It sounds crazy, but first home buyers could pose a threat to the profitability of the big banks at a time when the sector is already under enormous earnings strain.
Banks are worried that the federal government's first home buyers' scheme will hurt the quality of their loan book and drive up their cost of funding, according to a report in the Australian Financial Review.
While the news isn't hurting the share prices of our big banks this morning, this is something bank investors should pay attention to, and I'll explain why in a moment.
The Westpac Banking Corp (ASX: WBC) share price, the Commonwealth Bank of Australia (ASX: CBA) share price and the National Australia Bank Ltd. (ASX: NAB) share price are rallying around 1% this morning.
The Australia and New Zealand Banking Group (ASX: ANZ) share price is up 0.5%, which is still ahead of the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index's gain of 0.4%.
Agency theory and moral hazard
A positive lead from Wall Street and better than expected Chinese trade data are overshadowing the first home buyer issue – at least for now. Also, the grumblings from the banks towards the government's initiative that allow first home buyers to only put a 5% deposit for a new home isn't new news.
If you are wondering why banks care, it's to do with agency theory. Borrowers with more skin in the game are less likely to default on a loan. Having to put 5% down vs. the standard 20% can make a big difference.
The other issue is that those putting a 5% deposit won't need to cough up for the Lender's Mortgage Insurance. This is because the government is effectively guaranteeing the other 15%.
Riskier borrowers treated as safest
The insurance, which can cost the borrower around $20,000, is to protect the banks from defaults. Those who can afford a 20% deposit do not need one, and first home buyers who qualify for this scheme will be treated as a member of the 20% club.
What makes the situation even dicer is that to qualify for the scheme, borrowers can't make more than $125,000 a year for singles or $200,000 a year for couples.
The scheme is aimed at lower to middle income households. You can see why the banks aren't happy as the government will essentially force the banks to treat these riskier borrowers as the safest borrowers.
The real winners are the losers
The banks are trying to push the government to allow them to charge higher interests to those accessing the scheme, but good luck with that. The program is meant to win votes and giving the green light to banks to charge more runs contrary to this objective.
The government would also argue that it will act as a backstop and cover losses should qualifying first home buyers default on their loans. Further, it is only going to allow two of the big four banks to access the scheme in order to create much needed competition.
The banks don't like being pushed into a corner but are compelled to look interested to rebuild goodwill with the community and the government after the bruising Banking Royal Commission.
But given that the scheme won't add to profits (and could instead cost them in terms of margin), you would think they would be secretly hoping to lose this race.
