Author: Jonathan Stacey - Analyst Balmain
Following the Global Financial Crisis (GFC) the major
Australian banks have tightened their control over the Australian financial
economy. In 2009 fixed interest rates offered by banks on Australian term
deposits rose significantly as banks both in Australia and globally competed to
refinance debt. The increase in term deposit rates, compounded by the Australian
Government Bank Deposit Guarantee, reduced the competitiveness of non bank
income investments. Clearly the increased cost of capital puts pressure on bank
profits which logically flows through to interest margins charged to borrowers
and paid to depositors. The Big 4 (ANZ, CBA, WBC & NAB) have commenced reducing
interest rates offered on longer term deposits, whilst increasing mortgage rates
in the short term. This could set the stage for the comeback of non bank income
Today around 55% of the Big 4 banks’ funding comes
from their Australian deposit base1. Between January 2007 and September 2010
Australian deposits at the Big 4 increased 89% to $977 billion2. The bulk of
bank funding remains short term, as can be seen in Chart 1.
Chart 1 – Aggregated
bank funding maturity analysis from 2003 to 2009 for consolidated banking
groups: Australia and New Zealand Banking Group, Commonwealth Bank of Australia,
National Australia Bank, Westpac Banking Corporation.
Data Source: Big 4 Banks
Post the GFC, wholesale funding became more expensive as banks
reduced their interbank lending volumes and kept this lending at short duration.
In July 2009 Commonwealth Bank of Australia (CBA) raised $1 billion, via
unguaranteed 5 year floating rate notes, at a margin of 145 basis points over
the 90 day bank bill swap rate (BBSW). Debt capital markets’ confidence has
improved since then, as evidenced by CBA raising $1.5 billion, at an 85 basis
points margin over the 90 day BBSW in September 20103. This is much lower than
the average 100 and 115 basis point premiums (over 90 day BBSW) the Big 4 banks
are currently paying on 1 and 3 year term deposits respectively4. Of concern to
fixed term investors, is the possibility that the banks may look to further
reduce term deposit rates if they can raise funds less expensively with equal
During the GFC Australian banks focused on
raising deposits as a stable source of funding. By increasing domestic deposit
funding Australian banks insulated themselves from volatile global money
markets. Post GFC the average Australian 1 year and 3 year bank term deposit
rates peaked at 6.0%pa and 7.0%pa respectively in December 20095. Between
September 2009 and August 2010 the aggregated term deposit base grew a whopping
20.6% to $416 billion6. Whist the average 1 year term deposit rate remains
6.00%pa, the average 3 year term deposit rate has gradually fallen to 6.15%pa by
Chart 2 – Term deposit rates correlation to banks aggregated term
Data Source: Reserve Bank of Australia
increase in costs such as the rise in term deposit rates has a negative impact
on bank profit margins. As chart 3 shows, the differential between the average 3
year term deposit rate and 3 year fixed residential mortgage rate has fallen
from around 4.00%pa in July 2008 to 0.65%pa in August 2010. Since then that
margin has increased to over 1.20%8. Is this a sign that the banks are looking
to reverse their margin squeeze?
Today the average 3 year fixed term lending
rate is around 7.35%pa whilst the average term deposit rate for the same period
has fallen to 6.15%. Again this is evidence of loan margins increasing and term
deposit rates reducing as banks move to maintain or increase their typical 2%
plus net interest margins.
Chart 3 – Profit margin 3 year fixed interest loan
Data Source: Reserve Bank of Australia
At the same time there is evidence that
the banks are also offering high interest rates on at-call funds held in online
savings accounts, typically for set short promotional periods. Interestingly
after the November 3, 2010 RBA Official Cash Rate 0.25%pa rise, some banks
increased their promotional rates, whilst holding term deposit rates on terms 12
months and longer. It may be that the motivation behind this is to roll-over
longer term investors to shorter term deposits. If so, it is probable that once
these promotional periods end, the banks may further reduce the deposit interest
rates. Whilst some investors will move their money elsewhere, inertia amongst
customers should result in a slow attrition and a greater profit margin for the
Government Bank Deposit Guarantee reduced the risk of bank deposit investments.
This guarantee is scheduled to be reviewed in October 2011, however there are
many who believe that it should be removed sooner as the increased risk the
banks faced in 2008 is largely gone. An effect of this guarantee was the reduced
competitiveness of mortgage trusts and other fixed income investments not
guaranteed by the Australian government. This resulted in the banks currently
facing very limited competition both in terms of fixed income investments and in
the commercial mortgage lending sector. However there are glimpses that this
period may be coming to an end.
It is likely that non bank mortgage investments
will be more attractive to investors at the expiry of the deposit guarantee in
2011, if not before, as banks reduce term deposit rates to improve lending
margins. By way of example we can already see how the returns from mortgage
trusts are becoming attractive once again when we contrast the results of
Balmain Wholesale Mortgage Trust against average 3 year bank term deposit rates
The Balmain Wholesale Mortgage Trust 3 year yield surpassed average
bank term deposit rates in August 2010 reaching 6.80%pa. In November 2010 the
yield reached 6.84%.
Today both mortgage trusts and banks are able to write
higher margin commercial mortgages than those written pre GFC. Loan-to-value
ratios have reduced and interest servicing capacity has increased on new loans
being written. These reduced risk and higher reward direct mortgage investments
are likely to again become an attractive option to income seeking investors.
Commercial mortgage trust investments perform best when investors commit to a
term that is equivalent to the term of the underlying securities. As expiry of
the deposit guarantee draws closer and bank term deposit rates reduce, non bank
income investments should become more competitive.
Chart 4 – Balmain MWMT Vs 1 &
3 Year term deposit rates
Data Source: Reserve Bank of Australia, Balmain Funds
The banks’ desire to drive shareholder
profits and limit capital funding costs is seeing them reduce interest rates on
longer term deposits. At the same time they have increased mortgage interest
rates beyond the increase of the RBA official cash rate. Investors that require
high income returns might start to consider non-bank alternatives for income
investments, and also accept that high income yielding investments will not
necessarily be liquid. In this situation, liquidity needs to occur from a
financial planning/portfolio perspective rather than only considering
investments that offer immediate or shorter term liquidity. Importantly
investors should recognise that inertia comes at a cost (to them) and might
start considering alternate income investments (either directly or via their
financial adviser), sooner rather than later.
Written by Jonathan Stacey, Analyst of Balmain NB Corporation Limited on behalf
of Balmain Fund Administration Limited. All metrics have been derived from data
obtained from: Balmain Funds, Reserve Bank of Australia, Australian Bureau of
Statistics, Australian Prudential Regulation Authority, Australian Financial
Markets Association, Bloomberg and Annual Reports for the following banks:
Australia and New Zealand Banking Group, Commonwealth Bank of Australia,
National Australia Bank, and Westpac Banking Corporation.
This document is provided by BALMAIN FUND ADMINISTRATION
LIMITED ACN: 134526604, Australian Financial Services License: 333213
(“BALMAIN FUNDS”), contains general information only and does not
constitute financial product advice. In preparing this document, BALMAIN
FUNDS has not taken account of your objectives, financial situation or
needs. Because of this, you should, before acting on this document,
consider the appropriateness of the information, having regard to your
objectives, financial situation and needs. In preparing this document
BALMAIN FUNDS has relied upon and assumed, without independent
verification, the accuracy and completeness of all information available
from public sources or which has otherwise been reviewed in preparation
of the document. The information contained in this document is
current as at the date of this document and is subject to change without
notice. Past performance is not an indicator of future performance.
Neither BALMAIN FUNDS, nor any of its directors, authorised
representatives, employees, or agents, makes any representation or
to the reliability, accuracy, or completeness, of this document. Nor do
they accept any liability or responsibility arising in any way for
errors in, or
omissions from, this document. BALMAIN FUNDS strongly recommends that
you seek independent accounting, financial, taxation, and legal
advice, tailored to your specific objectives, financial situation or
needs, prior to making any investment decision.
This publication contains certain statements which may constitute
“forward-looking statements”. Such statements are subject to inherent
uncertainties which could cause actual values, performance or
achievements to differ materially from those expressed, implied or
projected in any
forward looking statements.
BALMAIN FUNDS disclaims any intent or obligation to update
publicly any forward-looking statements, whether as a result of new
future events or results or otherwise. Investors are cautioned that
forward-looking statements are not guarantees of future performance and
investors and borrowers are cautioned not to put undue reliance on
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The writer, Jonathan Stacey, does not hold any long or short,
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