One of the things that really rubs mortgage holders the wrong way is interest rates. Or more to the point, how and when the banks change their rates.
When the RBA cuts the cash rate, banks can often take their time passing the rate cut through to customers. And even then, it might not be cut by the same amount.
Of course, when the RBA raises rates it’s a different story. As soon as the RBA’s media release hits the market, it seems as though the banks are tripping over themselves in the race to raise their rates.
Mind you, a rate rise is something new homeowners might not be familiar with, given that the last rate rise was all the way back in 2010.
Delaying a rate cut by a few days might not add up to much for individual homeowners. However, with the millions of mortgages they hold, the banks’ bottom line definitely benefits. Each day they delay passing it through adds millions more to their profits.
While doing this benefits the banks, it certainly does not help with their public image. Up until the Royal Commission, perhaps the truth is that they just didn’t care.
For their customers, though, it’s just something else that adds to their cynicism.
How Aussie banks really raise funds
With the Royal Commission in full swing, CEOs of the big banks must feel like they are walking on eggshells. Even the slightest whiff of impropriety or opportunism could put them back on the stand.
But that doesn’t change one important piece in the picture. That is, that the cost of their funding has been on the rise.
In the main, banks finance their loan books two ways. First, via their depositors — that is, people like you and me putting money into our accounts.
It’s a tremendously cheap way for the banks to raise funds. Plenty of everyday accounts pay no interest at all.
And term deposits barely pay above 2%, unless you are willing to lock your money away for long periods at a time.
Australia’s largest bank, the Commonwealth Bank [ASX:CBA], raises something like 65% of its funding this way.
The other way banks raise funds is by issuing bonds (or paper). And this is where it is all getting a bit harder.
Issuing bonds means you are up against every other institution doing the same thing. Whether it be other banks, corporations or governments raising funds.
Bond investors look at two key things. The interest they will receive, and the quality (or grade) of the paper they are investing in.
However, don’t be misled by bank bashers. The paper issued by Australian banks rank as high, if not higher, than most.
Banks are getting more competitive
Despite their high rating, the cost of this other form of funding has been on the rise. The Australian property market is softening, though not crashing as the doomsayers predict.
Though given their exposure to property, Australian banks will feel any downturn in the market.
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The Commonwealth Bank reports its full-year results in less than a month (8 August). The other big three will report later in the year (late October to early November).
What the market will be looking particularly closely for in these results is the level of bank loans in arrears or default.
Any significant uptick in loan impairments will see the banks’ funding costs continue their rise. That is, those investing in their bonds will want a higher interest rate for the perceived increase in risk they are taking on.
Adding to the banks’ funding costs is the competition from others issuing bonds. Not least of which is the US Treasury, as it funds the ever-growing US budget deficit.
That means bond investors have a bigger choice. Not only in what paper they invest, but the interest rate they expect.
As investors know all too well, US rates are on the rise. Despite two rate rises this year, another two could be on the cards. Given the commentary from the Fed, the market is locking in at least one of these.
That means Australian banks, like others, will need to offer higher rates to attract investors.
Banks have two ways they can handle this. They can either absorb this increase in funding costs, which will lead to lower profits and dividends. And, unhappy shareholders.
Or, once the scrutiny of the Royal Commission dies down, they can start gradually increasing their mortgage rates.
Earlier this week, Macquarie was first cab off the rank. It increased its variable home loan rates by 0.06%.
Not a lot, I know, but enough to put pressure on those already under stress. The real question now is when, not if, the other banks do the same.
All the best,
Editor, Options Trader