KPMG predicts fresh outbreak of mortgage rate lending wars

Thousands of homeowners whose fixed rate home loans come up for renewal this year stand to benefit from another outbreak of the mortgage rate war between the major banks, accounting firm KPMG says.

However, with their interest margins already painfully thin, a leading economist says banks may instead choose to compete in other ways to grab market share.

In its annual Financial Institutions Performance Survey, KPMG said despite the major banks increasing their total assets by 13 per cent last year, their underlying performance rose by just 5 per cent.

KPMG deputy chairman of financial services, Godfrey Boyce, said that was due to contraction in the interest rate margin earned by banks on their lending. The interest margin is essentially the difference between the interest paid by banks on money they borrow and the rate they lend it out at.

Across the major banks the interest margin contracted from 2.64 per cent to 2.46 per cent during 2005.

"This reflects intense competition across the banking sector, pressure on mortgage books, and the continued switch from floating to fixed mortgages," said Boyce.

The BNZ-instigated mortgage war which began in late 2004 has seen interest margins shaved to levels not seen for five years.

While in recent months there has been something of a truce between the major players, a hefty proportion of existing fixed-rate mortgages come up for renewal later this year.

"On the face of it, this provides an opportunity for the banks to improve their interest margins with borrowers moving onto floating interest rates," said Boyce.

"But there's likely to be considerable bank and mortgage broker activity to attract these borrowers away from their current bank to a lower rate mortgage - in other words, a new phase of the mortgage war."

Boyce said interest rate margins were likely to be reduced a little from where they were currently, but that reduction was likely to be smaller than those seen in previous skirmishes. "I don't think the banks can take the same level of pain as they took through 2004 and 2005."

Boyce estimated the reduction would be in the order of five or six basis points or 0.05 to 0.06 per cent. Floating mortgage interest rates would remain indexed to bank bill rates.

But Victoria University associate professor of economics and finance John McDermott said the banks were close to as low as they could go on interest rate margins already.

"It's hard to know unless you're an insider whether five or six basis points can be shaved, but in late 2004 we saw the margins get to a level where the return on investments for those products simply didn't make sense and they've edged back upward again.

"We might see ebb and flow coming through the market and that would be quite normal but whether we'd see wholesale discounting ... it wouldn't seem to be in any single bank's interest to do it ... they already understand what the response would be from the other banks."

McDermott believed competition for market share would take different forms including more intense marketing or even service improvements.New Zealand incorporated banks* underlying 2005 performance:

Total assets up 13.4 per cent

Operating income up 4.3 per cent

Net profit after tax up 4.7 per cent

Ratio of operating expenses to operating income 46.8

* including Westpac