This morning the Australian banking supervisory regulator APRA moved to prevent further falls in Australian house prices by removing restriction on interest-only investor lending and this could help lift the share prices of banks like Westpac (ASX: WBC) or CBA (ASX: CBA).
Back in March 2017 as house prices rocketed higher in Melbourne and Sydney on the back of investors feeding on cheap borrowing rates and lax lending standards APRA introduced a rule that limited new interest-only lending to 30% of total lending for banks, with further limits on the amount of interest-only lending at loan-to-value ratios (LVRs) greater than 80%.
APRA also required the banks to ensure there was “strong scrutiny and justification” of any instances of where LVRs were greater than 90%.
Unsurprisingly the profit-hungry banks were happy to feed the speculative investor appetite for home loans in the central bank rate-cut-infused years up to March 2017, as mortgage lending is easily the most profitable risk-adjusted business for Australian banks going.
Moreover, interest-only lending is conducted on better net interest margins for the banks compared to owner-occupier lending, with the loans still collateralised against the equity in the physical property.
In other words even though the banks would have to record the high LVR interest-only loans as slightly higher risk weighted assets on their balance sheets, their additional profitability more than offset the requirement to carry incrementally more capital in reserve as a proportion of risk weighted assets on their balance sheets.
The more idle capital a bank has to carry in reserve, the lower its return on equity (as a key measure of profitability), however the higher profitably of interest-only loans more than offsets the downstream capital adequacy adjustments from issuing them.
What does this mean for 2019?
The more banks can practice the financial alchemy of turning short-term deposits or borrowings into long-term asset backed loans the higher their profits. This is because banks profit by paying less on what they borrow than they receive on what they lend.
So APRA’s decision to scrap restrictions in interest-only lending is likely to prove a boost to big bank profitability in 2019 and beyond.
Australian house prices are also likely to be supported by the return of investors to auction markets, although whether it’s enough to prevent further house price declines in 2019 is yet to be seen.
You can find Tom on Twitter @tommyr345
The Motley Fool Australia owns shares of National Australia Bank Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.