Six ways ‘Mercedes’ mortgages could hurt Australia

But Mott puts real meat on the bones, revealing that since the end of the pandemic, there are now twice as many owner-occupier mortgages written to households with income above $200,000 than to households with income below $100,000. For reference, the median household income in Australia is about $115,000.

Further, there are now half as many owner-occupier mortgages written to households with income above $500,000 (that is, the top 1 per cent of households) than there are to households with income below $75,000 (the bottom third of households by income).

Small-to-medium enterprise lending has changed too. Loans are increasingly available only to entrepreneurs who can put property up as security. Fully secured SME lending, which makes up 77 per cent of all SME bank loans, has grown at a compound annual rate of 6 per cent over the past five years. Unsecured SME lending has grown at a CAGR of just 1.7 per cent.

Four driving factors

What’s driven this? Mott says it is a combination of four structural factors: the Basel capital rules encouraging fully secured, low loan-to-value lending; macroprudential tightening introduced as house prices have surged; responsible lending laws; and the broader conservatism after the banking royal commission.

The transformation of banks into mortgage factories has been compounded by their failure to grow in other ways. International expansion hasn’t worked, and they’ve largely sold off their wealth businesses. Increasingly, Mott says, the banks look like each other.

The commoditisation of the sector is underscored by their decision to, in effect, outsource their distribution to mortgage brokers. Such brokers sell more than 70 per cent of home loans, ripping about $4.2 billion in commissions out of the sector’s profit pools each year and forcing the banks to compete on price.

The impact of the banks’ loss of pricing power and shift to structurally lower returns has been well documented. Net interest margins have come down from 2.94 per cent at the start of the century to about 1.8 per cent. Return on equity has fallen from a peak of 19.7 per cent in 2008 to about 10.7 per cent. Mott puts the cost of capital for the sector about 10 per cent.

He expects NIMs and ROE to keep falling, even after a brief period of stabilisation towards the end of this year. With the banks trading at a hefty premium to the average valuations over the past five years (individual premiums range from 12 per cent to 21 per cent, according to Macquarie) Mott’s analysis of the longer-term outlook for the sector should give investors pause.

Six problems from de-risking

Like most of the analyst community, Mott believes the market is too optimistic on the sector in the short term. But zoom out, and we see longer-term challenges.

The questions shareholders need to ask are: What will realistically change to reverse these structural changes? Can we really expect macroprudential settings to ease with house prices so high? Will the Basel regime be changed to reduce the incentive to write mortgages? Are responsible lending laws really likely to be relaxed? Are banks likely to be game to try to step back from the broker market?

The potential for bank returns to keep falling is one of six problems Mott sees from the great de-risking of the sector.

Lending becomes increasingly concentrated among high-income earners; Housing affordability gets worse due to sustained supply shortages; SMEs and start-ups that don’t have a house to secure their loan will be starved of capital; given the role that small business plays, the economy becomes less dynamic, weighing on growth, wages and employment; and more borrowers are pushed into the riskier shadow banking sector, such as buy now, pay later, and private credit.

“Banks are there to take risk via allocating capital to businesses and households and generate an economic return for shareholders,” Mott says. “If banks are forced to continue minimising risk, returns will continue to be competed away and capital will not be efficiently allocated to the economy.”

Who will swing the pendulum back?

The question Mott leaves unanswered is who will take the lead on swinging the pendulum back?

Bank CEOs are starting to more openly discuss this structural shift, but will probably be accused of talking their own book. The prudential regulator has often described this as a high-risk period for the sector, and not without justification given house price growth.

Will the increasingly interventionist Albanese government be prepared to push for change given that its traditional heartland of working families is most at risk of being frozen out of the mainstream banking sector? Or is the prospect of being seen as giving the banks approval to take more risk simply too unpalatable from a political perspective?

NAB’s McEwan was fond of saying the basics of banking haven’t changed for centuries. But Mott presents a powerful argument that the overall sector has changed dramatically in the past decade – and there are real consequences to that.