Mortgage Rate Forecasting, January 2017 (Pre-Trump)

With the clock winding down to the Inauguration of US President Elect, Donald Trump, a quick update on Australian mortgage rate forecasting.

In the last 2 months we have seen most Australian lenders increase their home loan rates across their fixed products (2, 3 and 5-year fixed rates) and well as increases to variable rate products. This is inline with our prior forecast in November. Investor loans have had a higher hit, in part due to higher systemic risk, the APRA 10% annual volume increase limit (banks using price to temper strong demand), and simply less sensitivity to rate increases (it’s not going to stop investors given high house price growth and the ability to negative gear away some of the higher increase).

Based upon maintaining a margin above where the cash rate is expected to be (2.25% premium), the lowest discounted variable rates are, on average, expected to reach 5.70% within 10 years. This is an average case forecast with variation possibly up to 2% higher.

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As we have discusses before, now is a great time to borrow with fixed terms for as long as possible as rates are low, the RBA is expected to consider interest rate increases (1 in 3 chance of a rate hike this year) and incumbent banks are increasing interest rates even without RBA rate changes. The cheapest variable home loans have already increased about 0.2% in the last 2 months.

We believe the best way to mitigate the risk of higher interest rates is by opting for one of our 10-year FlexiFix mortgages. The interest rate is fixed for 10 years but borrowers can repay, refinance anytime without break fees after 3 years. If rates don’t go up, go down or you feel more comfortable in being able to manage interest rate rises, then you can switch without facing any finance related costs from our side.

This can be done with a straight mortgage or with a split loan (part FlexiFix, part variable).

Other Forecast:

We will look at what happens to expected rates after the Presidential Inauguration. Many experts expect to see a few interesting changes over the next few weeks.

To find out more and be the first to obtain the loan when we launch, visit

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Capital Floor Impact: Wholesale versus Retail


The latest thoughts on new bank capital rules are that risk-weight floors are introduced so that advanced banks are no longer able to significantly deviate from regulatory views on capital adequacy for credit exposures based on internal models.

Banks that have internal models have shown large discrepancies between institutions in how they view the same type of risk. So international regulators are considering making a few adjustments that cover this:

  1. Should large banks have a huge capital advantage over small ones? Diversification across much larger pools is a justification but there should be a limit.
  2. Should the maximum deviation be contained? For better prudential risk management would suggest yes. And this is most easily delivered by having a minimum limit on how little capital a bank would hold against a specific risk.

Minimum Levels: A Floor

This brings us to IRB Floors. Any internal ratings base bank will potentially be subject to holding capital based on the higher of:

  1. The internal view on risk
  2. A minimum percentage of the regulator’s view on the risk via standardised rules.

Advanced IRB banks show evidence to regulators as to why IRB models should apply – receiving regulatory approval for the probability of default and loss-given default based on historical evidence compared to the bank’s credit scoring methodology.

The Floor would then say that is OK as long as the bank isn’t stretching the capital too far from aggregate data gathered by regulators that forms part of its standardised one-size-fits-all view.

Statistical Error versus Conservatism

A bank may have experienced lower losses based on sampling rather than the real risk but someone has to be wrong or too conservative: just because a borrower takes a loan from a smaller bank rather than a Major bank shouldn’t mean they become vastly different in risk.

Minimum thresholds already exist in some cases and one was introduced by APRA for residential mortgages as a response to the Financial System Inquiry. This also happens in other cases, particularly for banks in FIRB status (halfway from being considered eligible for full internal ratings based status).

Back to Basel

Credit Rating

APS 112 (Standardised) IRB Capital 60% Floor 75% Floor 90% Floor


5.00% 2.12% 3.00% 3.75% 4.50%


10.00% 3.46% 6.00% 7.50%


BB 10.0% 6.27% 6.00% 7.50%


B 15.00% 9.91% 9.00% 11.25%


Returning to the Basel committee, there are 3 potential numbers being suggested for the Risk-Weight Floor: 60%, 75% and 90%.

Using 30% LGD and a 3-Year maturity, this suggests the following impact to corporate credit:

Basel III with a 75% RW Floor on Corporate Loans (LGD = 30%, Maturity = 3) increases the required capital on A and BBB loans significantly. If a bank cannot adjust the loan spread, then the return on capital will drop dramatically.

Given the 4 Major Australian banks hold $575bn in corporate credit exposures and assuming this is realised as an upfront loss of 1% (averaging the implied loss across all credit ratings), this will equate to destroyed value of $5.75bn if banks had to mark-to-market. Of course, as banks are hold-to-maturity this will be reflected in lower return on equity but the overall impact will be the same over time.

Credit Rating

Expected Spread @ 25% RoRC New Required Spread New RoRC (was 25%) Implied Loss of Value on Loan


2.06% 2.47% 14.13% 1.22%


2.44% 3.45% 11.53%


BB 3.37% 3.68% 20.92%


B 5.48% 5.81% 22.03%


Importantly: banks will have to absorb the cost for loans made in the past and new loans will have higher interest rates.

Residential Mortgages:

Within consumer lending, the 4 Majors continue to have a major pricing advantage due to the capital they hold versus all other banks. Standardised banks hold 35% risk-weight against sub-70% LVR loans (APS 112), whereas the 4 Majors are holding an average of 25% across the entire loan book.

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The originally proposed and retracted 25% Risk weight floor would represent a 71% risk weight floor versus the standardized level (35% RW).

Clearly, we expect 60% to have limited impact whereas 90% would lead to a higher capital charge. Working through the 90% example:

A Standardised bank has an approximate risk weighting of 37%, as some loans carry a higher risk weight (LVR above 80% and 90%, defaulting loans, non-standard, no LMI etc…).

If the 90% Floor comes in, this would force the 4 Majors to hold 33.3% Risk Weight. This is 8.3% higher than the 25% average Risk Weight allowed by APRA.

Mortgages are different as banks can re-price:

8.3% on 10% capital ratio and 30% current return on regulatory capital across the residential mortgage portfolio suggests banks will raise rates by 0.25% to maintain profitability (8.3% * 10% * 30%) – an equivalent to an RBA rate increase. Banks can do this for variable loans made in the past by adjusting their standard variable rate upwards. New and old loans will have higher interest rates and consumers pay for Basel’s actions, not the banks, if banks choose to pass on the cost and they seem to be very active in doing this.

The major difference here is that banks can re-price their variable rate mortgages. Perhaps corporates are smarter than consumers but one should think that consumers should look for better risk protection and not continually subsidise major bank profits,

So watch out for Basel, especially if your bank can re-price your debt.

Note: Photo of Wayne Byres from Louise Kennerley via smh. 

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