Westpac bustles for a mortgage advantage

There is a straightforward reason, and a more complex one, why Westpac was the odd bank out yesterday as the sector rushed to pass on the Reserve Bank’s 25 basis point reduction in official interest rates to their mortgage rates. Westpac reduced its headline rate by more than the central bank's cut.

The simple explanation is that ahead of the Reserve Bank move Westpac had the most expensive headline rate. It was at 6.26 per cent compared to Commonwealth’s 6.15 per cent, ANZ Bank’s 6.13 per cent and National Australia Bank’s 6.13 per cent.

Had Westpac just passed on 25 basis points it would have been the only major bank with a headline rate above 6 per cent – all the others would have had a '5' in front of their home loan rates while its would have been 6.01 per cent.

Perceptions being important, Westpac cut its rate by 28 basis points to 5.98 per cent. While it will still have a higher headline rate than its peers, the difference is marginal and, most importantly, it isn’t out there alone in the 6 per cent-plus range.

The more sophisticated analysis relates to what’s been happening below the headlines.

In the initial post-crisis phase, when governments deployed their generous first home buyers’ schemes, it was Westpac and Commonwealth Bank that gorged themselves on mortgages to take advantage of what they saw as a generational opportunity. Today Westpac is more of a retail bank than its peers.

The sheer extent of the growth, coupled with the then-escalating costs and uncertain availability of wholesale funding, caused Westpac some indigestion and it allowed its market share in mortgages to stabilise while it focused on the liabilities side of its balance sheet and on retail deposits in particular.

For much of the post-binge period Westpac and Commonwealth have been comfortable holding their share of mortgages while continuing to compete for deposits.

The headline rates for home loans don’t, however, tell the full story as all the banks offer largely unpublicised discounts to retain their customers or to woo their competitors'.

Until relatively recently National Australian Bank, with it's "Breaking Up" campaign and offer of the lowest headline rates, and ANZ Bank have been steadily growing their mortgage books at above-system rates.

Westpac and Commonwealth, however, have begun fighting back by discounting their headline rates for new customers (which doesn’t affect the profitability of their existing loan portfolios) and, in Commonwealth Bank’s case, pricing its headline rate more competitively (which does affect the existing portfolio).

That’s probably partly because with very weak demand for credit from business and non-housing credit from consumers, there is very little growth available across the system. It makes sense for the banks to try to make sure they get their fair share of whatever top line growth is available. They are also all very focused on reducing costs to maintain profitability.

With the liabilities side of their balance sheets 'fixed' and deposit-heavy and, within the current low interest rate framework not much growth available, there would inevitably be more attention being paid to the assets side.

The larger proportion of deposits and their lower cost in the current environment does enable the banks to pass on the rate reductions without damaging their net interest margins, although wholesale funding costs, which had been falling, have edged up slightly after the Cyprus crisis and amid the volatility created by the talk of the US Federal Reserve Board "tapering" its quantitative easing program.

The question raised by the alacrity with which the banks responded to the Reserve Bank cut is how depositors will respond as the rate reductions flow through to already-modest deposit rates.

For prudential reasons – both of the regulatory kind and from their own experiences during the crisis – the banks need to maintain significantly higher levels of deposit funding than they did pre-crisis. If the deposits start flowing out heavily in a search for greater yields, either bank margins or home loan rates will be adversely affected.