Will The Banks Out-Hike The RBA?

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This story features WESTPAC BANKING CORPORATION, and other companies.
For more info SHARE ANALYSIS: WBC
The company is included in ASX20, ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

By Greg Peel

Prior to February the big banks had decided to increase their own lending rates, particularly their standard variable home loan rate (SVR), by 10-15 basis points above the 25 basis point hike the RBA implemented in November. This represented the break in the “staring competition”, as the banks had been wearing margin crunches brought about by the independent increases in global cost of funds in order to gain market share back from the ailing non-bank and small bank pretenders. Once one broke, they all went.

This prompted harsh words from the new treasurer, who made a political stance by reprimanding the banks on their rises, even though he knows full well there’s absolutely nothing the government can do about it. It also prompted criticism of the treasurer from the new shadow treasurer, even though he is probably even more aware of what little the government could do about it. Polly-speak was intended to gain some sort of political mileage, but the banks are operating under a regime of global borrowing costs and Australia is merely one little cog in the wheel.

So get set for more fruitless polly-speak this week when the RBA hikes its target rate by 25bps this afternoon and the banks shortly follow with SVR increases of 35-40bps. The simple fact of the matter is spreads on cost of funds have continued to move adversely since the February hike, and business is business. There is, however, a remote possibility the RBA will pre-empt the banks and raise a full 50bps, in which case additional independent hikes would not be forthcoming.

Could the RBA possibly go the full 50? We know from the minutes of the February meeting that the RBA was very close to doing just that last month – going the full 50. This represented a turnaround in sentiment from December, where economists were previously suggesting February may not see a rate hike given the banks had already added their own premiums. But economic data and, more importantly, inflation data released in the meantime turned the tide completely. The only thing stopping the RBA from going the full 50 was a consideration that it would be less painful to spread the rise over two months. In other words, a 25bps in March became certain.

But still the data remain relentless – strong economy and surging commodity prices fuelling inflation. Economists very quickly added an expectation of another rate rise in May following the March quarter data. In other words, the market is already preparing itself for another 50bps rise in total. As there is little sign of relief to date, would it perhaps be more prudent for the RBA to rip the bandaid off in one go this afternoon, rather than the slow and torturous method? Precedent has certainly been set in the US for “shock & awe” adjustments, although those have all been the other way.

Were the RBA to go 50, the banks would not need to add any further premium. The most unlikely event is the RBA will go 25 points and the banks will only raise by 25 as well. Premiums of 10-15 points are far more likely bringing the effective hikes to 35-40 points. A 50 point rise is not really that likely.

That’s the way Macquarie economists see it. A 50 point rise would be the most immediately beneficial for the banks, given it would provide margin relief (and they avert the need to appear like evil profit-chasers to the general public as they can simply blame the RBA). However, the RBA’s intention in raising rates is to slow the economy, immediately affected by a drop in demand for credit, and while a 50 point hike would be most effective it would mean banks would see higher margins on falling volumes.

A 25 point rise accompanied by no extra premium from the banks would be the less painful for borrowers, and would thus see the least drop off in demand. However, the banks will still be suffering from lack of margin as 25 points is not enough to cancel out recent spread movements on funds. This would be the worst result for bank investors.

Thus the best result for the banks, and thus bank investors, is a 25bps hike from the RBA shifted up to 40bps by the banks. This is the happy middle ground, if one can be happy at this point.

Macquarie warns that whatever happens, St George Bank ((SGB)) is the most vulnerable. The Dragon has a low deposit base, is thus more heavily reliant on offshore liquidity, and has a lower credit rating, thus has inferior access to that offshore liquidity. It also has 50% of its home loan portfolio and 13% of consumer finance loans sourced in NSW – the state in the most vulnerable economic position.

Macquarie’s banking sector analysts prefer Westpac ((WBC)) and Commonwealth ((CBA)) as the least exposed of the sector. They have an Outperform on the former and a Neutral on the latter within the sector. They shy away from ANZ ((ANZ)), and particularly National ((NAB)) with its exposure to the weak UK market. Both are Underperform, as is St George.

Macquarie’s strategists, who start with the broad market and then assign sector weightings, is Underweight banks – a stance that has become more common amongst brokers in the last couple of weeks.

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