Welcome to the bank reporting season.
Within a month, four of the Big Five banks will produce interim earnings while the Bank of Queensland trots out its figures in the middle of next week.
The ANZ, St George, National and Westpac will all produce solid profit performances in the first half of the 2007 financial year and analysts are generally agreed that the main points to be watched will be the level of bad and doubtful debts in housing mortgages and personal, such as credit cards.
And while there were fears there could be an upsurge in the level of dodgy loans and actual losses, it is now becoming clear from the APRA and Reserve Bank data, plus the RBA’s financial stability statement on Monday that much of that concern was misplaced.
In fact the RBA’s comments on the banks and the banking system should be read by all bank shareholders: unless the RBA has made a horrible error, it’s clear there are no black holes in bank balance sheets.
Perhaps the most interesting area to watch is the implicit warning about the contraction of lending margins on housing mortgages because of low demand and high levels of competition.
The RBA points out that there are hardly any mortgages being sold where the borrower is paying the bank headline adjustable or fixed rate, such is the intensity of competition.
Banks’ share prices have increased by around 14 per cent over the past six months, slightly underperforming the broader market. The market has been driven more by one off situations involving private equity (Qantas and Coles) and lately, the recovery in commodity prices.
The RBA said on Monday that market-based measures of credit risk also remain benign, with bank bond spreads remaining low by the standards of recent years, and the premiums on credit default swaps – both senior and subordinated – falling further over the past six months.
“In the financial sector, both the banking and insurance sectors continue to record high rates of return on equity, benefiting from continued balance sheet expansion, low levels of non-performing loans and the strong performance of equity markets.
“While there has been robust competition in lending to households for a number of years, recently there has also been a noticeable pick-up in competition for business lending, with margins under downward pressure and an easing of lending conditions.
“As has been the case for some time, the challenge for financial institutions is how best to measure, and price for, risk in an economy that is now in its 16th year of expansion
“Bank business credit grew by 17 per cent over the year to January, up slightly from 16 per cent over the preceding year, and faster than the 11 per cent growth in banks’ on-balance sheet housing credit.
“Growth has been particularly strong in large loans, including syndicated facilities where a number of lenders each finance a portion of the total amount.
“Nearly $100 billion of such facilities were approved last year, 38 per cent higher than in 2005, with around one quarter of these used to finance mergers and acquisitions, compared to an average of 15 per cent over the period since the early 1990s.
“Competition also remains intense in the housing loan market, which, over recent years, has been associated with some notable changes in lending practices.
“As discussed at some length in previous Reviews, these include: an increase in permissible debt-servicing and loan-to-valuation ratios; the use of alternative property valuation techniques; an increased reliance on brokers to originate loans; and the wider availability of ‘low doc’ loans.
“More recently, it appears that many lenders have attempted to maintain strong growth in their mortgage portfolios at the same time as the demand for housing finance has moderated from its peaks in 2003.
“This competition is evident in the contraction of margins on variable-rate housing loans, with the vast majority of new borrowers now paying an interest rate less than the major banks’ standard variable home loan indicator rate.
“The average interest rate paid by new borrowers was around 60 basis points below the standard variable rate as of mid 2006, compared to an average discount of around 45 basis points two years earlier, and around 20 basis points in the mid 1990s. Consistent with a large proportion of housing loans having been taken out in recent years, the average discount on outstanding loans has increased to around 40 basis points.
“With refinancing accounting for over one quarter of new housing loan approvals over the past two years, it seems likely that average housing loan margins will continue to contract, even if the size of the discount on new loans stabilises.
“It appears that competition has also picked up around fixed-rate housing lending, as some lenders have responded to increased demand for these products. In late 2006, fixed rate loans accounted for around 20 per cent of owner-occupier loan approvals, well above the average of around 10 per cent since 2000.
“At the same time, the margin on fixed rate loans has narrowed slightly, with the 3-year fixed indicator rate increasing by less than the 3-year swap rate over the past year.
“The narrowing of housing loan margins has been particularly pronounced in the low-doc segment of the mortgage market. These loans involve a large element of self-verification in the application process and are designed mainly for the self-employed or those with irregular incomes who do not have the documentation required to obtain a conventional mortgage.
“The interest rate paid on new low-doc loans was, on average, around 20 basis points below the major banks’ standard variable indicator rate in mid 2006, compared to 50 basis points higher than the standard variable rate two years earlier.
“This is equivalent to 45 basis points above the actual rate paid on new full-doc
