Competition likely to keep a lid on interest rates

KPMG New Zealand Date 2nd May 2006

Competition likely to keep a lid on interest rates despite slow-down

Slowing growth in the banking industry may tempt banks to lift the interest rates at which they lend, but mortgage holders can take comfort from the fact that competitive pressures are likely to keep a squeeze on interest margins, KPMG’s annual survey of the banking industry finds.

Godfrey Boyce of the firm’s Financial Services division says the renewed “mortgage war” and tightening interest rate margins have eaten into banks’ underlying performance for the 2005 financial year – and indications are that things will not get better anytime soon.

Underlying performance - operating income less operating expenses excluding items of a non-recurring nature and unrelated to on-going operations - was flat overall and for major banks grew by a relatively modest 5 percent.

“The major banks increased their total assets by 13 percent in 2005. So why does this result in only a five percent increase in underlying performance? The answer is interest margins.”

Interest margins contracted in the 2005 year, dropping below the 2.5 percent level, approaching levels last seen in 2000 and 2001.

“This reflects intense competition across the banking sector, pressure on mortgage books and the continued switch from floating to fixed rate mortgages,” said Mr Boyce.

Fixed rate mortgages now constitute 80 percent of the banks’ mortgage books, up from 60 percent in 2002. Fifty four percent of the major bank’s lending is for residential mortgages.

“As the banks contemplate slower growth as a result of the economic slow-down, it becomes important for them to find ways of arresting the erosion in interest margins,” he said.

“This may mean a truce in the ‘mortgage war’ and inevitably a flow on effect to mortgage interest rates. Four months into the new financial year, there is evidence emerging that interest rates are stabilising.”

But he predicts that despite the slowing economy and the banks’ desire to increase interest margins, renewed competition could take the edge off upward pressure on interest rates later in the year.

“Pressure on margins is likely to return, particularly as the fixed term mortgages written in 2004 come up for rate-resetting.

“On the face of it, this provides an opportunity for the banks to improve their interest margins with borrowers moving onto floating interest rates. But there’s likely to be considerable bank and mortgage broker activity to attract these borrowers away from their current bank to a lower rate mortgage – in other words, a new phase of the mortgage war.”

Mr Boyce said the growth in lending achieved over the last five years had more than compensated for the loss of interest margin conceded. He cited ASB Bank as a prime example, doubling assets to over $40 billion, more than doubling profit after tax to in excess of $400 million on an annualised basis but reducing overall interest margin to just below two percent – all in the space of four and a half years.

New Zealand incorporated banks increased their total assets by just over 13 percent, significantly above the 2004 increase of six percent. But operating income, up just over four percent, was marginally behind the previous year and growth in net profit after tax almost halved on the 2004 figure of 9.3 percent.

ENDS

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