How the Banks are about to make some serious money
By David Chaston
"David Chaston is a commentator on New Zealand interest rates, and watches them through his on-line service http://www.interest.co.nz"
The Banks are about to rake in some serious earnings from their mortgage portfolio, thanks to the Reserve Bank and its OCR policy.
The OCR (the Official Cash Rate) has been raised six times in 2004. The OCR is the RBNZ's main instrument of monetary policy, to influence the cost of money and consequently the economy's demands that drive inflationary pressures.
There are two main causes for the current rise in consumer prices – the housing component of the CPI, and the government charges component. Housing is rising at over 6% pa. and those pesky government charges at over 5% pa. The regulators eyes are only on the housing component, however.
The RBNZ has been raising its rate while the rest of the world has been happy with low rates. The New Zealand base rate is now significantly higher that it's international counterparts.
In fact, the international mood is now for rising bond prices and falling money market yields.
The New Zealand money markets are in the middle of this global trend, with overseas investors stocking up on the good yields available here. Our yields are high, but they are trending down like everywhere else.
Dr. Bollard raised the OCR on 29 October to 6.50% but issued a dovish statement signalling he felt further increases were unlikely.
The money markets have taken this comment on board, and 90 day commercial bills now yield just 0.25% more than the OCR. Over the past year, this important spread has fluctuated and has been up to 0.50% more.
The 90 day commercial bill rate is important because it is a funding and pricing vehicle for the Banks for their floating residential mortgage book. The variable mortgage rate is set from the 90 day bill pricing.
But if the 90 day bill pricing does not rise following the OCR rise, there is no actual pressure on the Banks to raise the variable housing rate.
They will, of course. Already ASB has raised its variable rate from 8.50% to 8.75%, and Westpac from 8.60% to 8.80%. The rest will undoubtedly follow. And they will follow because everyone expects them to – 'everyone' includes both the regulators and consumers.
But with declining money market yields, the cost to the banks has not gone up.
The floating mortgage rate margin above the 90 day bill rate has been hovering a tad below 1.70% for the last six months. Over the last two years, that margin has been briefly over 1.90%, but the longer run average has been about 1.80%.
This critical margin is about 1.70% now, and is about to bet a boost of another 0.25% in the next week or so, and should settle out at just under 2%
There is $26.6 billion in variable rate residential mortgages. A price and margin increase of 0.25% that is not accompanied by a cost increase, means that the banks will pocket another $66.5 million per year.
Despite the contrary impression, banking is a hotly competitive business. It is hard to see many other segments contributing better earnings growth than this.
It might be those competitive pressures that limit these earnings.
After all, fixed term rates are a much better proposition for borrowers at this time.
And already, a challenge has been laid down by Superbank and others with 'guaranteed low variable rates'. In Superbank's case, they are offering 7.49%. Not to be outdone, Ashburton's Loan Society is offering 6.99%.
Whatever happens - either the main banks go with the flow and raise rates to get the higher profits, or the competitive pressures hold the increases well below what is expected - this hardly makes the RBNZ policy move look very relevant.
The variable rate has little influence on housing costs or demand. And encouraging a rise without an equivalent cost increase, in effect transfers the thick end of $65 million extra profit to Australian bank shareholders just to try and dampen local inflation, and exposes the application of the OCR as an odd policy tool.
The law of unintended consequences is alive and well.
The RBNZ might be better to look at open market activities directly in the money markets. It could buy or sell in the 90 day commercial bill market directly to move the cost of these funds to where they think it needs to be.
As this column has noted previously, there are major doubts that this would be a well-targeted policy as it would still hit a wide range of non-housing cost targets that are no threat to inflation, and miss the government charges sector altogether.
But at least our monetary policy wouldn't directly benefit foreign bank shareholders so blatantly.