Mutuals unlikely to reap full benefit of rising rates – report

Rising interest rates signal a boost in income for lenders, but mutuals are unlikely to reap the full benefit, according to a latest S&P Global Ratings report.

The official cash rate jumped 25 basis points in May – the first rise in nearly 12 years. More rate rises are expected over the year ahead as the Reserve Bank of Australia starts to unwind monetary stimulus put in place to help the Australian economy through the pandemic, and to maintain inflation and employment targets.

In a report released on Australian mutual lenders on 29 May, S&P Global Ratings said it expects continuing competition, a subdued lending market and higher funding and credit costs to dilute the full benefit of rising rates for mutuals, also known as customer-owned banks.

These factors were crucial for Australian mutuals, which would remain “price takers on both sides of the balance sheet,” the global ratings agency said.

Consistent with other lenders, customer-owned banks passed on the full 25-basis-point increase in the cash rate to borrowers. The effects of the interest rate rise would be delayed as the market reverted to variable rate mortgages over the next two years, S&P Global said.

Off the back of record-low interest rates, a surge of borrowers locked in cheap fixed rate mortgages, a trend that peaked at the end of 2021, S&P Global said. Currently, new lending is predominantly written on variable rates, but it will take time for fixed rate loans to mature and reprice at higher rates.

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As interest rates rise, bank credit losses are expected to increase marginally, and off a very low base. Borrower debt-servicing capacity has been assessed at a higher level than current lending rates, helping to keep credit losses at low levels.

Summing up the report findings, S&P Global analyst Lisa Barrett (pictured above) said Australian mutual lenders would continue to face competitive pressures, particularly on the pricing side, from larger banks. 

Nearly all mutuals have a positive rating outlook, reflecting improving systemwide finding, she said.

“In addition, rising interest rates will help bolster gross earnings and margins for lenders, especially as fixed-rate mortgages reprice in the next few years,” Barrett said. “Mutuals have been battling thinning margins over the past decade, so the rising interest rate environment we’re seeing now will be welcomed by the sector. What’s more, we expect credit losses to remain at a relatively low level.”

As lenders of all sizes were seeking to grow their lending books, Barrett said competition for mortgages was likely to remain reasonably strong.

“There’s also prospects for a subdued lending market and somewhat higher funding and credit costs. These sorts of factors will definitely dilute some of [the] benefits lenders will see from rising interest rates,” Barrett said.

Acknowledging mortgages were a “commoditised product”, for mutuals to remain competitive, continued attractive pricing would be “critical,” Barrett said in the report.

Heavy use of mortgage brokers by most lenders heightens the importance of remaining price competitive to successfully originate new mortgages, she said.

“As small fish in a big pond, mutual lenders remain at a structural disadvantage to the large banks,” she said. “The scale and incumbency of the major banks mean mutuals must compete aggressively and, consistent with their philosophy, provide preferential member pricing to continue to grow their lending books.”

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Within the report, S&P Global Ratings rated 15 Australian mutual lenders. Among those with a long-term rating and outlook of BBB/Positive and total loans between $5.5bn and $13.5bn were Great Southern Bank, Newcastle Permanent, People’s Choice Credit Union, Teachers Mutual Bank, Bank Australia, Beyond Bank and Greater Bank. Total term funding facility (TFF) outstanding ranged from $292m to $677.5m.

Among the short- to long-term sources of funding available to mutuals listed within the report were reducing excess liquid assets, term deposits, negotiable certificates of deposit (NCDs), senior unsecured debt programs and securitisation (the latter two options are generally only accessible to larger mutuals).  

As interest rates rise, S&P Global expects mutuals’ margins to benefit from repricing of fixed-rate loans.

“Systemwide, about 75% of the current fixed-rate mortgages will expire by December 2023. While the mix of new loans (variable versus fixed) has largely returned to pre-pandemic levels (80/20), most mutual lenders are stuck with a portion of loans at lower than the current market price,” the report said.  “While some have hedged part of this risk, any unhedged portions will continue to impinge on margins until they reprice.”

In addition to lending, S&P Global said mutuals were also price-takers in domestic funding markets, noting their funding was largely derived from retail deposits – a source it viewed as “relatively more stable” than wholesale funding.