Mortgage Discounts – Digital Finance Analytics (DFA) Blog

Household Debt Ratio Grinds Higher And Mortgage Discounts Rise

The latest RBA chart pack, just released, shows that household debt, as a percentage of disposable income continues to rise. Also from our analysis, banks are offering larger discounts again.

RBA data shows interest payments are below their peak, but are also rising (though the May cash rate cut will have an impact down the track as mortgage rate cuts come home). However, given static incomes (which are for many falling in real terms), this debt burden is a structural, and long term weight on households and the economy, and is dangerous. However low the interest rate falls, households will still have to pay off the principle amount eventually.

We are also seeing some relaxing of lending standards now, as banks chase investor loans well below 10% growth rates, and continue to offer cut price loans for refinance purposes. Average discounts on both investment loan have doubled.

NSW Investment Property On The Slide

The data from the ABS today, provides a view of all finance for September, and contains a number of significant points. Trend data (which irons out the noise month by month) shows that lending for owner occupied housing was $20.6 bn, up 2% from last month ($20.2 bn). Personal finance was down 1.1% from $7.3 bn to $7.2 bn, whilst commercial finance – which includes investment home lending – was down by 0.4% from $44.4 bn to $44.3 bn.

However, looking in more detail, and separating out investment lending from other commercial lending, we see that investment housing was $12.9 bn, down from $13.2 bn last month. The relative proportion of new loans for investment housing in the month sat at 38.6%, down from 39.6% last month. So owner occupied lending is now dish of the day.

We also see that business lending, net of investment housing, fell from 48.1% to 48%, although the value rose a little from $31.2 bn to $31.3 bn. We continue to see the relative share of lending to the commercial sector falling, which is not healthy for future growth prospects. The banks prefer to lend against residential property as the current capital adequacy ratios still makes this more attractive than commercial lending, and loss rates are lower, so net margins remain strong. Firms are still holding off from investing, and many who would borrow are finding the terms, and costs prohibitive. We will discuss this further in the next report on the business sector, to be released shortly.

The other data point, which is quite stunning, is the fall in investment lending in NSW. Looking at the original data we see that it fell from a peak monthly flow of more than $6 bn in June to $5.5 bn, supported by a relative growth in investment by entities other than individuals, which would include self-managed superannuation funds and other commercial entities. Momentum looks set to fall further, in the investment sector, whilst owner occupied lending is set to grow. Indeed the trend line for owner occupied loans in the graph above, shows a clear movement up, as banks reset their sites on attracting owner occupied business and refinance – this explains all the heavy discounts currently available for owner occupied loans in the market at the moment, funded by hikes in rates to existing borrowers.

Mortgage Discounts Crash

Latest data from the DFA surveys which is going into the forthcoming edition of the Property Imperative, shows that the era of very large mortgage discounts is passing. The average discount has now fallen from above 100 basis points to around 60 basis points and it will continue to fall further. This means a windfall for lenders who can pocket the extra margin, or use it to attract owner occupied new business.

The range of discounts between the upper and lower bounds is reducing, with the lowest bounds around 20 basis points.

The most insightful data is the split by loan type. Loans for investment loans (both new and refinanced) are much reduced, with the average a little above 20 basis points – some lenders offer no discount at all now. On the other hand, owner occupied borrowers with new or refinanced loans can obtain a larger cut in rates. This reflects the new competitive landscape, where lenders are seeking to swing business away from the investment sector to owner occupied lending.

You can read our earlier analysis on discounts here.

Battle Shifts Further Towards Owner Occupied Home Lending

As we predicted, the banks have upped the ante on their owner occupied loans, for new customers, as the regulatory enforced slow-down on investment lending starts to bite. As well as hefty discounts, rebates are on offer, paid for by the hike in interest rates to new and existing investment loan borrowers. The changes to capital for advanced IRB banks, not due until next year, is a convenient alibi. The truth is, banks need the home lending fix to keep growing.

For example, according to Australian Broker:

A major bank has announced it will be running a home loan rebate campaign, which could save consumers over $1,000 on new owner-occupied loans.

From Monday 24 August, Westpac will be running its home loan rebate campaign to celebrate the popular Chinese Mid-Autumn Festival, which falls on Sunday 27th September.

As a part of this promotion, eligible customers will be entitled to receive a $1,088 rebate after applying for a new owner-occupied home loan with the major bank’s Premiere Advantage Package. Customers must receive conditional approval by Wednesday 30 September 2015.

The rebate figure of $1,088 was chosen because the number 8 is a lucky number in Chinese culture. According to Westpac, auction numbers on the 8th of August – the eighth day of the eighth month –were up 51% in Melbourne when compared to the same weekend last year.

With Chinese foreign buyers now accounting for about one in six new properties sold in NSW and VIC, Westpac general manager of third party distribution, Tony MacRae says this is an opportunity for the major bank to celebrate cultural diversity and the Australian Chinese community.

“Undoubtedly the Chinese community is the largest Asian migrant segment in Australia and we pride ourselves in supporting this key segment,” he said.

“Promoting cultural celebrations such as the Mid-Autumn Moon festival helps Westpac to deepen relationships with brokers supporting our Chinese and migrant customers.”

Mortgage Discounts Still Running Hot

Latest data from the DFA household surveys highlights that many prospective borrowers are still able to grab significant discounts on new or refinanced home loans. The chart below shows the weighted average achieved across loans written, compared with the RBA cash rate. Despite the recent falls, discounting is still rampant.

However, we also see significant differences between players and across different customer segments and loan types. Not all households are getting the larger cuts. Discounts also varies by LVR and channel of origination, with those using a broker, on average, doing a little better.

The deep discounting flowed through to some margin compression in the recent results from the banks, and falls in deposit margins, as they continue to attempt to grab a larger share of new business. Households with a mortgage of more than a couple of years duration would do well to check their rate against those currently on offer in the highly competitive market. Even after switching costs, they may do better.

We also updated our strategic demand model, and our trend estimates for mortgage numbers out to 2020. We expect to see investment loan growth containing to run faster than owner occupation loans. Over the medium term we expect the number of owner occupied loans to grow at an average of 2.8%, and investment loans at 7.8% per annum over this period.

Behind the model we have made a number of assumptions about population growth, capital demands, house prices and economic variables, as well as the demand data from our surveys. Significantly, much of the demand is coming from those intending to trade down, buying a smaller place, AND a geared investment property. We will update the segment specific demand data in a later post.

A Deep Dive Into Mortgage Discounts

We have been highlighting the battle for market share, and the varying discounts which are available to some. Today we deep dive into the world of discounts, drawing data from our market model. We conclude that households, on average, get better discounts which using a broker, discounts for investment loans are more generous, and reconfirm that more affluent households get the best deals. We also see that competition and deep discounts are making many loans unprofitable to the banks who make them (taking fully absorbed costs into account). As such, the current deep discounts are unsustainable.

We start by looking at the average discounts in basis points individual loan providers are offering. Some are significantly more aggressive than others. We have hidden the real names of the lenders concerned. We see that there are more banks offering owner occupied loans than investment loans. The best average discount for an investment loan is from provider 9.

Some of the owner occupied providers are quite generous in their discounts, but generally investment loans get bigger discounts at the moment.

Looking at channel of origination, and year of inception of the loans, we see that consistently third party (broker) loans get bigger discounts, and that the discounts have been growing in recent years. In the owner occupied sector, discounts for loans via the branch (first party) are slightly lower in 2015.

In the investment loan sector, we see a trend of growing discounts in recent years, with third party originated loans getting a better deal.

Turning to the DFA property segments, in the investment loan category, we see that portfolio investors are getting the very best discounts, whilst first time buyers are not doing so well, but they are slightly ahead of holders, refinance and trading down households.

Looking at our master household segments, we see that the wealthy – professionals and young affluent get the best deals. Those with less bargaining power do not do so well.

This is true of both investment mortgages (above) and owner occupied mortgages below, though we see that in the latter case, the discounts are slightly less generous.

We also see that interest only loans command a larger discount in some states, especially in ACT. Others are more line ball.

In comparison interest only owner occupied loans can consistently command a larger discount, than normal repayment loans, but as highlighted already these discounts are on average a little lower than in the investment sector.

So what is the profit impact of these discounts? DFA has calculated the relative profit of each loan and using an index we can display the relative profit contribution in cash terms. For owner occupied loans, up until 2013, most years were net profitable to the lenders. We note that this changed in 2014 and 2015 as discounts expanded, and competition increased. Overall in cash terms they are making a slight net loss on some loans written now. This is partly explained by the one off costs of setting up a new loan, and initial broker commissions. As loans age, they on average become more profitable.

The investment loan profit footprint is very interesting, as here we see a consistent fall in the profit index since 2010, with the largest drops in 2014 and 2015. This is explained partly by the significant growth in volumes, and the deeper discounting. Again, older loans become more valuable. Most banks would calculate an amortised cost of origination, spread over a number of years, but we prefer a true cash view.

We conclude from this that recent loans for many providers (especially those less efficient) will be loosing money initially, and the portfolio will be supported by the older more profitable loans. We also think that discounts are unsustainable at current levels, and will see them come off over the next few months.