Short-term funding costs continue to squeeze margins
Steep short-term funding rates are the single biggest pressure on bank net interest margins and there is little sign of this stress abating.
The spread between the three-month bank bill swap rate and the overnight index swap rate dropped in May suggesting that the recent spike in bank wholesale funding costs would be short-lived.
The BBSW-OIS spread closed the month down four basis points to 48 basis points.
Unfortunately, it jumped up from the low point of 40 basis points reached mid-month.
"Despite showing signs of improvement over the early stages of the month, which saw the spread fall to 40 basis points, we suspect this week’s events in Europe helped to push it higher by month end,” said JP Morgan banking analyst Andrew Triggs.
“However, we note that this is both well above the long-term average and also a material increase from the low point of 40 basis points."
To Triggs, these costs remain the major pressure point for net interest margins at present.
Modest fall in spread
The analyst is forecasting a three basis point fall in net interest margins, on average, for the major banks in the 2018 second half and a one basis point decline in the first half of 2019.
Forward pricing suggests a “modest” fall in the spread over coming months, Triggs told clients in a note.
The BBSW-OIS spread peaked at 58 basis points in March following the US Libor-OIS spread which spiked to a six-year high that month due to a rising supply of US Treasury bills.
Outside the BBSW-OIS spread, Triggs added, margin drivers for the banks were relatively steady in May.
“At-call deposit spreads were unchanged, while term deposit spreads were mixed. Meanwhile, term wholesale issuance picked up,” he wrote.
That said, given a jump in CDS spreads this week on European sovereign concerns, as well as a slowdown in deposit growth per APRA’s recent banking stats, the analyst thinks investors should keep a close eye on funding cost indicators in the near term.
Subdued deposit growth
From where he sits, the major banks have made good headway on meeting annual funding targets for 2018.
“However, if the subdued deposit growth persists it may require more concerted efforts in the wholesale funding space.”
“We will be watching trends on deposit growth with interest from here, given deposit spread improvements are necessary to help offset pressure from reducing mortgage asset spreads.”
In the note, Triggs pointed to the material step up in the banks’ net stable funding atio as evidenced by latest round of bank reports.
“While the bare minimum requirement is 100, all the majors now sit at or above 110 per cent, which could potentially signal that APRA has informally set a higher buffer to the minimum,” he said.
“We think these strong net stable funding ratios should support improved deposit spreads from here, particularly as loan growth slows.”