The banks are quietly rotating their books. Who wins, who loses?
Let’s stop and think about the APRA restrictions again.
Now we know that APRA have gone hard on the banks about the pace of growth in investor loans, and in interest-only loans in particular.
So far it seems the banks are playing ball. We’ve seen all financial institutions increase mortgage rates, though there has been some pivoting away from investors and interest only toward owner-occupiers in the pricing.
Ask any mortgage broker and they’ll tell you it’s a much tougher credit environment, especially for investors.
Now let’s think about this from the bank’s perspective.
You’re in a competitive industry. Until recently the name of the game was market share – you were growing your mortgage book as fast as profit margins would allow.
But then along comes APRA and totally flips it on its head. You don’t get to say how fast your mortgage book is growing any more – at least to investors. APRA says investor loans can’t be growing at more than 10% a year.
They also put limits on investor only loans, saying they can’t be more than 30% of issuance.
Suddenly an industry that was spread out over a range of growth rates is pulled into a very tight pack. Every bank will want their investor mortgage book growing at 9.99%. They’ll all want 29.99% of their loans to be interest only.
Suddenly they’re marching in lock step.
So maybe you compete on price, but the pricing space was competitive already, so there’s not much you can do there, and you’re funding costs are largely determined overseas so it’s out of your hands.
So what do you focus on to get a competitive advantage? How can you separate yourself from the pack?
Not all loans are the same. Some borrowers are riskier prospects than others.
So say you’re a bank growing very close to your 10% speed limit. You’ve got one more loan you can make before you’re maxed out. You have two choices in front of you. Which one do you go with?
The one that’s lower risk.
The aim of your game, if you’re growing as fast as you can already, is to start rotating your book into a higher quality portfolio.
That might mean choosing higher quality applicants over less quality ones.
But it may also mean going back through your book and weeding out lower quality ones to make room for higher quality ones.
And that might mean that interest-only investors, when it comes time to roll their loan over, might be facing a very tough time of it. The banks will be looking at them and saying, if I cut this borrower loose, will I be able to replace them with a better one?
I might be able to cut them loose and pick up a higher quality borrower, thereby saying under APRA’s speed limit, but improving the quality of my book.
Now that probably means passing a stricter eye over an individual borrowers circumstances, but knowing what we know about the banks’ business models, it probably also means differential preferencing for different geographies.
Banks might be saying, other things being equal, we’d like to replace Perth borrowers with Sydney borrowers…
… for example.
We are seeing some signs of this. Mortgage brokers in Perth are saying things are pretty tough right now, and APRA’s measures are a ‘sledgehammer’. From mortgage broker mag, The Adviser:
“The Australian Prudential Regulation Authority (APRA) has been castigated by brokers for its nationwide “sledgehammer” crackdown on interest-only loans, which have been labelled as “myopic” and “devastating” for regional Australia.
Damian Collins, managing director of Momentum Wealth in Perth, told The Adviser that APRA’s moves to limit the flow of new interest-only loans were based on a “sledgehammer” approach that neglected to consider the impact on areas outside of Sydney and Melbourne.
… Mr Collins said: “We got told in WA [in April], that for investor refinances, [lenders] are not doing them… so, you can tell APRA is definitely putting the pressure on the banks to manage their loan book growth, which is strange because in WA there aren't a lot of investors doing anything at the moment.
“So, I guess [APRA] aren’t really looking at it state by state, they're just looking at it as a global pull and finding any way they can to make changes.”
The Momentum Wealth MD went on to say that some of his clients in WA had previously been able to borrow around $2 million and, within a couple of months of the macroprudential measures being announced, that figure dropped down to $700,000.
Mr Collins lamented that the regulator had not taken a state-by-state approach.
“It's like taking a sledgehammer to the problem and certainly has affected investors across the country… You'd think [APRA] would be able to do it better, but they haven't,” he added.
Touching on the crackdown on interest-only loans in particular, Mr Collins said that the penalties now made this type of loan practically redundant for investors. According to the Momentum Wealth managing director, the repayments on some interest-only loans are the same now as P&I.
He said: “It's at the stage now where, for a lot of our investor clients, we're saying: ‘Get a P&I loan, it’s just not worth paying that premium for paying interest-only.’”
It is not that Perth is getting hit with the same stick as Sydney and Melbourne. It’s that APRA gave the banks the stick and the freedom to hit whoever they wanted.
For the sake of loan quality, they decided to hit Perth – hard.
That has the potential to create a self-fulfilling prophesy in some of these markets that are struggling.
I’m still watching Perth. I think there will be some bargains to be had. But I also don’t think its time to jump in just yet. Give it a few more months and see how the APRA restrictions and this loan-quality business play out.
Too soon for Perth?