Banks' floating rates are light on buoyancy

Weak competition among banks in the variable home loan market is leading to higher costs for borrowers.

Analysis by the Sunday Star-Times shows the main banks have not fully passed on cuts in the Reserve Bank's official cash rate, and that some banks are worse than others.

Floating-rate loans, unlike fixed-rate loans, are sold on their ability to rise and fall with the OCR, though current moves suggest they don't always have much buoyancy.

At the top of the scale is Kiwibank, which has the best floating rates on the market, offering a variable rate of 8.7%. The state-owned bank funds almost exclusively from New Zealand depositors and its costs are likely to be lower.

Kiwibank's rivals argue that their cost of borrowing has risen, which means they have been unable to pass on all of the OCR cuts, but the evidence indicates that some banks have used the turmoil as cover to increase margins on their floating-rate loans faster than others.

That evidence is the spread in variable rates on offer from the main banks.

Kiwibank's rate is 2 percentage points better than the worst, the 10.7% revolving credit loans of ANZ and National Bank. All the other banks charge the same for revolving credit as for standard reducing variable rate loans.

The highest standard variable rate loan is 9.45% from the big Aussie banks some 0.75 points higher than Kiwibank's. Elsewhere, HSBC's 9.95% is a full 1.15 points higher.

That spread of rates, from banks that have broadly similar funding costs, compares to a much narrower spread on fixed-rate loans. This supports the view that the big banks just aren't competing as hard on variable rate loans, and that floating-rate borrowers are getting a worse deal than fixed-rate borrowers.

The difference between the best and worst two-year fixed rates among the big Aussie banks and TSB and Kiwibank is just 0.3 percentage points.

Philip Macalister, publisher of GoodReturns, said floating rates had traditionally moved in lock-step with the OCR. "I struggle to remember when they were last out of sync."

BNZ chief economist Tony Alexander said the break was because "the previous relationship between wholesale interest rates and floating mortgage rates has been blown apart by the financial crisis".

While official cash rates around the world have been dropping, it was against a backdrop of increased borrowing costs for the banks, he said.

Compared to the cost of borrowing locally, banks used to pay about 0.1 percentage point more to borrow on international markets. That premium increased as high as 2.2 points earlier this year, although currently, money markets were effectively frozen.

Westpac's David Cunningham said that the OCR was usually a fairly accurate reflection of funding costs over a three- to six-month period. But in the past year, borrowing costs for the banks had at times added 2 percentage points over the 90-day bank bill rate.

In other countries the dislocation between floating rates and official cash rates is extreme. Alexander points to the US, where floating rates are almost unchanged despite a more than 4% drop in the cash rate.

Macalister suspects that at least some of the failure to pass through OCR cuts comes down to the banks rebuilding margins, although he added: "Consumers all have to bear in mind that during the last few years of the so-called price war, the banks' margins on their home loans were squeezed and squeezed. Analysts looked at the banks and said what was happening in New Zealand was unsustainable."

Cunningham admitted there was an element of this. "We [the banks] needed to return to some degree of normality."

But Macalister said there had also been a widening gap between two-year fixed rates and floating rates.

Kiwibank, for example, is charging just 0.75 points more for its floating rates compared to its two-year fixed rate. All its rivals are charging between 1.25 points more (ANZ National Bank) and 1.67 points (TSB).

The spread of variable rates reflected business decisions, said Alexander, and there were some interesting factors that influenced them.

Firstly, banks could move their fixed rates without disturbing the income they received from all the other fixed-rate loans they had on their book, he said.

By contrast, lowering the floating rate reduced the income from all such loans.

Secondly, there were not as many eyes on floating rates as there were on fixed rates, a state of affairs in part engineered by the banks through their aggressive fixed-rate competition over the past few years.

Alexander said the public paid more attention to variations in fixed rates even though the average fixed-rate home loan was around $135,000, compared to around $50,000 for floating loans. Macalister estimated that as little as 5% of all mortgage debt was on floating rates.

But the level of scrutiny on floating rate loans is rising, reckons William Cairns of second-tier lender Cairns Lockie.

With interest rates falling so rapidly, borrowers coming to the end of fixed-rate terms are increasingly looking to avoid re-fixing until rates have fallen further.

But Westpac's David Cunningham warned: "Don't assume the carded rates you see are those customers are paying."

Brokers say banks are willing to knock up to 0.5 points off floating rate loans for periods of up to two years for new borrowers.

This meant that banks effectively had tiers of floating loans at different rates at any one time, said Dom Davis from Mortgages By Design.

Although that allowed the banks to look like they were helping customers by accepting discounts, it also reflected their business decision to make more money out of floating mortgages, said Davis.

By contrast, fixed-rate margins were much tighter, and consequently the best a borrower could expect was a 0.15 point discount off the carded rates.

Despite assumptions by borrowers that floating rates will vary, loan agreements don't commit banks to any rules.

This past week Aussie banks came under fire for not passing on all of the surprise 0.75 point rate cut there. Westpac passed on 0.65 points of the cut. National Australia Bank passed on 0.62. ANZ passed on 0.58.

The current anomalies in floating rates lead some to ask whether borrowers should have an explicit contract forcing the lender to track a particular funding benchmark.

Business borrowers often pay a rate based on, for example, the 90-day bank bill rate plus a constant margin.

Cairns said providing such explicit loans would have their benefits, but said the banks would have to build in sufficient margin to cope with rises and falls in the costs of borrowing.

2008 MOVES

OCR: 8.25% until late July when it was cut to 8%. It fell again to 7.5% in September, and then again by 1% in October. Total net drop in 2008 of 1.5%.

Kiwibank: Started the year at 9.99%, but moved up to 10.2% in March. Once Reserve Bank started cutting, it followed, slashing 1.5% off rates from August. Now at 8.7%. Total net drop of 1.29%.

ANZ and National Bank: Common ownership has meant common pricing. Started the year at 10.55% and ended it at 9.45%. Net drop of 1.1%.

Westpac: Started the year at 10.55%, but moved up to 10.69% in March, and again to 10.95% in May. From there it cut 1.5% once the OCR started to fall. Now at 9.45%. Net drop of 1.1%.

ASB: Started the year at 10.55%. Moved up to 10.75% in March. Has since cut to 9.45%, though was slow to get there. Net drop of 1.05%.

BNZ: Started at 10.55%. Moved up to 10.69% in March. Since then it has dropped to 9.75%. Net drop 0.8%.

TSB: Started at 10.25%. Moved to 10.5% in March. Has since cut 1.05%. Now at 9.45%. Net drop of 0.8%.

Source: GoodReturns