Resurgent Stocks Ignore Mortgage Belt Woes

Australia’s biggest home lender, the Commonwealth Bank, is alerting both business and the investment community that we are headed for a big rise in unemployment and a considerable slowdown in key sectors of the economy.

But the share market simply does not believe the bank even though, as the largest home lender, it has the best knowledge in the country as to what is about to happen in the mortgage belt.

Part of the reason for the share market strength is that we are seeing areas of strong consumer demand emerging and there is hope that the slowdown will be accompanied by lower inflation and interest rates.

Online currency operation Airwallex tells us there is a strong demand in payments for travel and for education. That would indicate that overseas students are returning strongly but it also shows that, locally, families do not want to take their children out of private schools and are meeting the accelerating costs with sacrifices elsewhere. 

Amongst older people, the strong share market is keeping superannuation balances high and giving people confidence to return to the travel market after the long absence created by the COVID years.

Back to the Skies

That travel money may be spent in local markets but Airwallex data indicates that Australians are returning to their love of travelling abroad. 

But there is a local downside to the rise in overseas travel. One of the factors that caused the retail boom in the COVID years was that Australians stopped travelling overseas and spent their “travel money” on domestic sectors, led by their dwellings. In addition, they turned to department stores to buy goods and so we saw our large retailers perform well at the expense of a multitude of small suburban clothing and other shops.

The retail sector needs those upmarket consumers to continue spending and the fact that they are returning to their old overseas travel habits is a danger sign.

Hitting the Road

Another area of strong demand is toll roads. The increase in traffic numbers on the Transurban toll roads again surprised. In the March quarter, Sydney toll road traffic rose 12 per cent despite a 6.1 per cent increase in tolls (to match inflation). Melbourne traffic rose a similar amount but remains below pre-COVID levels; Brisbane was also strong.

COVID drove an increase in the number of cars on the road and that has forced people to take the faster toll road options, particularly in Sydney and Brisbane.

Amidst those emerging trends is increased turmoil in the banking sector. Over the last decade, banks increased their margins on housing loans on higher demand and relaxed lending criteria. The combination led to booming profits. But the current higher interest rates and tighter lending criteria means demand for new loans is down substantially. Not surprisingly, there has been a margin war to gain sound customers. And so, if you are a mortgage holder who can clearly pay their higher loan instalments on time, you have had the opportunity to negotiate a much lower rate. In turn, that lowers the housing profit margin for the banks. 

Protecting Bank Margins

Some banks are protecting their margins by restricting their deposit rate increases but this can be dangerous because overseas borrowing is now much more expensive. So if their local depositors become active and switch to those banks that now offer higher deposit rates, the depositor laggard bank will be forced to pay fair deposit rates. This mixture of forces will affect bank profits in different ways in the current year. 

It is the reverse of what is happening in the US where the big banks are winning well because money is flowing out of the doors of smaller banks into big American banks who are relishing the cheap money. I suspect that in coming months in Australia there will be efforts to restore some of the mortgage margin but it won’t be easy because Australian banks lost control of large chunks of their customer base to mortgage brokers who are skilled at switching banks.

In the past, mortgage problem loans have been limited as long as unemployment remained low because people kept their mortgages alive ahead of most other commitments. This trend will be repeated in the coming months but 2023 presents a difference: the rising cost of living. A lot of families, even though they have employment, have seen their commitments rise, partly as a result of bank overlending at low rates in the boom years. Many of those caught in the cost-of-living squeeze are now pressing banks for concessions because they know (often because mortgage brokers told them) that currently banks are very reluctant to throw people out into the streets. Often interest-only arrangements are possible.

Banks and Builders

But the wider challenge to the banks and the housing industry is the fact that their business model is broken. Because they controlled the supply of funds, banks were able to demand builders write fixed priced contracts. In the process they wiped out large slabs of the building industry. The banks will need a different model moving forward where bank lending has the flexibility to provide extra funds to home buyers when the cost of building a dwelling rises. In turn, this means that banks will take some of the home lending risk, making home lending less attractive.

What shocked me in recent weeks is that banks began to get very nervous about overexposure to suspect builders and basically walked away from new loans where the builders did not match bank requirements. It would seem that some banks are, in fact, overexposed to builders who are shaky. That represents a danger for bank profits. 

BHP Buys OZ Minerals

There will have been a celebration in the BHP ranks when the company secured control of OZ Minerals.

The Big Australian now controls one of the most attractive copper basins in the world at a time when copper prices look to rise strongly as a result of electrification and increased demand for renewables. The South Australian basin is one of the more attractive areas for copper mining in the world, but the demands of the renewable industry will mean BHP will want to speed up development of the basin. 

That requires not only BHP getting its act together but governments moving faster, leading to a shortening of the elongated process between discovery and mine development. Almost certainly BHP will erect a smelter based in renewable energy which will require detailed engineering. The test for BHP will be whether it can overcome the South Australian deposit blockages that has held back development for so many years.