MORGAN STANLEY: Big bank margins may suffer as Australian borrowers increasingly abandon interest-only loans


Westpac’s quarterly report has revealed a major shift underway
among Australian borrowers.

Yesterday the bank said it was “on track” to slash its new
interest-only loans to below APRA’s regulatory cap of 30% by the
September deadline, saying 36% of its new lending was
interest-only, a dramatic fall from 47% last quarter.

And its results for the June quarter also revealed that a
significant number of borrowers switched from interest-only to
principal and interest repayments.

Further analysis by Morgan Stanley’s equities team showed showed
that in July, the move to principal & interest increased even
more rapidly on an annualised basis:

Given the recent out-of-cyle rate increases by the big banks on
interest-only loans, it’s not hard to see why.

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

Those increases have been partly in response to restrictions
introduced by the Australian Prudential Regulation Authority
(APRA), capping interest-only lending at 30% of all new loans

Morgan Stanley said that while the big banks could absorb the
shift to lower interest-rate repayments in the short-term, the
trend will start to put a squeeze on margins next year.

“While CBA refused to disclose the amount of switching in 2017,
today’s data from Westpac suggests that interest-only loan
switching could be playing out earlier than the market is
expecting,” the bank said.

Of course, as customers switch to more cash-hungry principal and
interest repayments it’s unlikely to help Aussie consumer
sentiment either.

Consumer confidence has taken a turn for the worse in August

as households deal with low wage growth, high household debt and
rising energy costs.

Morgan Stanley said that future headwinds from the shift will be
stronger at Westpac, as around half of its Australian mortgages
are interest-only loans — compared with around 40% for the other
major banks.

Westpac’s proportion of interest-only loans has been falling
steadily to 44% in its third quarter, from 52% in the second

Despite, or perhaps because of that, Westpac remains Morgan
Stanley’s preferred bank among the big four. The MS analysts said
Westpac has a “better near-term earnings outlook”, is less
susceptible to credit risk and offers a better risk/reward ratio
at current valuations.

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