Major banks ‘playing with fire’ by encouraging churn

“Encouraging churn through a widening pricing differential between the front-book and back-book via discounting and repricing is playing with fire,” the report said.

“As the largest player in the market, CBA actually have the most to lose by pushing above-system growth in mortgages through a discount strategy. While they gained share for a period of time, the inevitable price-matching by peers sees increased churn across the back-book (which CBA has the biggest share of),” it said.

The problem with encouraging churn is that it increases retention and origination costs, an issue that has been exacerbated by the popularity of the broker channel, according to the report.

“With increased broker usage, notification of rate moves to borrowers is now more rapid than ever,” it said.

“On Digital Finance Analytics (DFA) estimates, about one quarter of the mortgage book churned in the last 12 months begs the question whether this is productive or not.”

The report questioned whether the actions of the big four were “irrational” or a conscious attempt to squeeze their smaller competitors.

It noted that CBA’s price-led strategy to utilise “cheapening” deposits to grow home loans above system saw a heightened degree of price-matching by the other major banks to retain market share.

“Regional banks and smaller players were largely forced to sit on the sidelines as they were unable to match the cost of funds, or efficiency (both operational, and on regulatory capital), of the major players, and therefore unable to match front-book pricing.”

The report made some interesting observations about last year’s rate hikes, kicked off by Westpac in November. While the majors cited additional capital requirements as the primary reason for the re-pricing of their variable rate home loans – with increases ranging from 15 to 20 basis points – JP Morgan suggests that the majors actually used the additional funds to increase their dominance of the Australian home loan market.

“Effectively, it is as though the industry saw the November 2015 re-pricing as a war-chest to go and buy market share through bigger front-book discounts, rather than remaining disciplined on price to preserve ROEs.”

However, the report does note that in recent weeks pricing dynamics have improved, highlighting that average front-book discounts have been wound back by roughly 20 per cent in recent weeks, with changes being communicated to the broker community.

[Related: Westpac closing branches as brokers take over]