THE DISTILLERY: CBA's cutting question

Scribes consider the implications of banks passing on falling rates, with one warning a trend to cut could reverse the big four's fortunes.

Commonwealth Bank of Australia has a big pile of money waiting for it at the end of the 2013 financial year. While the bank bashers will always claim that the big four have room in their lending metrics to drop their mortgage rates, expectations are rising that Commonwealth will actually do it now. What does this mean?

Fairfax’s Elizabeth Knight writes that the bank needs to make a choice between shareholders and customers when it comes to navigating the so-called 'purple patch' for banking, as dubbed by UBS.

“Commonwealth Bank has delivered a sufficiently strong result that consumers will start applying pressure for it to front up with out-of-cycle interest rate cuts. It was the fourth of the big retail banks to deliver its performance for the March period and it is abundantly clear that all are faring well despite the sluggish economy. While there is historically low growth in loans in Australia, the banks are reaping the benefits of a very benign market for impaired loans and a decline in their cost of funding. Since the Reserve Bank cut the cash rate this month some banks have hinted that they might give customers a little extra in rate cuts if they are affordable.”

The Australian Financial Review’s Andrew Cornell is similarly monitoring the net interest margins of the big four to see whether they offer some relief to borrowers.

“The bank delivered a 'higher margin' which it attributed to repricing, and for a bank like Commonwealth with such a large mortgage book, this suggests the benefit of holding back some rate reductions after Reserve Bank cash rate cuts. ANZ Bank, of course, has rumbled this game by cutting its key mortgage rate on Friday by more than the Reserve Bank. If the big home lending banks Commonwealth and Westpac follow suit, the improvement in margins could well reverse.”

Passing on a rate cut to borrowers could be a well-timed PR blitz for the banks, given the circumstances that Business Spectator’s Stephen Bartholomeusz sees them coming into.

“All the banks have reduced their reliance on wholesale funding and extended the average term of the funding they have raised to reduce their exposure to short-term volatility. In Commonwealth's case the average tenor of its wholesale funding is 3.8 years. One of the interesting aspects of the lack of system growth, combined with the major banks’ focus on costs and the improvement in credit quality, is that in the near term it should boost their profitability and capital generation. Growth comes with an upfront cost so its absence should swell near term profits, albeit at a cost to the longer term. That, and the conservative balance sheet settings the banks now have, helps explain why the market is now starting to talk about capital management and perhaps more of the special dividends that Westpac surprised the market with earlier this month. If they are generating more capital than they can deploy in a low-growth environment, giving it back to shareholders is a way of both satisfying shareholder demands for return and improving their performance metrics in the process.”

There’s the shareholder part of the customer-shareholder balance that Knight was talking about.

Meanwhile, Fairfax’s Malcolm Maiden explains how much of the federal government’s bottom line rests on the outlook for the Australian dollar, which could come in a variety of different circumstances. Maiden goes on to say that the worst thing for the federal government would be a fall in commodity prices and the terms of trade, without a dip in the dollar.

“It might happen if China’s demand falls and America’s QE program runs for longer than expected, or if Japan’s QE program fills the gap the Fed leaves. Goldman Sachs’ Australian economist Tim Toohey expects a heavier fall in the terms of trade than the budget predicts, and says if the $A also stays strong, the tax revenue shortfall through to 2015-16 could blow out to $150 billion.”

That would suck, majorly. The Australian’s John Durie and Barry Fitzgerald are similarly dealing with market economists this morning that don’t believe the government’s revenue forecasts will turn out.

The Australian Financial Review’s Chanticleer columnist Tony Boyd argues the federal government will be hoping that it’s tightening of the rules around tax concessions for mining exploration won't have some unintended consequences for smaller operators. The smaller miners are the ones the policy was geared towards, but the government is tightening the rules to raise more money from the big miners, who are milking it for all it’s worth.

The Australian Financial Review’s Matthew Stevens welcomes at long last the consenting signature from Environment Minister Tony Burke for Rio Tinto’s $US1.45 billion South of Embley bauxite project.

Meanwhile, AFR economics editor Alan Mitchell reasons that the next federal government will be just as compelled to invest in infrastructure as this one has been in the latest budget, to help the cash-strapped states.

“So, here’s a question. Why not borrow now as much as we can of the money needed for infrastructure over the next five to 10 years? Global interest rates are as low as they are going to go, and if we borrow now we can lock the low rates in. The money then would be invested by, say, the Future Fund until governments needed it.”

Oh good grief, yes! Can we please end the ridiculous debate about debt and deficit? Anyone who runs a balance sheet in any capacity knows debt and deficit isn’t a bad thing if it’s leant on for a worthy long-term cause that will pay off.

Infrastructure for decades to come… that sounds alright.

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