Why Westpac has 'Nowhere to Run'

The new bank levy has managed to grab headlines in the past week, distracting investors from Westpac's first-half performance at a time when talk of a housing bubble has reached fever pitch.

With interest-only loans making up 50 per cent of its mortgage book, Westpac is the most exposed bank to the Australian housing bubble, according to a leading banking analyst.

For the very first time Westpac has disclosed its exposure to interest-only lending, saying it contributes half its mortgage book and 46 per cent of 2017 first-half flows, UBS analyst Jon Mott wrote in a note entitled ‘Nowhere to Run”. This compares to 40 per cent for the system.

“While Westpac has indicated applications have already slowed to the mid-30s, there is a long way to go for it to get below APRA's 30 per cent cap," he argued, adding that banks will ultimately need to target 20 to 25 per cent to allow a buffer.

“This is likely to have two implications. Westpac may need to ration credit or reprice its book further – good for net interest margins, but bad for volumes. Second, its mortgage run-off rate will begin to rise as the book amortises faster under principal-and-interest loans."

It is worth noting, Mott went on to say, that investment property loans rebounded to 44 per cent of Westpac’s flows in the first-half up from 35 per cent a year ago, and New South Wales grew to a record 44 per cent of mortgage flows.

“While further repricing of interest-only loans looks likely, some form of credit rationing may be required especially via the broker channel.”

Vulnerable to change

This view jibes with Morgan Stanley’s Richard Wiles who agreed that a fundamental change in the mortgage market will weigh on Westpac’s growth prospects and returns.

"And with Australian mortgages accounting for more than 60 percent of the loan portfolio, Westpac is vulnerable to the impact of fundamental change in the market ... we expect slower loan growth and more competition for lower risk loans relative to peers," he wrote.

The Morgan Stanley analyst confirmed that Westpac has more investment property loans, more interest-only loans and more exposure to New South Wales than peers. As far as Wiles is concerned, the downside risks to the share price are rising, despite management’s focus on costs, stable credit quality and an improved capital position.

Indeed, further concentration into retail banking is inevitable for the lender since it has seen substantial growth in mortgages, particularly to the faster-growing cities of Sydney and Melbourne where activity has been the strongest.

“At the same time, institutional lending remains the subject of efforts to improve returns - largely through balance sheet reduction," said Mott. The analyst is expecting the housing market to slow sharply as APRA's macro prudential changes come into effect.

Not only does he see risks to household cash flows - as banks reprice their books and borrowers face a 30 per cent increase in repayments as they move from interest-only to principal-and-interest loans - but he thinks credit growth will slow and bad debts will rise. Plus, Mott is telling clients that if the housing market and household debt does not slow, APRA is likely to turn-up-the-dial on macro prudential measures.

“We also expect some increase in consumer arrears and impact on the broader economy as mortgage repayments rise between 30 and 40 per cent as borrowers migrate from interest-only loans to principal-and-interest loans," he added.

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