Mortgage Margin Outlook
The Swedish FSA (FI) has updated their quarterly analysis on changing mortgage margins versus typical funding costs. The analysis as provided by FI statistics seems to show the last 90-day mortgage rate new loan rate settings versus a benchmark composite funding cost from covered bonds, deposits and other funding for larger banks. As not to get into details about the analysis itself, we have taken note that the profitability margin as reported is decreasing. In fact, it has decreased all year. FI indicates that more transparency about customers is driving the reduced margin. Perhaps digging deeper into the typical drivers and recent rate and economic events, we might find that competition and positioning from rate movements has some role to play and in the future for margins.
Since FI’s analysis for last quarter ends as of September 30th, the impact from the largest 100bp rate increase on mortgages and funding has not impacted the figures yet. The next quarter’s analysis will incorporate that effect. So, we can also expect some more impacts to typical drivers.
Going back to what’s happened lately, mortgage margins have been decreasing as compared to the Riksbank reference rate. We ask why? Well, there is certainly more competitiveness from smaller and niche players. The smaller and niche players often focus and position their pricing more competitively to gain more volume. There are a number of mortgage brokers who reach out to customers and ask them if they want a better rate. For which customers will be more incentivized to shop around more as rates rise and they become more aware of their own budget impacts from inflation. This competitiveness in turn will potentially force the larger banks to consider reducing their pricing while still maintaining target profitability levels. Additionally, niche players are focusing on to better analyse customer credit scores and performance. In doing so, better credit analytics can improve and provide a more accurate score which increase the ability to more transparently price competitively speaking. It can also help understand your capital and stress requirements more accurately as well. However, we view banks are profit seeking organisations and will price where the market and peers allow them to attract target customers. So, rate moves enable banks to openly change their pricing strategy. With the recent 100bp rate move and possible future rate moves, banks and niche players can continue to position their pricing and better assess credit quality of their customer. Thereby, potentially reducing mortgage margins further as rates rise with increased competitive posturing. And let’s not forget that customers, regulators and the banks are concerned about affordability. This will increase the willingness for the customer to move banks if the rate is better somewhere else.
Not to forget the funding side of things, it seems FI infers that covered bond and deposit margins have not changed. Without being certain what we can say is that when rates rise quickly, historical bond spreads can also reduce as well. The theory is that bond investors see the yield rising and adjust their target invest returns and may not worry as much about a few bps changes in spread as they see their yields going up by 150bps very quickly. For example, a 148 yield increase can seem acceptable. However, this is not a certainty. Credit concerns with increased inflation, mortgage affordability concerns, can work the opposite way to increase spreads. It all depends on the player and the perceived credit quality of the institution issuing the covered bonds. So, let’s say that there is potential for funding spreads on covered bonds to increase in the future but some specific dynamics of investors and issuers need to be monitoring and considered.
For deposits, there are a number of high-rate providers and also very tight pricing for the large banks. With recent rate rises, customer with excess cash and worries about the equity markets, will certainly shop around. This can and most likely will force larger banks to adjust their pricing strategy for savings accounts. Thus, reducing margins on deposit products with increased competition on rate to attract customers. With rate moves, banks will adjust their pricing to maintain their deposit funding or increase deposit funding. With decreased equity investment opportunities, we could also see growth in the overall deposit market in Sweden. For which the banks can position to their pricing to attract volumes. Of course, cannibalisation of existing customers is always a concern but we are guessing the banks are interested in providing the customer with a fair return on their deposit.
Overall, the funding profitability margins have a potential to have further decreases for the banks but with possibility increased funding opportunities with deposits. This possible decrease in funding profit margins met with decreased mortgage profit margins may provide even more tighter overall profit margins for mortgage players in Sweden. Something that needs monitoring, a proactive strategy and will be realized now and in the near future.