MANAGING OUR “MARGIN” SQUEEZE

Companion recently advised our mortgage borrowers that the interest rate on their home loans was decreasing by half of one percentage point (or 50 basis points to use the financial jargon). This reduction was in response to the RBA’s easing in monetary policy last week by reducing the official “cash rate” by 100 basis points.

The reason we only reduced mortgage rates by 50 basis points is because that’s all we could afford!

Companion is basically in the business of financial intermediation – we attract deposits from members who wish to save or invest, in order to lend money to members that have a need to borrow. The difference between the interest we pay to our depositors and the interest we charge our borrowers is what we call our Interest Rate Margin or “Margin” for short.

And because of the current crisis affecting the global economy and the attempts by the RBA to reduce the impact on Australians of a world wide “recession”, our Margin at Companion has taken an absolute pounding over the past 4 to 5 months. This is primarily because a substantial part of our loan book is funded by Fixed Term Deposits, the majority of which will not reprice for 7 to 10 months from now. In other words, we are locked into paying some depositors an interest rate that was set last year, at a time when the RBA cash rate was 400 basis points higher than it is now. The speed with which the RBA has been cutting rates is unprecedented, reflecting the severity of this global economic meltdown, and compounding the affect on our Margin.

Companion is not alone in this Margin squeeze and in my view it is only a matter of time before other lenders like Companion have no option but to limit their rate decreases to something less than the RBA’s official cash rate movement, at least until margins return somewhere closer to normal.

Indeed in today’s Australian Financial Review, the Chief Executive of the Commonwealth Bank, Ralph Norris, has signalled that the CBA “is unlikely to pass on future interest rate cuts in full”. This announcement comes on the back of National Australia Bank’s CEO Cameron Clyde issuing the same warning in the press last week, saying that NAB would not be able to pass on future rate cuts in full because of the increase in the NAB’s cost of funds, which is squeezing their “margin”.

Unfortunately because of the size and impact of our margin squeeze, Companion has had to respond earlier than others, despite our absolute desire to do otherwise. Despite our action, in my view our mortgage products are still quite competitive relative to comparable products in the market.

Ray O’Brien
Chief Executive

February 12th, 2009 | 2 Comments »