‘Irrational’ mortgage competition may hit banks, Macquarie warns

Macquarie sees bank margins peaking, with ‘irrational’ competition in the home loan market hitting profits.

Australian banks face a potential hit to earnings of between 20 to 25 per cent as competition in a stagnant mortgage market bites into their profit margins, Macquarie analysts warn.

With banks having to compete in a home loan market that is not growing as fast as it was a year ago when money was cheap, analysts at Macquarie say competition for mortgages and deposits could mean significantly lower profits for the banks in coming years.

The analysis comes after Bank of Queensland last week warned of falling net interest margins, a key measure of bank profitability, in an “irrational” market that is temporarily pushing some banks to price mortgages below their cost of capital.

“While management are optimistic about “rationality” returning to the mortgage market, pricing may stay “irrational” longer than people anticipate,” Macquarie analysts told clients in a note on Monday.

The investment conglomerate says the banks’ interim results next month are likely to reflect that the benefits of the rising interest rate cycle that started a year ago have hit a ceiling, with margins and earnings coming down from there on.

“Subsequent to margins peaking (we believe it already happened), our analysis points to downside risk to our below-consensus expectations in FY24-25,” the analysts said.

As more mortgages sold three to five years ago start maturing, those older mortgages will have to be refinanced and their “price” adjusted to reflect current rates.

The problem is that with less growth, the same market participants are competing for fewer mortgages and this competition is pushing banks to offer home loans at lower rates, which eats into their margins.

Three of the four majors – National Australia Bank, Australia and New Zealand Banking and Westpac Banking – will report interim earnings starting from May 4.

Macquarie is forecasting the combined earnings for the three banks to rise 21 per cent to $22.9 bn, before falling 7.5 per cent in fiscal 2024 to $21.2 bn. Commonwealth Bank, the largest of the four banks, is due to release its third quarter update on May 9.

On Macquarie’s numbers, new home loans yield banks margins between 0.5 and 0.6 per cent lower than the average margin from older mortgages.

That means they are capturing a return on their invested capital of about 7 to 8 per cent from the new mortgages they write, compared to a return of between 20 to 25 per cent from their older mortgages.

“In a scenario where all mortgages churned onto current front-book mortgage rates, our analysis … estimates banks will see a ~15-20 per cent impact to their earnings (and 20-25 basis points impact to margins). CBA and WBC are more impacted given their overweight exposure to mortgages, while ANZ and NAB are relatively less impacted.”

Macquarie says it is unlikely that all mortgages will refinance onto new home loans, but assuming 75 per cent of them migrate to new rates, the impact on earnings would be between 12 to 17 per cent.

Dynamics in funding markets, and particularly in the deposit market, is another factor hitting their margins.

“We also expect an ongoing shift to more expensive deposits, unwinding some of the funding benefits that banks currently enjoy,” they added.

Banks are having to compete for deposits – comprising about 70 per cent of their funding – as cheap funding secured during the pandemic matures and as savers are lured by the higher interest rates offered elsewhere.