Tag: Moody’s

UK regulator suggests relaxed mortgage affordability test to encourage refinancing

According to Moody’s on 15 January, UK Financial Conduct Authority (FCA) chief Executive Andrew Bailey, reiterated the organisation’s intention to improve so-called mortgage prisoners’ access to refinancing by relaxing current mortgage affordability regulations that preclude them refinancing into cheaper mortgage deals because they fail to meet affordability standards that were tightened in 2016.

Relaxing the mortgage affordability parameters for refinancing such borrowers’ mortgages would be credit positive for more than 60 UK RMBS securitisations containing pre-crisis assets, which equate to more than £29.0 billion of outstanding bonds.

The FCA has suggested that authorised UK lenders would be willing to refinance such mortgage prisoners if the borrower qualified for refinancing under the new rules, which would require the new mortgage installments to be lower than previous installments and for the borrower to be up to date with their payments. The new rules would replace current affordability tests for these borrowers, which make sure a borrower has enough money left to pay their mortgage installments in a stressed interest rate environment after covering all other basic needs (e.g. bills, food, childcare).

At present, a borrower refinancing with its current lender does not always require affordability re-testing, but some lenders, such as Southern Pacific Mortgage Limited and Bradford & Bingley plc, have stopped originating loans in recent years. Furthermore, a significant number of mortgage loans were sold to entities that are not authorised lenders, such as private equity firms or investment banks. In both cases, those affected borrowers can only refinance with new lenders, thus falling under the stricter affordability testing introduced post- crisis. FCA estimates that there are about 140,000 affected borrowers, 120,000 whose loans are owned by firms not authorised to lend and 20,000 borrowers whose lenders are inactive.

Moody’s expect performance to improve for securitisations containing legacy assets if the changes are enacted. The majority of mortgage prisoners’ installments accrue interest at relatively high floating rates. Therefore, their mortgage installments will increase in the event of an increased base rate, as is currently expected in the UK. Higher rates make affordability more challenging and have the potential to cause additional defaults.

If those borrowers can refinance at a lower interest rate, the mortgage loans instead exit the securitisation pools early, leading to increased credit enhancement for remaining noteholders and reduced future losses.

The exemption will have the greatest positive effect for more recent securitisations of pre-crisis mortgage loans because the majority of recent securitisations of legacy assets have been cleaned of arrears loans.

Transactions that closed prior to 2009, while also benefiting from the early repayment of loans and increased credit enhancement, are typically smaller in size and also usually already contain a high proportion of loans in arrears. Hence the redemption of loans by mortgage prisoners will tend to concentrate the pools’ exposure to loans with borrowers having real affordability problems.

Major Canadian Banks To “Open” Their Banking

According to Moody’s, on 11 January, the Canadian government published a consultation paper on its previously announced open banking initiative to foster competition within its banking industry. The initiative will provide policy recommendations on how best to allow retail bank customers to share their financial transaction data with fintechs and other financial services providers such as small and mid-sized banks to facilitate application development so that retail clients can compare financial products and change bank accounts more easily.

The government initiative is credit negative for the largest Canadian banks’ retail operations because it has the potential to incrementally weaken the industry’s favorable industry structure of a few concentrated players, and therefore the banks’ retail franchise strength and associated high profitability.

The largest Canadian banks are Bank of Montreal (BMO, Bank of Nova Scotia (BNS), Canadian Imperial Bank of Commerce (CIBC), Royal Bank of Canada (RBC), The Toronto-Dominion Bank (TD) and National Bank of Canada (NBC). As of 31 October 2018, these six banks held 87% of Canada’s banking assets.

Canada’s banking system is highly concentrated and more profitable for the largest incumbents than in other banking jurisdictions.

Moody’s says “we believe the six largest banks have sufficient financial resources and fintech expertise to adapt to innovation in consumer banking. Nonetheless, technological disruption is likely to erode the incumbents’ profitability in certain retail lending products, such as credit
cards, and/or payments over the long term as smaller, more agile banks achieve competitive advantages”.

Rising UK household debt is credit negative

According to Moody’s, on 7 January, UK trade unions published their annual report, which warned about a credit crisis as UK average non-mortgage household debt jumped above £15,000, almost 50% higher than before the 2008 financial crisis. The increase in household debt leaves borrowers vulnerable to sudden economic stress, such as that which might crystallise in a no-deal Brexit scenario. An incremental increase in unemployment would have negative consequences for highly leveraged consumers. Higher joblessness, reduced real wages and, to a lesser extent, lower refinancing availability would increase delinquencies and defaults in consumer loan pools backing residential mortgage-backed securities (RMBS) and asset-backed securities (ABS).

Additionally, softening house prices can exacerbate the negative effect of rising defaults on RMBS. In case of a severe economic stress, the macroeconomic outlook for the UK would weaken, leading to a decline in house prices nationwide, which would have a mixed effect regionally across the UK. We expect more negative consequence in regions with higher unemployment and in industries that are more materially affected by such a stress scenario. However, we expect that any deceleration in house prices will be less severe than during the 2008-09 financial crisis given less inflationary stresses within the market. The performance of buy-to-let (BTL) and nonconforming transactions would weaken, especially for some recently originated collateral pools that have assets with relatively weaker underwriting standards. The performance of credit card ABS collateral would also deteriorate, especially for those pools with more exposure to highly leveraged obligors.

We have negative collateral forecasts for all UK consumer sectors

Our forecasts are negative for all UK consumer sector collateral. Our collateral performance forecasts over the next 12-18 months address the direction of expected losses for the market in general, not specific collateral pools among the deals we rate.

In normal circumstances, the absolute level of household debt is not necessarily as important as affordability measures such as the ratio of payment or loan to disposable income. Given the low interest rate environment, affordability is still relatively high for UK borrowers. However, sudden economic stress that leads to negative real wage growth and increasing unemployment has the potential to change matters.

The average household debt figure in the trade union’s analysis is based on data from Bank of England, Office for National Statistics and the Student Loans Company. It excludes mortgages but includes everything else (i.e., credit cards, personal loans, payday loans and student loans), which deviates from the Bank of England’s definition of non-mortgage household debt.

The rapid growth of non-mortgage (mainly unsecured) debt has contributed to household debt since 2013 after years of constrained credit in the aftermath of the 2008 financial crisis. The growth patterns of mortgage and non-mortgage debt have switched gears compared with pre-crisis patterns: non-mortgage debt (e.g., credit cards and consumer loans) have had a high single-digit growth rate since 2015, with slightly slowing growth in 2018 to a level of 6%, whereas pre-crisis, mortgage debt had these high growth rates. The 2018 data shows that UK households had average non-mortgage debt of approximately £10,000, even excluding student loans, and this is in line with levels reported in 2008.

US Bank Stress Tests To Be Eased

On 9 January, Moody’s says, the Federal Reserve Board (Fed) proposed revisions to company-run stress testing requirements for Fed-regulated US banks to conform with the Economic Growth, Regulatory Relief, and Consumer Protection Act (the EGRRCPA), which became law in May 2018.

Among the revisions, which are similar to those proposed in December 2018 by the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corp. (FDIC), is a proposal that would eliminate the requirement for company-run stress tests at most bank subsidiaries with total consolidated assets of less than $250 billion. The proposed changes would be credit negative for affected US banks because they would ease the minimum requirements for stress testing at the subsidiary level.

The proposed revisions would also require company-run stress tests once every other year instead of annually at most banks with more than $250 billion in total assets that are not subsidiaries of systemically important bank holding companies. Additionally, the proposal would eliminate the hypothetical adverse scenario from all company-run stress tests and from the Fed’s own supervisory stress tests, commonly known as the Dodd-Frank Stress Test (DFAST) and the Comprehensive Capital Analysis and Review (CCAR); the baseline and severely adverse scenarios would remain.

The proposed changes aim to implement EGRRCPA. As such, we expect that they will be adopted with minimal revisions. In late December 2018, the FDIC and OCC published similar proposals governing the banks they regulate. The stress testing requirements imposed on US banks over the past decade have helped improve US banks’ risk management practices and have led banks to incorporate risk management considerations more fully into both their strategic planning and daily decision making. Without periodic stress tests, these US banks may have more flexibility to reduce their capital cushions, making them more vulnerable in an economic
downturn.

On 31 October 2018, the Fed announced a similar proposal for the company-run stress tests conducted by bank holding companies as a part of a broader proposal to tailor its enhanced supervisory framework for large bank holding companies. Positively, the Fed’s 31 October 2018 proposal would still subject bank holding companies with total assets of $100-$250 billion to supervisory stress testing at least every two years and would still require them to submit annual capital plans to the Fed, even though the latest proposal would no longer require their bank subsidiaries to conduct their own company-run stress tests. Also, supervisory stress testing for larger holding companies would continue to be conducted annually. Continued supervisory stress testing should limit any potential reduction
in capital cushions at those bank holding companies.

We believe that some midsize banks will continue to use company-run stress testing in some form, but more tailored to their own needs and assumptions. Nevertheless, this may not be the view of all banks, particularly those for which stress testing has not been integrated with risk management. Additionally, smaller banks may have resource constraints.

The reduced frequency of mandated company-run stress testing for bank subsidiaries with assets above $250 billion that are not subsidiaries of systemically important bank holding companies is also credit negative, although not to the same extent as the elimination of the requirement for the midsize banks. The longer time between bank management’s reviews of stress test results introduces a higher probability of changing economic conditions that could leave a firm with an insufficient capital cushion.

The Fed’s proposal also would eliminate the hypothetical adverse scenario from company-run stress tests and the Fed’s supervisory stress tests. The market has focused on the severely adverse scenario, which is harsher than the adverse scenario so this proposed change is unlikely to have significant consequence.

China will allow banks to issue perpetual debt

According to Moody’s on 26 December, China’s State Council’s Financial Stability and Development Committee announced in a statement on the People’s Bank of China website that it was researching multiple ways to help commercial banks replenish capital and push for the issuance of perpetual bonds. The statement extends the thinking laid out by the regulator in 2018, when it suggested ways to augment and replenish banks’ capital with new capital instruments.

Allowing banks to issue perpetual bonds to boost their capitalization is credit positive for Chinese banks, their depositors and senior unsecured creditors. Perpetual bonds are classified as Additional Tier 1 (AT1) securities and ranked lower than senior instruments in a liquidation, meaning that they will strengthen banks’ capacity to absorb losses. The bonds will qualify and be counted toward banks’ total loss-absorbing capacity requirements, which take effect on 1 January 2025, if not earlier.

The move will also ease pressure on banks’ capital.

Although loan growth is slowing, the full phase-in of a capital conservation buffer and the migration of prior shadow banking assets back to banks’ on-balance sheet loans are two sources of strain. Issuing perpetual bonds will widen the pool of potential investors in banks’ capital instruments, creating another channel to raise AT1 capital.

Preference shares have been the dominant form of AT1 instruments that banks have so far issued, but investors with debt-only investment mandates cannot access them. Banks are currently allowed to issue preference shares to increase their overall Tier 1 capital ratios, which requires the approval of the China Banking and Insurance Regulatory Commission (CBIRC) and the China Securities Regulatory Commission. Because perpetual debts are not “shares,” their issuance is likely to require the oversight of both the CBIRC and the People’s Bank of China, as is the case for Tier 2 debt instruments.

Although several banks have expressed interest in issuing more AT1 capital instruments, banks will only begin to issue perpetual debt once the regulator provides further guidance. The size of Chinese banks’ assets means that issuance is likely to be relatively sizable and success will depend on market depth and pricing. Because they are not the same quality of equity capital, perpetual bonds have no impact on a bank’s Common Equity Tier 1 ratio.

US Bank Capital Requirements Eased

Moody’s says that relaxed regulatory oversight for the largest US regional banks would be credit negative.

On 31 October, the US Federal Reserve (Fed) proposed revisions to the prudential standards for the supervision of large US bank holding companies to implement the Economic Growth, Regulatory Relief, and Consumer Protection Act (the Act) that became law in May of this year. The proposal would apply less rigorous capital and liquidity standards to most large regional bank holding companies with less than $700 billion of consolidated assets or less than $75 billion of cross-jurisdictional activity, a credit-negative.

In particular, the Fed proposals would relax current supervisory requirements for banks with assets of more than $250 billion, which goes beyond the Act’s primary focus on banks below that threshold. However, the proposal is still consistent with the Act’s emphasis on regulation that increases in stringency with a firm’s risk profile, defining four categories of banks as described and named in Exhibit 1 (other firms are no longer subject to the Fed’s enhanced prudential standards under the Act).

The 11 firms in Category IV would be subject to significantly reduced regulatory requirements under the proposal, including public supervisory stress testing every two years instead of annually. These firms would also be permitted to exclude accumulated other comprehensive income (AOCI) from capital and would no longer be subject to the liquidity coverage ratio (LCR) or proposed net stable funding ratio (NFSR) rules. Internal liquidity stress-testing would be required quarterly rather than monthly.

The four firms in Category III would be subject to modestly reduced regulatory requirements under the proposal. They would no longer have to apply the advanced approaches (internal models-based) risk-based capital requirements but would remain subject to the standardized approach requirements. Like Category IV firms, they could elect to exclude AOCI from capital. However, they would still be subject to the annual public supervisory stress tests. Their LCR and NFSR requirements would be reduced to between 70% and 85% of full requirements.

The changes in capital and liquidity requirements for Category III and IV firms are likely to reduce their capital and liquidity buffers, a credit negative. Moreover, the reduced frequency of capital and liquidity stress testing could lead to more relaxed oversight and afford banks greater leeway in managing their capital and liquidity, as well as reduce transparency and comparability, since fewer firms will participate in the public supervisory stress test.

Category I and II firms would not see any changes to their capital or liquidity requirements. The proposals do not address the US operations of foreign banking organizations, but a proposal on their supervision will likely be forthcoming.

US Housing’s Minor Slump

According to Moody’s, U.S. housing is in the midst of a minor slump.

Housing starts fell 5.3% to 1.2 million annualized units in September, close to our forecast of 1.195 million but weaker than the consensus of 1.22 million. Revisions were mixed. Starts are now shown to be 1.268 million annualized units in August (previously 1.282 million) and 1.184 million in July (previously (1.177 million).

Turning back to September, single-family starts fell 0.9% to 871,000 annualized units. Multifamily starts dropped 15.2% to 330,000 annualized units. It’s likely that Hurricane Florence hurt housing starts in September. To assess the potential impact, we look at the not seasonally adjusted starts in the South, which fell 17.3% in September, the most for any September since 2007. Total permits fell 0.6% to 1.241 million annualized units, weaker than we had anticipated. The good news is that single-family permits rose 2.9%, reversing some of the 5.3% decline in August. The trend in single-family permits has weakened, and starts are still running ahead of permits, which isn’t overly favorable. For the sixth consecutive month, multifamily permits dropped, falling 7.6% in September. However, permits are still running ahead of multifamily starts, suggesting a pickup in starts in the next couple of months.

Housing starts lowered our high-frequency GDP model’s estimate of real residential investment in the third quarter. The impact on GDP wasn’t significant. We are playing a little catch-up and Wednesday’s run of our high-frequency GDP model also incorporates the monthly Treasury budget and industrial production for September. Federal government spending is coming in stronger than previously thought, which boosted our estimate of third quarter GDP while September industrial production had no effect. Overall, third quarter GDP is on track to rise 3.3% at an annualized rate.

September U.S. retail sales disappointed, but the details were solid. Nominal retail sales rose 0.1%, well short of both our and consensus expectations. A decline in sales at gasoline stations and large drop in restaurants weighed on growth in total retail sales. Odds are that Hurricane Florence hurt spending at restaurants, consistent with past hurricanes. Our forecast had penciled in a decline in restaurants, but gasoline was a little surprising. Building material store sales slipped in September, but there should be a hurricane boost in October. Overall, Florence was a net negative for retail sales in September and there is little evidence of a boost from sales of the new iPhone.

The key for GDP is control retail sales, or total excluding autos, building materials, gasoline and restaurants. Control retail sales rose 0.5% in September but they were revised lower in each of the prior two months. Overall, control retail sales were up 4.8% at an annualized rate in the third quarter. September control retail sales suggest that real consumption likely rose 0.4%, which lowered our highfrequency GDP model’s estimate of real spending in the third quarter from 3.7% to 3.5%. This is still a solid quarter for consumer spending.

This week we also updated our cost estimates for both Hurricane Florence and Hurricane Michael. For Michael, we have increased our estimate of property losses to between $17 billion and $20 billion. Lost output due to disruptions and power outages remains between $4 billion and $6 billion, leading to a total price tag of $21 billion to $26 billion. We lowered our cost estimate for Hurricane Florence to $30 billion to $38 billion.

On the policy front, the minutes of the September Federal Open Market Committee meeting didn’t contain many surprises, and the discussion about whether it’s appropriate to eventually have a more restrictive monetary policy was healthy. It was not as hawkish as recent comments by Federal Reserve Chair Jerome Powell, who said that monetary policy is nowhere near neutral, which implied even more rate hikes. Therefore, the minutes don’t alter our subjective odds of a December rate hike (90%) nor our expectation that the Fed will raise rates once per quarter until they hit the terminal rate around 3.5%.

There is a strong consensus within the Fed that monetary policy will turn restrictive. Only a “couple of participants”—meaning two out of 16—would not favor going into restrictive territory absent clear signs of overheating and rising inflation. They are in the clear minority, but the discussion of restrictive monetary policy shouldn’t be surprising; this has been clearly evident in the Fed’s so-called dot plot, which since September 2017 has shown that the actual fed funds rate would eventually be set above the long-run equilibrium rate.

There were no other heated debates in the minutes. One interesting tidbit was the mention that there is little evidence to suggest that the upward pressure on the federal funds rate relative to the interest on excess reserves is attributable to any shortage of aggregate reserves in the banking system. We think the jury is still out on this, and this is important because the supply of reserves is going to be key in determining how much the Fed can reduce its balance sheet as well as the timing for the completion.

US Banks’ Mortgage Revenue Will Stay Depressed As Interest Rates Rise Further

According to Moody’s, on 11 October, the Federal Home Loan Mortgage Corp. reported that US 30-year fixed-rate mortgage rates reached their highest level since April 2011.

The average rate was 4.90% for the week that ended 11 October, compared with 3.91% a year earlier. For US banks, higher mortgage rates will constrain mortgage origination volume, keeping their once-sizable mortgage banking revenue at depressed levels, a credit negative. Higher interest rates will also heighten the potential that some customers will have trouble servicing their existing debt and could translate into weaker credit quality, a further negative for US banks.

Mortgage banking revenue at US banks has been on a downward trajectory for some time. This reflects both a drop in origination volume and lower gain-on-sale margins. The volume decline has followed a multi-year period during which consumers took advantage of rising home values and historically low interest rates to refinance their mortgages. Now that refinancing volume is at a lower level, home purchases are the source of most current originations.

Reduced gain-on-sale margins reflect heightened pricing competition that resulted from excess industry capacity. Going forward, although volume may not increase because of the climb in interest rates, gain-on-sale margins could rise as industry capacity contracts.

The 12 October third-quarter 2018 earnings reports from some of the country’s largest banks illustrate these trends. As shown in the exhibit below, both Wells Fargo & Company and JPMorgan Chase & Co., the country’s two largest mortgage originators, released results that showed mortgage banking revenue remains at or near multi-year lows. Specifically, at Wells Fargo, although mortgage banking revenue climbed in the quarter, for the nine months that ended 30 September 2018, mortgage banking revenue accounted for 3.9% of total firm-wide revenue, down from 10.5% as recently as 2013. At JPMorgan Chase, mortgage banking revenue declined in the third quarter and, on a year-to-date basis, it accounted for just 1.3% of total firm-wide revenue, down from 5.4% in 2013.

The recent rise in mortgage interest rates makes it unlikely that US banks’ mortgage banking volume and revenue can rebound materially in the next few quarters. However, given that mortgage banking has long been a cyclical business, the banks can improve their profitability by reducing capacity, as they have done in prior periods of lower volumes. Indeed, both Wells Fargo and JPMorgan Chase were reported to have reduced hundreds of positions within their respective mortgage banking units in the past few months. We believe both firms’ recent performance and response are representative of the wider industry trend More broadly, the recent rise in interest rates heightens the potential that some borrowers will have trouble servicing their existing debt, raising the potential of higher loan delinquencies. However, the US economy remains robust and the banks’ latest earnings reports show continued strong credit quality, an indication that higher rates have not yet undermined existing loan performance.

Greece’s full abolition of cash withdrawal restrictions is credit positive for banks

From Moody’s.

On 1 October, Greece (B3 positive) further relaxed capital controls that had been in place since June 2015 following an announcement by the Ministry of Finance in the government gazette. The country’s improving economic prospects and an increase in private-sector deposits in recent months allowed for the easing of capital controls, which will likely strengthen depositors’ confidence and help banks further improve their funding profiles, a credit positive.

The gradual return of deposits to the banking system over the past seven months and greater optimism following Greece’s successful exit from its economic adjustment programme are the key drivers behind the Ministry of Finance and the Bank of Greece’s decision to significantly loosen capital controls. In addition, a material reduction in banks’ dependence on central bank funding through the Bank of Greece’s Emergency Liquidity Assistance (ELA) mechanism signifies banks’ liquidity improvement in recent quarters.

As part of the relaxation of capital controls, the new measures include unlimited cash withdrawal for domestic deposits either through banks’ branches or ATMs; cash withdrawals from a credit and prepaid cards abroad of up to €600 per day and up to €5,000 per month; an increase in the limit on fund transfers abroad by companies to €100,000 per customer per day from €40,000 previously; and the ability for check payments in cash.

The easing of restrictions will likely encourage households and companies to return to local banks any money held outside of Greece’s banking system. An increase in customer deposits in recent years has helped Greek banks reduce their ELA balance, which totalled approximately €4.5 billion, or 2% of total banking assets at the end of August 2018, versus 21% in August 2015.

Also driving the ELA decrease was an increase in interbank lending transactions/repos as international investors’ appetite for Greek risk increased and they accepted a wider range of Greek assets as collateral for such repos. The ELA reduction supports Greek banks’ net interest margins because both the repo transactions and the new deposits carry a lower interest rate than the more expensive ELA, which costs around 1.5%.

Three of six rated Greek banks have fully repaid their ELA balances: National Bank of Greece S.A. , Piraeus Bank S.A. and Pancretan Cooperative Bank Ltd . We also expect Eurobank Ergasias S.A. and Alpha Bank AE to repay their ELA balance over the next few months, while Attica Bank S.A.  will likely take a bit longer to fully eliminate its ELA.

The relaxation measures gradually ease capital controls put in place in June 2015 to stem deposit outflows from Greek banks during the first half of that year (see exhibit). However, the successful implementation of Greece’s economic adjustment programme, which concluded in August this year, and prospects of a gradual return to economic growthare already driving higher private-sector customer deposits, which grew by 4.1%, or €5.2 billion, during the first eight months of 2018.

Following the political and economic turmoil in 2015, tensions have eased over the past two years. The current government has managed to legislate a large number of reform measures, despite its slim majority in parliament and without triggering large-scale protests, as had been the case during the previous two adjustment programs. However, domestic politics and social instability remain the main risks to policy implementation and economic recovery. A potential prolonged political uncertainty, combined with looser capital controls, could cause significant deposit outflows, as was the case in the first half of 2015.

Australia’s major banks preserve profitability by raising home loan rates

From Moody’s.

On 6 September, the Australia and New Zealand Banking Group (ANZ) and the Commonwealth Bank of Australia (CBA) raised their home loan rates by 16 and 15 basis points respectively, following a similar move by Westpac Banking Corporation (WBC), which raised its rates by 14 basis points on 29 August.

The increases in home loan rates are credit positive for Australia’s major banks, which include ANZ, CBA, the National Australia Bank (NAB) and WBC, because they underline the strong pricing power of the banks, which is a key factor supporting their profitability. These interest rate rises will help mitigate the negative effects of rising wholesale funding costs, slower credit growth, and higher regulatory and compliance costs.

The rate increases by the major banks follow similar announcements earlier in 2018 by small and midsize Australian banks. The increases in home loan lending rates have been a response to higher wholesale funding costs, which have been rising since the start of 2018, for banks reliant on this type of funding.

The rate increases have been concentrated in variable-rate home loan products, which are more popular in Australia than fixed-rate loans. For banks with lower levels of wholesale funding than the majors, these have generally been around 10 basis points for owner-occupier principal and interest loans, and higher for riskier products such as investor and interest-only loans.

Higher home loan rates will offset higher wholesale funding costs, with short-term funding costs being particularly affected in 2018 (Exhibit 2).

Long-term debt issuance costs have increased proportionally less and, importantly, remain low by historical comparison (Exhibit 3). That said, we expect debt issuance costs to continue to increase as global interest rates rise. This will increase banks’ overall cost of funding as banks replace cheaper, wholesale maturities with more expensive debt.

The rate increases demonstrate that, despite intense political scrutiny and Australia’s Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, which had primarily fallen on the major banks, they still retain pricing power.

Before the rate increase announcements by the major banks, it appeared that their pricing power had been somewhat constrained while the Royal Commission was ongoing because, historically, they have been the first movers on home loan rates. However, in 2018 it has been mortgage rate increases by smaller banks that have paved the way for the major banks to follow.

From an asset-quality perspective, despite the very high level of household leverage in Australia, we do not expect the current round of home loan rate hikes to result in a significant increase in loan delinquencies or credit costs. That is because labour market conditions, which are a strong indicator of mortgage performance, are likely to remain favourable, underpinned by solid economic growth forecasts, trade tensions notwithstanding.

Additionally, the increases in home loan rates are small compared with buffers built into home-loan serviceability assessments.

Australian banks commonly assess borrowers’ repayment abilities based on a minimum interest rate of 7.25%, which is well above an average home loan rate of around 5.25% posted by Australian banks over the past three years.

Moreover, collateral quality will remain strong, despite ongoing house price corrections in Sydney and Melbourne. The average loan-value ratio for Australian bank home loan portfolios remains at around 50%.