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Australia rate cut expected to boost mortgage lending, but mixed bag for banks

A widely expected move by the Reserve Bank of Australia to cut rates for the first time since 2016, coupled with other regulatory developments, is likely to boost mortgage demand, analysts said, though the overall impact on the banking sector may be mixed.

The Australian central bank on June 4 lowered the cash rate by 25 basis points to a new low of 1.25% after nearly three years on hold at 1.5%. The last rate cut came in August 2016.

Banks in the country had already moved to lower their mortgage rates in anticipation of the RBA's rate cut. Housing loans made up 62.5% of banks' loans and advances as of April, according to Australian Prudential Regulation Authority data.

The RBA said while announcing the rate cut decision that conditions in the housing market remain "soft," even as adjustments are continuing after a significant run-up in home prices in some Australian cities.

Further, the central bank noted that growth in housing credit has stabilized recently, while mortgage rates remained low and there is stiff competition among lenders for high-quality borrowers. The RBA also said credit conditions remain tightened and lending demand by investors has been subdued for some time.

The Australian housing market has been in a downturn in recent years, as national dwelling values have declined by 8.2% since hitting a peak in October 2017, according to property data provider CoreLogic. Yet, the pace of decrease slowed in May, as dwelling values were down 0.4% during the month, the smallest month-over-month decline since May 2018.

Boost demand

"Any rate cut should see an increased demand for mortgages as the previously 'marginal' borrower is now able to better afford repayments and meet the regulatory requirements," said Brendan Rynne, chief economist at KPMG Australia, in an email to S&P Global Market Intelligence.

Rynne added that domestic housing demand will be underpinned by the rate cut, which will make the cost of borrowing cheaper, as well as recent proposed changes to mortgage lending by the APRA.

The regulator proposed in May that banks be allowed to review and set their own interest rate floor in their assessments of whether borrowers can afford their repayment obligations, down from previous guidance of a 7% minimum interest rate.

"With interest rates heading south, and loans becoming both cheaper and easier to attain, this could very well be the turning point the market has been waiting for," Graham Cooke, insights manager concentrating on consumer-focused research at Australian comparison site Finder, said in emailed comments.

Further, Cooke noted that the Coalition government's election victory in May means that negative gearing "is going nowhere," which would boost demand for mortgages taken out for investment purposes.

A property is negatively geared if rental income is less than the expenses incurred to purchase the investment property. The loss can be offset against an individual's income, resulting in an overall lower tax bill. In the run-up to the elections, the Labour Party had vowed to limit negative gearing to new investment properties, in order to boost tax revenue and increase housing supply to younger and first-time homebuyers.

The combination of the RBA's rate cut and regulatory developments has resulted in "a rapid change in sentiment in the housing market," UBS analysts wrote in a May 30 note.

A change in the Australian housing market has a wider impact on the banking sector and the Australian economy, as the economy is very leveraged to housing and household debt to disposable income ranks among the highest in the world, according to the UBS note.

May not help

If housing market sentiment improves, "it will definitely be beneficial for banks' bottom lines in a lending market that has been starved of investor interest for several months now," Cooke said.

But UBS analysts are more cautious on the rate cut translating into improved mortgage growth. Given the scope of outstanding debt, Australian banks are much less leveraged to a recovery in housing lending than before, even if there is a boost to new lending flow, the note said.

Further, the lower cash rate will place pressure on banks' net interest margins and their ability to generate lending spreads, as they are pressured to pass on the rate cut impact to customers.

Instead, if the domestic housing market does not improve quickly, lower interest rates "could put material pressure on the banks' earning prospects over the medium term," the UBS note said.