How Will Banks Fare If Housing Market Cools?

Australia | Oct 04 2021

This story features COMMONWEALTH BANK OF AUSTRALIA, and other companies. For more info SHARE ANALYSIS: CBA

Does the outlook for the banks hinge on whether tightening measures will be instigated to cool home buyer lending?

-Measures to rein in the housing market could be on the way by year end
-Initial action likely to be modest and probably involve limits to DTI and LTV lending
-Main upside for banks will be measures allowing for a re-pricing of mortgages


By Eva Brocklehurst

As soaring house prices in Australia put lending under scrutiny, are regulators now gently massaging expectations for tighter conditions as 2022 approaches? Several brokers suspect some measures could be contemplated to cool the market.

Any macro prudential measures are likely to put a damper on housing and Macquarie expects credit growth and, potentially, property prices will moderate as a result. If these measures are effective it would limit the potential upside risk to bank earnings from credit growth.

A statement from the Council of Financial Regulators (CFR) has also raised broker alert levels, with a warning that a period of credit growth that materially outpaces household income will add to the medium-term risks that face the economy.

Still, brokers agree regulators do not appear to be in a rush, and while APRA (Australian Prudential Regulatory Authority) plans to release a paper over the next couple of months, it does not appear major tightening is imminent.

Commonwealth Treasurer Josh Frydenberg has reinforced the CFR statement, commenting about the need to restrain borrowing, particularly the amount of high debt-to-income (DTI) lending.

While surprised by the Treasurer's comments, as he had been keen to ease lending standards after banks tightened previously, Jarden now believes this is a clear signal of the tightening risk on the horizon. The broker expects 2022 could arrive before regulators make a move, after assessing the impact of lockdowns and the uncertain economic recovery.

JPMorgan also suspects APRA could be in a tightening mood, perhaps looking to target investors rather than owner occupiers/first home buyers. Investor loan applications have been rising, albeit the share of home loan balances is below historical averages.

As a result of the acceleration in housing credit growth, Morgan Stanley expects macro prudential measures will be implemented by the end of the year. Moreover, as the broker notes, Commonwealth Bank ((CBA)) CEO Matt Comyn has said "we think it would be important to take a modest step sooner rather than later".

Housing credit, over the 12 months to August, was up 6.2%. Credit Suisse also points to an all-time high of $17.2bn in refinancing home loan commitments, 60% above a year ago. Borrowers appear to be seeking the lowest rates and cashback offers are also being used to attract customers to switch banks.

The broker notes, of the major banks, Westpac Bank ((WBC)) offers the highest cashback offer for refinancing among the major banks, at $3000 when customers switch their home loan. Bank of Queensland ((BOQ)) and Suncorp ((SUN)) are also offering similar cashback amounts.

What Sort Of Tightening, And When?

Morgan Stanley expects an announcement from APRA in December, with the most likely measures being a limit on high DTI and high loan-to-value (LTV) lending and/or changes to interest-rate floors and buffers.

The broker believes at least two of these tools could be used to meaningfully narrow the gap between household credit growth and income growth. The measures are expected to reduce housing loan growth to 5% during 2022.

Nevertheless, the broker concedes, given the 2014-17 experience, initial action could be modest. The broker calculates every 50 basis points increase in bank interest rate floors reduces borrowing capacity by -5%. If this was applied to all new loan approvals this could reduce housing loan growth by -1.5%.

Commonwealth Bank has disclosed that fewer than 10% of applicants borrow at capacity and fewer than 2% were impacted by the 15 basis points 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, home loans to borrowers with DTI's above 6x accounted for 24% of new flows for the major banks. There is a tendency to focus on investor risks but, as the broker highlights, ultra-low interest rates also pose issues for owner occupiers as well.

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

Jarden expects a cap on high DTI lending would have the greatest impact on investors with multiple loans, while an increase in serviceability buffers would likely affect all borrowers.

APRA has previously flagged that counter-cyclical capital buffers can be used to rein in credit growth, yet the banks are holding excess capital at present and, hence, Jarden and JPMorgan assert any increase in capital buffers would not have a meaningful impact in the short term.

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

In the end, given a federal election is expected in early 2022, any tightening is likely to be modest as a housing market correction in the lead up to an election would be construed as “unwelcome”.

Hence, Jarden agrees a modest but visible measure to take some heat out of the housing market is the most probable scenario. The broker remains positive about the outlook for house prices and credit growth because of continued low interest rates and the improving economic outlook post lockdowns.

Bank Valuations

The main upside for the banks, therefore, is likely to be coming from any macro prudential measures being used to re-price mortgages. In ranking the banks Macquarie notes mortgage fortunes at ANZ Bank ((ANZ)) have declined, while losses in terms of market share have accelerated.

Even though the bank has argued that it will not use a price lever to chase market share for its own sake, as growth lags peers by -4.5% Macquarie suspects this could turn out to be a costly mistake, unless margins can compensate. Banks have outperformed the broader market by 4% in September but the broker assesses, in the longer term, there is limited appeal in the sector.

On face value banks are expensive, although when reflecting the current cost of equity in the market the sector becomes only slightly overvalued, in Citi's view. The market appears to be pricing in an improvement in underlying returns in FY22 and beyond, likely because of higher interest rates and improving deposit margins.

While the sector may be priced broadly appropriately, there is a divergence amongst banks. Citi believes Commonwealth Bank and ANZ Bank are overvalued, while Westpac and National Australia Bank ((NAB)) are only modestly expensive.

While there has been some moderation in bank share gains since May most of the major banks have been re-testing 1-2-year highs. The banks have endured a protracted period of falling returns on equity, complicated by the pandemic ,and Citi concludes the lack of recovery in underlying returns, normalised for bad debts and buybacks, has meant outperformance has stalled.

The broker notes Commonwealth Bank has been the only one to record a modest improvement in underlying returns, to 13.1%, but this has been offset by a sharp recovery in the share price. If a economic downturn does eventuate, the valuation of the sector may make it more susceptible to underperformance compared with the broader market, the broker adds.

See also, Banks Still Face Challenges Ahead on September 8, 2021.

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