 to arrive before regulators move, after assessing the impact of lockdowns and the uncertain economic recovery.

JPMorgan also suspects that APRA may be in a tightening mood, perhaps seeking to target investors rather than owner-occupiers / first-time buyers. Requests for investor loans have increased, although the share of home loan balances is lower than historical averages.

Due to accelerating mortgage growth, Morgan Stanley expects macroprudential measures to be implemented by the end of the year. In addition, as the broker notes, Commonwealth Bank ((CBA)) CEO Matt Comyn said “we think it would be important to take a small step as soon as possible”.

Home loans, over the 12 months ending in August, are up 6.2%. Credit Suisse is also pointing to a record $ 17.2 billion in mortgage refinancing commitments, 60% more than a year ago. Borrowers seem to seek the lowest rates, and repayment offers are also used to entice customers to change banks..

Brokerage notes, from major banks, Westpac Bank ((WBC)) offers the highest repayment offer for refinancing among the major banks, at $ 3,000 when customers switch home loans. Queensland Bank ((BOQ)) and Suncorp ((SUN)) also offer similar cashback amounts.

What type of tightening, and when?

Morgan Stanley expects an announcement from APRA in December, with the most likely measures being a limit on high DTI loans and high value loans (LTVs) and / or changes in rate floors and cushions. interest.

The broker believes that at least two of these tools could be used to significantly narrow the gap between household credit growth and income growth. These measures are expected to reduce the growth of home loans to 5% in 2022.

Nevertheless, concedes the broker, given the 2014-17 experience, the first actions could be modest. The broker calculates that each 50 basis point increase in bank interest rate floors reduces borrowing capacity by -5%. If this were applied to all new loan approvals, it could reduce home loan growth by -1.5%.

The Commonwealth Bank has revealed that less than 10% of applicants are borrowing at full capacity and less than 2% were affected by the 15 basis point increase in its floor in June. This, in turn, suggests to Morgan Stanley that modest changes to the floor will have minimal impact on loan growth.

JPMorgan calculates, in the June quarter, that mortgage loans to borrowers with DTIs above 6x accounted for 24% of new flows for large banks. There is a tendency to focus on investor risk but, as the broker points out, ultra-low interest rates also pose problems for homeowners.

That said, bank disclosures on high DTI loans are very limited and, as JPMorgan notes, so far New Zealand mortgage growth has defied a number of attempts by the Reserve Bank of New Zealand. Zealand to cool the market.

Jarden expects a high DTI loan cap to have the biggest impact on investors with multiple loans, while an increase in service buffers would likely affect all borrowers.

APRA has previously reported that countercyclical capital buffers can be used to curb credit growth, but banks currently hold excess capital and, as a result, Jarden and JPMorgan argue that an increase in capital buffers does not would not have a significant impact in the short term. term.

Nonetheless, Jarden calculates that increasing the sustainability buffer by 0.5% would reduce borrowing capacity by -5% and directly slow credit growth by -0.5-1% over a 12-month period.

At the end, given that a federal election is slated for early 2022, any tightening is expected to be modest because a correction in the housing market in the run-up to an election would be considered “unwelcome”.

Therefore, Jarden agrees that a small but visible measure to relieve the housing market is the most likely scenario. The broker remains positive about the outlook for house prices and credit growth amid still low interest rates and improving economic outlook after the closings.

Bank valuations

Therefore, the main benefit for banks is likely to come from any macroprudential measures used to revalue mortgages. In ranking the banks, Macquarie notes the mortgage fortunes at ANZ Bank ((ANZ)) declined, while the losses in terms of market share accelerated.

Even though the bank has argued that it will not use price leverage to drive market share for its own good, as growth lags -4.5% behind its competitors, Macquarie suspects that this could prove to be a costly mistake, unless the margins can compensate. Banks outperformed the broader market by 4% in September, but the broker believes that over the longer term, the sector’s appeal is limited.

At first glance, banks are expensive, although if you reflect the current cost of equity in the market, the industry is only becoming slightly overvalued, in Citi’s opinion. The market appears to be forecasting an improvement in underlying yields over FY22 and beyond, possibly due to rising interest rates and improving margins on deposits.

While the sector price may be generally appropriate, there is a divergence between banks. Citi considers Commonwealth Bank and ANZ Bank to be overvalued, while Westpac and National Bank of Australia ((NAB)) are only modestly expensive.

While there has been some moderation in bank share gains since May, most of the big banks have retested the 1-2 year highs. Banks have endured a prolonged period of declining returns on equity, complicated by the pandemic, and Citi concludes that the lack of recovery in underlying returns, normalized for bad debts and surrenders, has resulted in outperformance at the point dead.

The broker notes that the Commonwealth Bank was the only one to record a modest improvement in underlying returns, to 13.1%, but this was offset by a strong rally in the share price. If an economic downturn occurs, the valuation of the sector may make it more vulnerable to underperformance relative to the broader market, adds the broker.

See also, Banks still face challenges ahead September 8, 2021.

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