Finance Market Update - 25 October 19
The banks margins are under threat and they will do anything to protect them. In this update we talk about the NIM, the upcoming investigation to mortgage pricing and how likely rate cuts now are this year.
The all-important NIM
One of the core drivers of profitability for banks is the difference in how much it costs them to borrow money to how much they can charge people to borrow money from them.
Technically this is referred to as the 'Net Interest Margin' and is a term we will hear a lot more about during the recently announced and up-coming ACCC investigation into mortgage pricing.
We have talked before about the big bank’s big books and profits and even the NIM, but let's dive a little further as it will help us understand how much it does and will continue to influence their market positioning and pricing, and therefore cost to mortgage holders.
Focusing on the big four banks, when we talk about cost of capital it is referring to how much it costs them to get money from the various sources available to them. The main sources are from deposits (your money and mine), capital markets (shares, equity and short-term loans) and by issuing bonds (a complex IOU arrangement).
Of those main sources, on average for the big banks they get around 70% from deposits (your money and mine), and the rest from the short term 'money market' (where the RBA and banks lend to each other overnight or for up to 90 days) and from issuing bonds to investors (aka lenders) based domestically and overseas.
It is important to know these sources because each source has a different cost for the bank and their cost mix determines their pricing, and because they make profit from the difference in the price they can get money at to how much they can lend it to the market (you and me) at, the cost of each source makes the loans more or less profitable.
When banks say the NIM us under pressure what they are essentially saying is it is getting more expensive for them to borrow money, and the amount they can lend it at is going down, so is their profit.
A real-world example of this is that there are fixed rate mortgage options around 2.89% available, and the banks borrowing costs them close to that.
Seeing as the big 4 banks (CBA, WBC, NAB, ANZ) made a combined cash profit of $29.5 Billion in 2018, most people would (rightly) think they could stand to see profit decrease a bit.
For those financially inclined, in FY18 the average NIM was 200 basis points, which translated to an aggregate $62.6 Billion in net interest income between the four of them.
We will continue to hear banks bang on about their NIM and how lower cash rates and mortgage rates are impacting it but given they have been poor to pass along rate cuts, or more accurately communicate how they make their decisions, their crowing will likely fall on deaf ears from the public, but the ACCC will be listening, closely.
Show me the money
The federal government at current Treasurer J-Fry announced the ACCC (Australian Competition and Consumer Commission - aka the competition watch dog) will be instigating an inquiry into mortgage pricing.
Pricing is a serious issue, but one that happens in any free market.
The political sound bite from government on why the inquiry is happening is because the banks failed to pass on all of the 0.75 rate cuts from the three that happened this year.
All of the big four banks passed on the full 0.75 points in rate reductions to investors, but for people living in their homes and paying Principal & Interest repayments only got a cut between 0.55 and 0.59.
That's a considerable 0.20 points the banks are leaving on their existing customers, and this is why the government wants to take a closer look at their numbers, their decision making and justifications for not passing on full rate cuts.
That’s the central issue. The banks will drop the rate for investors, but for loyal customers who are living in their home and paying down the debt, they get less rate reductions.
But the big banks could be doing a better job for their existing customers, and for people who bank with them and particularly have a home loan with them, it is time to shop around.
We've talked before about the rise of neo-banks and second tier lenders and in reality there are so many viable, if not better, options than the big banks out there.
There are around 3,000 mortgage products in the Australian marketplace offered from around 150 organisations (circa 100 of those are Banks / ADI’s). It can be confusing to wade through all of this, particularly because many of them are almost identical, but using a finance broker like Skyward Financial can really help you get to the optimal deal quickly and with guidance.
But let’s face it, the big banks aren’t legally obligated to pass on all rate cuts and in a democratic free market economy a business should be able to price their products and services as they see fit, and in reality people are not that loyal to their bank, most are very willing and able to move, and probably should.
Being able to change one’s view when presented with new information is paramount to success.
In the last update we predicted a cut in November, but now this is seeming less likely due to comments made by the governor of the RBA in Washington a few weeks ago and recently released data showing marginal improvement in the jobless rate. We have lowered our view to a 20% chance in November.
As we said, the employment rate is the most important number in the RBAs numbers game, and it showed a more positive result of 5.2% than anyone expected, so the RBA has a bit of breathing space before having to cut again, and we think they will take that space to sit and not cut, for now.
But - our view is that it is a question of when, not if, rate cuts will happen, but we are calling for no more rate cuts this year.
We still view the impending reactions of our central bank to be a combination of rate cuts and QE (as discussed in the last update here) – but it might just be happening a bit later.