03 Jul 2017 Property Investors Should Expect More Interest Rate Pain
For all the political heat on banks, the last few weeks have shown toxic relations with government are no barrier to an old-fashioned unilateral hike in interest rates.
The big difference this time around is banks have been more tactical about it, by targeting rate hikes at one group in particular: property investors.
And I'd bet it's not the last time the banks will make property investors bear the brunt of higher interest rates this year.
All four major banks in June raised interest rates by between 0.3 and 0.35 percentage points on interest-only home loans, mainly used by investors, while also cutting some other rates by a much smaller amount.
There may be some legitimate regulatory reasons for this, but it will also pay off nicely. Morgan Stanley analysts say the rate rises add up to about $900 million in extra annual profit for the big four, all things being equal.
But did you hear politicians or the media lining up to slam the greedy bankers? Me neither.
That is because it's become increasingly clear in recent months the banks will be given much more latitude from politicians, and an implicit nod from regulators, to move rates as long as the higher costs are directed mainly at investors and interest-only customers.
There are three reasons to think this dynamic will continue, which means property investors or people who only pay interest will probably wear a bigger share of any future rate hikes.
One reason is the prospect of tougher capital rules.
Any week now, the Australian Prudential Regulation Authority (APRA) will reveal how much extra capital banks must hold to be more shock-proof, a change that on its own would dampen profits.
Yet it's a safe bet some of this impost will end up being borne by mortgage customers. Why? Because the banks have a strong track record in passing on the cost of tougher capital requirements to customers, as well as shareholders.
A recent Reserve Bank paper pointed out that since 2008, official interest rates set by the RBA had dropped 5.75 percentage points, but the rates banks charge on home loans were only down by about 3.9 percentage points over this period.
This was only partly because of higher bank funding costs, the paper suggests, as the gap between mortgage rates and banks' implied funding costs had also widened by 1.1 percentage points in this period.
In other words, more than half of the “unofficial” interest rate changes made by banks since the GFC have not been the result of funding cost changes, but a desire to cushion profitability.
Some believe the next round of capital rules may also have a particular sting in the tail for investor loans.
CLSA analyst Brian Johnson has pointed out Australia is “largely,” but not totally, compliant with international banking rules knowns as Basel, because of our unusually favourable capital treatment given to housing investor loans. Were this to change in the coming weeks, it would be another reason for banks to jack up interest rates on investors.
A second and related reason why investors and people with interest-only loans may keep copping it is the regulators' concern about the housing market.
In March, APRA imposed a 30 per cent cap on the proportion of new mortgage lending that can be interest-only, alongside a previous 10 per cent cap on growth in the stock of housing investor loans.
Banks have adjusted to these caps through a combination of tougher lending rules, and price signals.
However, the combination of these two caps is also to limit competition in housing investor lending.
The caps make it harder for smaller banks to expand quickly in the housing investor market, because if they get too aggressive, they risk falling foul of either cap.
For larger banks, on the other hand, this brake on competition means there is less risk of losing customers to rivals if they jack up interest rates.
The RBA would never say this out loud, but the private banks are also doing some of the RBA's work for it. The recent rate hikes by banks should quell some of the RBA's fears about households' excessive interest-only borrowing, without any need to move the cash rate.
A note from UBS economist Scott Haslem on Friday was even titled “Are the major banks setting RBA monetary policy?” – and it's a fair question as far as mortgage customers are concerned.
A third reason why property investors may face higher interest rates is the political target on the banks' backs. When they are so on the nose with pollies, bankers are naturally hesitant about slugging the majority of mortgage customers, who are owner occupiers, with higher rates.
But when housing affordability is so stretched in NSW and Victoria, it's a brave politician who comes out and bashes the banks for jacking up rates on landlords.
Indeed, every incremental rate hike for property investors makes it that much harder for these buyers to out-bid owner-occupiers or first-home buyers.
And let's not forget the bank tax. All the banks stressed the tax did not drive the latest round of rate hikes, but it would be naive to think they won't try to pass it on to borrowers eventually.
Whether it is tougher capital rules, curbs on the housing market, or the bank tax, lenders have plenty of excuses to raise interest rates at their disposal. Property investors have become the easiest group for the lenders to target, and this doesn't look like changing soon.
Clancy Yeates – The Age