Interest Rates Have Dropped – So What?
Home lending interest rates have dropped, and I am left wondering whether we should breathe a sigh of relief that this is the end of interest rate hikes or be cynical and assume that this is a simple marketing ploy by banking marketers who have had the heat put on them to lift borrowing enquiry.
Banks are like cats. They will dart away at the slightest of concerns, but treat you like their best friend when it’s feeding time. Understanding banking drivers may be the best way to understand what is happening here.
Act 1 – The Scaredy Cat
Let’s remind ourselves that banks are made up of credit, the money makers/ relationship people, and the exec team who are ultimately responsible to shareholders for profit.
Credit are responsible for managing risk. They hold a lot of power in a bank. At a transaction level, if they do not like a deal, they can scupper it. At a more strategic level, if they see a storm coming, they can batten down the hatches, which equates to changing lending criteria and thus limiting how much is lent.
In recent times the exec teams have probably quite rightly taken the advice of credit and to some extent ‘closed up shop.’ Certainly, most banks have had a policy of ‘no new to bank’ lending. If you are not an existing customer, you will struggle to get lending from a bank you do not have a relationship with.
On the commercial lending front, times interest covenants have come under pressure. Commercial borrowers will typically have a covenant on the loan that says the profits must be least 2.5 times the interest bill. With interest rates quickly rising, many businesses and commercial property investors have started to breach their covenants. That means, regardless of how much equity there might be in a deal, the borrower has been ‘nudged’ to sort things out, which often means repaying some debt.
On the property development front, what bank would blithely lend to a residential developer at the moment? Sales volumes have dropped considerably.
What all this probably means for the last several months, I suspect, is that across residential and commercial property lending, the amount of money being repaid is much higher than the amount of money being lent. That in turn means that banks have cash on hand that is earmarked for property lending that is sitting in the safe…not earning anything.
So, the cat has been darting from borrowers in fear of the impact of inflation, higher interest rates, potential recession.
Act 2 – The Hungry Friendly cat
Our cat drives me nuts. If I drop something she will get a fright and scamper out the cat door and beeline to the garden. If I then open some salmon, she will smell it and come slinking past me , pretending she does not know I am there, but somehow manages to rub my leg. If a cat is hungry the fear ebbs away.
Act 1 was credit banging the buckle up, here comes the storm drum. Act 2 is the exec team looking at their full year forecasts, and thus impact on their bonuses and saying, ‘this won’t do, you can’t get a return on money sitting in the bank’.
That calls for creativity. That is what they are paid for. What we know is that the swap rates are coming down from 2 years onwards. They have been doing that since June. That means the cost of their funding for those time frames is getting cheaper. So that, theoretically, justifies bringing down retail rates for the same time period. That will help stimulate the residential market.
What about commercial? Well, relax times interest cover ratios and that will help sign off more commercial property deals. And that is what we are now seeing – banks enticing us with cheaper rates and more relaxed covenants. That has been reinforced, anecdotally, with relationship managers letting customers know they are open for business.
Act 3 – Sleeping Cat
Cats most of the time sleep. They do not like a fright, and they are really a bit too regal to be schmoozing up to people for food. Most of the time they keep to themselves.
After this flurry of rate drops, I suspect we will see a period of slight change. That is, I suspect the rate drops are more about feeding the bottom line, rather than an indication of a trend of rate decreases back to the good old days of 2% rates.
I hope I am wrong; I hope that rates will glide ever downwards. What makes me think it will not happen this year is:
- Inflation has not yet started receding
- The job market remains incredibly tight – i.e. in a lot of sectors it is difficult to find staff. I went to the pharmacy today at 3pm and it was closed due to lack of staff
- I suspect the rate decreases do not signal the start of a downward trend
- We may be approaching the peak of inflation/ interest rate hikes
- The interest rate peak may not be as high as previously forecast