Australia’s big banks face margin squeeze

Pedestrians walk past a Commonwealth Bank of Australia branch in Sydney. The profit Commonwealth Bank and its main competitors make on lending has dropped to a seven-year low as bond costs climb.Bloomberg/SydneyThe profit Commonwealth Bank of Australia and its main competitors make on lending has dropped to a seven-year low as bond costs climb.Net interest margins, the difference between funding costs and the interest charged on loans, dropped to an average of 2.02% for Australia’s four largest banks, a level unseen since 2008, data compiled by Bloomberg show. The measure is set to fall further in 2015, according to Macquarie Group.Margins are under pressure as banks discount mortgages to grab market share, while savers deposit less money after the interest they get paid fell to a record. Bond costs in Australia are climbing at the fastest pace since 2012 as the prospect of tighter US monetary policy affects global markets.“It is just the reverse of quantitative easing,” Michael Wiblin, a Sydney-based analyst at Macquarie said. “With rates turning in the US, spreads are likely to widen as well. Margin pressure is likely to be more visible in the second half.”The Federal Reserve has ended an asset purchase program that added $1.66tn to its balance sheet and the US central bank will probably start raising interest rates in September for the first time since the 2008 global financial crisis, according to futures data compiled by Bloomberg.Australia’s major banks, which have recorded five consecutive years of record profits, are having to offer juicier premiums now than in the second half of last year to attract domestic bond investors.Westpac Banking Corp, the country’s second-biggest lender, paid 90 basis points more than the swap rate on A$2.7bn ($2.1bn) of five-year notes issued in January. That compares with spreads of 85 basis points on 2019 bond deals concluded in November by both Australia & New Zealand Banking Group and National Australia Bank. NAB paid just 82 basis points more than the bank-bill swap rate when it priced 5 1/4-year notes in August, while ANZ’s five-year offering in July was also at an 82 basis-point spread.In the secondary market, the average yield premium for swap rates over government notes in Australia jumped to 37 basis points last month, from a low of 11 in September, data compiled by Bloomberg show. The spread widened 13.5 basis points last quarter, the biggest jump since the three months ended June 30, 2012.The increased costs are poised to hurt lenders already beset by competition that has driven discounts on benchmark variable mortgages to as much as 120 basis points. The standard floating rates at Commonwealth Bank and Westpac are at six-year lows, while ANZ’s is the cheapest since at least 2000. NAB says its rate is at a near 40-year low.The plunge in mortgage rates has been fueled by unprecedented easing from the Reserve Bank of Australia, which this month took its cash target down to a record 2.25% as languishing confidence weighs on the economy. With swaps markets pricing in as much as 50 basis points of further easing this year, interest rates look set to fall further. The average special rate Aussie banks pay on term deposits fell to an unparalleled 3.2% last month. The volume of term deposits with banks fell to A$531.6bn in December, a six-month low and 2% below the August peak, central bank data show.Macquarie’s Wiblin expects margins to decline further in the 2015 fiscal year, with a prediction that ANZ’s could narrow by eight basis points. He sees Commonwealth Bank’s falling by six basis points, with Westpac down by five and NAB by two.Australian lenders are offering as much as 115 basis points discount on their benchmark variable mortgage rate to grab market share, according to broker Mortgage Choice.“Amid lower rates, banks may be forced to discount more aggressively for growth to offset faster mortgage repayments,” Omkar Joshi, an investment analyst at Watermark Funds Management who helps oversee A$1bn, said by phone. “With deposit rates already low, the benefits from that part of funding is limited.