PricewaterhouseCoopers says mortgage market competition among the major banks likely to heat up as rates rise

By Gareth Vaughan

A mortgage price war could break out among the country's major banks if interest rates rise as predicted over the next couple of years, PricewaterhouseCoopers (PwC) says.

Speaking to interest.co.nz as PwC released the latest edition of its bi-annual Banking Perspectives report entitled Resilient result in challenging half year, PwC partner Sam Shuttleworth said he expected a move by customers back to fixed-term rates and away from the floating, or variable, home loan rates that have soared in popularity over the past couple of years.

This expectation comes with most economists now expecting the Reserve Bank to hike the Official Cash Rate (OCR) by 50 basis points from its current level of 2.5% on September 15, as both economists and the central bank itself broadly expect the OCR and floating mortgage rates to rise by around 2%-3% over the next two years. See more here in the crystal ball.

"The banks have profited from the weight of residential borrowers on floating rates," Shuttleworth said in a Double Shot interview. "That said, the residential borrowers have also profited because the floating rates have been less than fixed rates. So it has been a win-win situation."

"(But) the interesting thing is we know there are some (rate) increases coming," Shuttleworth added. "This could fuel competitive pressures again for fixed rates bearing in mind the banks do like a bit of fixed rate lending because it gives them a bit more security. If everyone's floating there is a greater ability to switch banks. If they fix they're a more secure customer base."

He said there was likely to be a movement away from floating to fixed rates in coming months.

"How much I don't know. But if you look forward in a year's time, if nothing else changes, 80% of the market will be floating."

The latest Reserve Bank figures show that, as of June, NZ$94.637 billion, or 56%, of the country's total NZ$169.118 billion worth of home loans were on floating rates. A further NZ$45.192 billion was fixed for terms with less than a year to run and another NZ$21.092 billion was fixed for terms due to rollover within two years. That means 95% of home loans by value are currently floating or on fixed terms up for renewal within two years. See all bank home loan rates here.

Switch may 're-stimulate pricing competition'

The percentage of New Zealand's home loans on floating interest rates rose above half for the first time since the Reserve Bank started collecting the data on floating versus fixed-term rates in June 1998 as recently as March, at a time when floating rates have been lower than fixed rates for a sustained spell. This compares with a peak of 87% on fixed-term rates as recently as January 2008. See story here on how having the majority of home loans on floating rates boosts the Reserve Bank's monetary policy.

PwC notes that household residential borrowing constitutes 60% of the big five banks' total loans and advances to customers meaning it's a key driver of interest income.

"Once the residential mortgage floating interest rates begin to rise off their current low base, we would expect the demand by the public for fixed interest rates to increase, and given the prominence of household lending in the market place, this could re-stimulate pricing competition within the banking sector," PwC says.

A price war would be a significant change in the current market environment, which Westpac New Zealand CEO George Frazis described this week as being one where none of the major banks are seeking to make their mark as a price discounter. PwC's comments follow recent ones from SBS Bank CEO Ross Smith who predicted "a bit of a scrap for market share" because most banks' lending books have been shrinking with flat lending becoming the new growth.

Kiwi subsidiaries 'a drag' on parents

The potential for heightened price competition in the home loan market comes as PwC predicts growing pressure on the New Zealand arms of the big Australian banks - ANZ, ASB, BNZ and Westpac - to boost their dividends. 

In their first half-year ANZ, ASB and BNZ paid their Australian parents a combined dividend of NZ$583 million, down from NZ$843 million in the same period of the previous year. Westpac, which is preserving capital as it transfers some banking operations to Westpac NZ from its Australian parent, paid no dividend in either period.

PwC points out the big five banks, which includes Kiwibank, delivered an annualised 12.9% return on equity (RoE) in the first half of their respective financial years, which is down 4.4% from three years earlier. In contrast the Australian banks reported an average RoE of 16.7%.

"The New Zealand banks remain a drag on their respective group results," PwC says. "As such we expect significant pressure to come from the shareholders of the New Zealand major banks to improve returns, most likely through improving efficiency and reducing costs but also through further balance sheet growth and holding lower capital."

Their average tier one capital ratios and average total capital ratios are currently about 6% and 4% above their respective regulatory minimums.

Search for new income streams

PwC questions how long the Australian shareholders will continue to accept low returns from their New Zealand offshoots with the promise of greater things to come.

The obvious way to boost returns is to grow their lending books. But Shuttleworth said that was to a large degree dependent on macro economic forces. Without lending growth, innovative customer experiences, cost cutting and diversifying income streams was important.

"In Australia they (the banks) have greater product ranges, greater product channels, high focus on wealth where all the banks are major players," Shuttleworth said. "So I guess how you can supplement core earnings by other income sources will be an opportunity for the banks to investigate."

Acquisitions by the big players couldn't be ruled out, and with the potential for compulsory KiwiSaver, a savings focus among the big banks was likely to increase.

"You've got to explore all opportunities to see how you can bring further revenue or business into the banks and of course once you're there, there's greater opportunity to cross sell," said Shuttleworth.

Westpac's Frazis also said this week that his bank aims to aims to expand its wealth, insurance and financial planning businesses. And ASB launched a push in institutional banking late last year, dropping the use of its parent Commonwealth Bank of Australia's name to operate under the ASB Institutional brand.

PwC's report covers the first-half of the financial year of the big five banks - ANZ, ASB, BNZ, Kiwibank and Westpac.

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