Banks are itching to increase your mortgage interest rate

SYDNEY, AUSTRALIA – OCTOBER 30: NAB CEO Andrew Thorburn speaks at the NAB Full Year Results media conference at NAB House on October 30, 2014 in Sydney, . (Photo by Jessica Hromas/Fairfax Media) *** Local Caption *** Andrew Thorburn Photo: Jessica HromasIt was a gutsy call by the National Bank to raise mortgage interest rates on owner-occupier loans. It has opened the floodgates. Westpac was the first to follow and other banks are itching to do the same. It is not a matter of if – but when. It won’t be long before almost everyone’s mortgage will be more expensive.

For the banks it was just about finding the right moment – the one that would be the least damaging for their public relations.

For the past six months banks – big and small – have been inching up rates on property investment loans, fixed-rate mortgages and interest-only loans etc but have resisted their desire to move on the elephant in the room – the owner-occupier variable interest rate. It’s the one that affects most homeowners, creates the biggest headlines and gets politicians foaming at the mouth.

The betting was always that Westpac would be the next, followed by the Commonwealth Bank and that ANZ would ultimately have to join the party or pay the financial price.

Undoubtedly the banks would rather time rate changes around a move by the Reserve Bank but this opportunity is not likely to present itself for a while yet – maybe not at all this year.

Inside the upper echelons on the major banks executives tie themselves in knots about the timing and the magnitude of rate moves.

They are paranoid about the six-monthly parliamentary grillings at the panel throw spears at bank bosses for misdeeds and anything that looks like they are disadvantaging customers in order to enhance profits. Hiking owner-occupier interest rates when the Reserve Bank hasn’t been the prompt puts them squarely in the line of fire.

It won’t be an accident that banks are moving almost immediately after the last round of hearings in Canberra because it will be another six months before they have to go back again.

It has been estimated that NAB and Westpac will boost their earnings on the back of this move on interest rates. The others can’t let this stand.

There would have been much debate inside NAB’s Melbourne bunker about how to sell this in the most palatable way.

In NAB’s case the rate change was dressed up quite well by including an announcement that first home owners would get a cut in their rate and investor loans would rise by more than owner-occupier rates.

The reality is that first home buyers are not constrained by interest rates, which are historically still very low. They are locked out of the market because they can’t afford a deposit on a loan – which in Sydney and Melbourne at least would be hundreds of thousands of dollars at a bare minimum.

And in a public relations sense, the community isn’t particularly sensitive to the increased costs of financing an investment property.

So what are these property investors going to do when hit by higher interest rates? Trouble is they can’t just move to another of the major banks for a better rate. All of them have been pushing up their home investor rates and none of them really want to take on many more investor customers because they are getting close to limits on growing investors loans set by the regulator, the n Prudential Regulation Authority. There is clearly no one attempting to grab market share in this product.

To a lesser extend the same applies for owner-occupier loans. With the Sydney and Melbourne markets experiencing huge price rises over the past four years, the risk appetite for lending in this market is certainly waning.

And this is another reason why other banks will ultimately join NAB and Westpac rather than hold back on interest rate rises in order to bolster their own market share.

Experts point to the possible exception being ANZ. It is flush with capital having sold much of its Asian business and may use the proceeds to fund leaving owner-occupier rates where they are.

This remains to be seen.

The traditional justification by banks for increasing interest rates (when the official RBA cash rate hasn’t moved) is that their own borrowing has become more expensive and they are passing this extra cost onto customers.

(The difference between the cost of bank borrowings and the rate at which they lend it to customers is called the net interest margin.)

NAB said this week that in the latest half-year result that margin had decreased. This doesn’t sit squarely with comments from the Reserve Bank that suggest that bank wholesale funding costs have actually decreased.

But to be fair, there are plenty of other factors that weigh into a bank’s funding costs – such as the rate it pays on our deposits.

CLSA bank expert Brian Johnson noted earlier this week that n bank earnings are five times more deposit sensitive than wholesale funding sensitive.

As one of NAB’s competitors observed, it is under more pressure than the others because it’s the smallest retail bank and price (of interest rates) is the only way to keep the margins up.

Ironically the Reserve Bank will be quietly pleased if the major banks follow NAB’s lead. It would dearly love rates to rise a little as a means of taking some heat out of the rising property market. The RBA would raise the cash rate if it could but has to measure this up against the effects it would have on already-low inflation and a generally sluggish economy.