BBSW-OIS spread improved in July: Analysts split over big bank rate hike

  • By Elizabeth Fry

Short-term funding pressures eased in July with the spread between the three-month bank bill swap rate and the overnight index swap rate closing the month 15 basis points lower at 46 basis points.

Despite showing some signs of improvement over the month however, the spread is still well above its long-run average.

Steep funding costs are the biggest pressure point for banks' net interest margins right now and JP Morgan’s Andrew Triggs reckons this will trigger a round of mortgage re-pricing.

“Given an emerging view that this is a structural (as opposed to cyclical) shift, we think it is inevitable that the majors will reprice mortgages over coming weeks/months," he said.

“So far however, only 2nd tier banks have been willing to do this but we think the major banks will follow despite the political pressures.”

In a report, Triggs wrote that term wholesale issuance was a lot stronger in July and US dollar senior CDS spreads also improved in the month.

Deposit spreads under pressure

But he also noted some early signs of pressure in term deposit spreads, with short and medium-term deposits spreads both edging higher.

“These rate changes may be linked to weaker retail deposit growth over recent months. Should these deposit pressures persist it would make the need for mortgage repricing more pressing.”

Triggs said term deposit spreads were a lot more volatile in July than they have been in previous months and, in line with recent management commentary, he believes they will be an important lever for the banks to offset net interest margin pressures elsewhere.

“Should deposit growth not recover this may make it more difficult for the banks to achieve improvement in deposit spreads, thereby increasing the necessity for the banks to reprice mortgages.”

The analyst’s view that the majors will lift rates comes just as ANZ cut rates by 34 basis points to 3.65 per cent on one of its ‘no-frills' mortgage products.

It also comes as the prudential regulator’s latest monthly banking statistics show major banks continue to cede mortgage share with ANZ losing the most.

Conversely, UBS analysts argue that the announcement by ANZ makes back-book mortgage repricing by the major banks less likely, adding to margin and revenue pressure.

UBS analysts Jon Mott and Rachel Finn say there two ways to interpret the rate cut on ANZ's Simplicity PLUS loans which they estimate make up 15 per cent of front book flows and 10 per cent of the back-book.

Hikes to attract criticism

The first is that ANZ has more buffer in its net interest margin than the market realises and can absorb higher funding costs for longer. They sees this as unlikely.

The second way to interpret this, the analysts went on to say, is that ANZ and the other majors have been losing market share to the small banks and non-banks given they are now much more focused on Responsible Lending.

“As a result, the major banks have tightened underwriting standards and borrowing capacity much further than the smaller players to date.”

“In effect, ANZ is using its funding advantage (deposits) relative to the smaller players and is willing to steeply discount its front-book pricing to stabilise market share.

Mott and Finn think it may be difficult for ANZ to justify offering deep discounts on front-book(new) mortgages, then subsequently reprice its back-book of existing loans as a result of higher funding costs.

“We believe this would attract criticism from both customers and regulators as existing mortgagors would effectively be subsidising new customers.”

Banking specialists refute any claims that ANZ's decision could start a mortgage price war; to them ANZ’s rate cut means nothing more than bringing the lender's uncompetitive rates back in line with the market.

 Also, they argue that Simplicity PLUS is a minor product.

As to whether a rate rise by the majors is imminent, Bell Potter’s TS Lim analyst added that rate hikes “were seasonal things” and conceded that other major banks might put rates up although "probably not immediately" because of the royal commission hearings.