MORGAN STANLEY: Big bank margins may suffer as Australian borrowers increasingly abandon interest-only loans

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Westpac’s quarterly report has revealed a major shift underway among Australian borrowers.

Yesterday the bank said it was “on track” to slash its new interest-only loans to below APRA’s regulatory cap of 30% by the September deadline, saying 36% of its new lending was interest-only, a dramatic fall from 47% last quarter.

And its results for the June quarter also revealed that a significant number of borrowers switched from interest-only to principal and interest repayments.

Further analysis by Morgan Stanley’s equities team showed showed that in July, the move to principal & interest increased even more rapidly on an annualised basis:

Given the recent out-of-cyle rate increases by the big banks on interest-only loans, it’s not hard to see why.

“The key driver is rising customer initiated switching in response to three successive rounds of interest-only loan repricing, with the largest repricing of 34 basis points (0.34%) taking place in June/July,” the analysts said.

Those increases have been partly in response to restrictions introduced by the Australian Prudential Regulation Authority (APRA), capping interest-only lending at 30% of all new loans issued.

Morgan Stanley said that while the big banks could absorb the shift to lower interest-rate repayments in the short-term, the trend will start to put a squeeze on margins next year.

“While CBA refused to disclose the amount of switching in 2017, today’s data from Westpac suggests that interest-only loan switching could be playing out earlier than the market is expecting,” the bank said.

Of course, as customers switch to more cash-hungry principal and interest repayments it’s unlikely to help Aussie consumer sentiment either.

Consumer confidence has taken a turn for the worse in August as households deal with low wage growth, high household debt and rising energy costs.

Morgan Stanley said that future headwinds from the shift will be stronger at Westpac, as around half of its Australian mortgages are interest-only loans — compared with around 40% for the other major banks.

Westpac’s proportion of interest-only loans has been falling steadily to 44% in its third quarter, from 52% in the second quarter

Despite, or perhaps because of that, Westpac remains Morgan Stanley’s preferred bank among the big four. The MS analysts said Westpac has a “better near-term earnings outlook”, is less susceptible to credit risk and offers a better risk/reward ratio at current valuations.

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