Big bank margins can suffer as Australian borrowers increasingly forego interest rate loans

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Westpac’s quarterly report showed that a big shift is underway among Australian borrowers.

Yesterday, the bank said it was “on track” to cut its new interest-only loans below the APRA’s regulatory cap of 30% by the September deadline.

And the results for the June quarter also showed that a significant number of borrowers switched from pure interest to principal and interest repayments.

Another analysis by the Morgan Stanley equity team showed that July, the move to capital and interest on an annualized basis increased even faster:

Given the recent major bank rate hikes on interest-only loans, it’s not hard to see why.

“The main driver is increasing customer-initiated switching in response to three consecutive rounds of interest-only revaluation, with the largest revaluation of 34 basis points (0.34%) taking place in June / July,” the analysts said.

These increases were in part a response to restrictions imposed by the Australian Prudential Regulation Authority (APRA), which limited interest payments to 30% of all new loans.

Morgan Stanley said that while the big banks could cushion the shift to lower interest repayments in the short term, the trend will start to depress margins next year.

“While the CBA refused to disclose the scope of the switch in 2017, today’s data from Westpac suggests that the switch from pure interest rate loans may come sooner than the market expects,” the bank said.

Of course, as customers switch to more cash-hungry principal and interest repayments, it is unlikely that this will improve the sentiment of Australian consumers.

Consumer confidence deteriorated in August as households have to contend with low wage growth, high household debt and rising energy costs.

Morgan Stanley said future headwinds from the postponement will be stronger at Westpac, as about half of its Australian mortgage loans are interest-only loans – compared to about 40% with the other big banks.

Westpac’s share of interest-only loans has steadily decreased in the third quarter from 52% in the second quarter to 44%

In spite of this, or perhaps because of it, Westpac remains Morgan Stanley’s preferred bank among the Big Four. MS analysts said Westpac has “better short-term earnings prospects”, is less vulnerable to credit risk and offers better risk / return on current valuations.

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