Australia's major lenders may look beyond mortgage lending as the traditional growth engine shows sign of slowing, putting into question the sustainability of their earnings.

ANZ Group Holdings Ltd., Westpac Banking Corp. and National Australia Bank Ltd. delivered year-over-year increases in cash profit for the first half ended March 31. Commonwealth Bank of Australia, which operates on a different fiscal calendar, reported cash profit of A$5.16 billion for its first half ended Dec. 31, 2022, up from A$4.85 billion a year prior.

"I have called peak earnings and expect lower shareholder returns ahead, as some banks choose to lend more selectively," Martin North, principal at Digital Finance Analytics, told S&P Global Market Intelligence via email. "The most significant issue is the deep discounting of new mortgage loans, and the impact on margins. I note some banks now have stopped the cash-back offers on refinancing. This is a signal of pressure ahead — coupled with low volumes of new loans and margin pressure on deposits," North said.

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The four major lenders have said they will redirect capital and investment to their business lending segment as stiff competition in mortgage lending would offset any gains from their margins due to rising interest rates.

Australian banks have offered cash-back incentives and discounted rates to compete for a piece of the mortgage business. However, mortgage lending growth slowed to 5.5% in the fiscal year ended March 2023 from 7.9% in the previous year, according to Reserve Bank of Australia data, released April 28. The value of new loan commitments for total housing reached A$24 billion in March — the first monthly rise since January 2022, but still 26.3% lower compared to a year ago, according to May 5 data from the Australian Bureau of Statistics.

"Mortgage lending has never been more competitive, and while we have ceded market share, recent declines reflect the conscious decision to be disciplined, and this is not the right time to take back share," Westpac CEO Peter King said during the bank's May 8 earnings call. "I think with mortgages being so over-competitive, capital and funding will redeploy into the business segment."

National Australia Bank CEO Ross McEwan said market dynamics in home lending have changed as volumes slowed and interest rates increased. "Over the past six months we have seen this dynamic play out with returns on home loans falling below the cost of capital. And while home lending remains a core market for us, in this environment, we will continue to make choices which seek to balance returns and volumes," McEwan said during the bank's May 4 earnings call.

Finding alternatives

Commonwealth Bank indicated it is prepared to increase investment in areas other than mortgage lending. CEO Matt Comyn said during a Feb. 14 earnings call that the home lending market is undergoing a period of change, where cyclical slowing in new lending growth occurred at a time where wholesale funding costs increased.

"Cash-backs are growing in size and prevalence, and we estimate the banks have deferred costs related to cash backs of over $1 billion. This figure has increased almost 50% in the past two years and, combined with a substantial increase in commissions over the same period, creates a margin headwind that will flow unevenly across the market," Comyn said.

The major banks have also warned that margins may have peaked. While net interest margins at the banks grew year over year for the half, increasing competition is crimping margins. Comyn said during the earnings call that margins "have not returned to pre-COVID levels" and that margins may have peaked in October 2022.

ANZ CEO Shayne Elliott acknowledged that margin pressure "became more pronounced as the second quarter progressed." ANZ expects a longer-term trend of margin compression, Elliott said during the bank's May 5 earnings call.

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