Australia's Mortgage Plan May Push Lenders to Pass On Rate Cuts

By Gemma Daley

Sept. 29 (Bloomberg) -- Australia's purchase of A$4 billion ($3.3 billion) of mortgage-backed securities to revive frozen markets for the debt may increase competition in the banking industry and encourage lenders to pass on any interest rate cuts.

``Increased bank competition always adds pressure to pass on rate reductions,'' Hans Kunnen, head of investment market research in Sydney at Colonial First State Global Management, which manages about $128 billion, said in a telephone interview on Sept. 27. ``Competition impacts price decisions.''

The purchases of mortgage securities through the Australian Office of Financial Management are intended to reinvigorate the home-lending market by providing funding for small lenders. Such funding has all but dried up because of the global credit squeeze, Treasurer Wayne Swan, 54, said in Canberra on Sept 26 when announcing the program.

The Reserve Bank of Australia will cut its benchmark borrowing rate by at least 0.25 percentage point on Oct. 7, according to a Credit Suisse Group index based on interest-rate swaps. Bank Governor Glenn Stevens reduced the cash-rate target by 0.25 percentage point to 7 percent this month, the first cut in seven years.

Australia's banking industry is dominated by its largest lenders -- National Australia Bank, Commonwealth Bank of Australia, Westpac Banking Corp. and Australia & New Zealand Banking Group -- who are barred from merging with one another under the government's so-called Four Pillars policy. The four are benefiting as smaller mortgage providers struggle amid rising wholesale funding costs.

``This move will certainly assist competition and may help with a decision to pass on cuts'' by the country's banks, said Su-Lin Ong, a senior economist at RBC Capital Markets Ltd. in Sydney. ``It will put pressure on them, but the bottom line is their cost of funding capital is still hard to get and expensive.''

The four biggest lenders this year each increased their main home-loan rates by at least 1 percentage point as the central bank raised the cash rate by 0.5 percentage point.

Mortgage Bond Sales

Mortgage bond sales slumped 85 percent to A$2.5 billion a quarter since the middle of last year as international investors retreated from property lending after losses and writedowns from the U.S. subprime collapse swelled to $522 billion. That's crippled the ability of smaller banks including Bank of Queensland and Aussie Home Loans to make loans.

Australian short-term funding costs surged this year to the highest since at least 1999, based on the spread between interbank lending rates and government bonds.

Small lenders, who would use the securities to provide mortgages, include Aussie Home Loans, Wizard Home Loans, Bendigo and Adelaide Bank Ltd. and Bank of Queensland. Such lenders don't have large deposits, like the larger banks, to fund their mortgages.

A year ago, smaller lenders accounted for 15 percent of the market, according to Mortgage and Finance Association of Australia. Their share of the market has dropped to 5 percent and Aussie founder John Symond said he hadn't been able to offer a mortgage with competitive rates for 12 months.

Competitive Pressure

``This will give non-bank lenders a chance to come back into the market and apply competitive pressure on interest rates,'' MFAA Chief Executive Officer Phil Naylor said in a telephone interview from Sydney on Sept. 27. ``This will put downward pressure on interest rates.''

The nation's one-month bank bill swap rate, which Australian banks typically use to determine yields on variable- rate loans, reached a 13-year high of 7.80 percent on June 11. It has since dropped to 7.4 percent.

The spread between one-year interbank rates and the one- year Australian government bond touched 1.45 percentage point on March 10, based on Bloomberg data. The spread widened to 1.16 percentage points on Sept. 26, compared with 0.97 on Sept. 1.

Mike Smith, head of ANZ Banking , signaled last week the nation's fourth-largest bank may not pass on to mortgage customers all of any potential central bank rate cuts when policy makers meet next month.

``Wholesale funding costs will determine whether cuts are going to be passed through,'' Joshua Williamson, a senior strategist at TD Securities Ltd. in Sydney, said in a telephone interview on Sept. 27.

Banking Industry

The mortgage debt purchases, supported by the Reserve Bank, are intended to strengthen the nation's banking industry while ensuring that small banks can compete, Swan said. The nation's treasury department will administer the flow of funds; the investments are planned as temporary, Swan said.

``This will free up some liquidity,'' Kunnen said. ``Our financial system is strong.''

Australia's financial system is weathering the global credit turmoil better than many others around the world, the RBA said on Sept. 25. Still, banks are taking a ``more cautious attitude to lending,'' the central bank said in its half-yearly Financial Stability Review published in Sydney.

``This action is appropriate to support competitive lending,'' Swan told reporters in Brisbane on Sept. 27, adding that officials would start work today on the policy. ``This will make our strong banking system even stronger and even more competitive.''

U.S. Plan

The Australian plan coincides with a push by U.S. lawmakers to revive credit markets by authorizing a $700 billion plan to buy troubled assets from financial institutions.

In the case of Australia, the Reserve Bank's recent stability review showed western Sydney homebuyers, who took out prime loans as prices peaked in 2004, have since had the worst rate of arrears in the nation. As a result, western Sydney has seen a sharp rise in property repossessions, the bank said.

The number of borrowers in western Sydney who are late on their repayments is more than double the national average, the bank said.

``A competitive lending market is vital to make sure consumers get the best variety of products, the best service and the lowest interest rates,'' MFAA's Naylor said. ``That's critical at the moment when there are mortgagees in trouble.''

To contact the reporter on this story: Gemma Daley in Canberra at gdaley@bloomberg.net