06 Jul Commerical Borrowing Rates are Rising Faster than the RBA
A lot of enquiries are now coming through from savvy farmers and business owners who are seeking guidance or understanding as to why their interest rates are rising much faster than the RBA announcements.
At first glance the initial assumption being made by the borrower is that the banks are leveraging the opportunity to increase customer margins to accelerate their revenue and profitability.
This may be the case is some scenarios, but the answer is a lot more complex than this simple observation at first glance.
There are four possible explanations.
- Swap Curve + Cost of Funds
During the peak excitement of COVID, when the cash rate and yield curve flatlined at 0.10%, we all enjoyed variable rates benchmarked off the 90-day BBSY which skimmed around 0.12% for quite some time. A difference of just 0.02% or about one double shot almond latte per week. Enough time to rebrand our thinking that the variable rate simulated the cash rate and regardless of what loan product you were on.
We all drew comfort knowing that the borrowing rate was just the simple addition of the client margin and cash rate. Hence, if your client margin was 2.00% above BBSY, then your borrowing rate was 2.12%. Very nice indeed.
Fast forward to today, the cash rate is 1.35% and the 90-day BBSY is 1.91% equating to a difference of 0.56%. Hence, there is another 50-point rise in loan facility over and above the cash rate.
In addition, any requests for new money or facilities that have matured and need rolling over, will capture an increase in the treasury cost of funds. This is because the new term of the loan facility (3 years, 5 years, 15 years etc) is now costing more for the banks to provide to their clients on a variable basis than it did when the curve was flat lining. So new money will incur even higher charges. In boxing terms this is the old One Two, right on the chin.
- Reference Rate.
Remember the days when the banks used to increase the commercial lending rates when the RBA moved their rates? Everything seemed predictable and transparent. Now the banks move their rates when they need to respond to market movements to protect their Net Interest Margin (or profit).
They do this simply by setting commercial borrowers interest rates against a reference rate which is a meaningless rate by observation. When the banks need to lift all boats in the harbour, they do so by simply lifting the reference rate. You may get a letter in the mail explaining this (which gets tossed in the bin), or the banks make an announcement in the Australian Financial Review buried in pages amongst dry political journalism that no one reads.
To camouflage this activity further, they may raise the reference rate by odd indistinguishable numbers like 7 basis point, 9 basis points etc. Our limbic system (the part of the brain involved in our behavioural and emotional responses) will quickly dismiss this as immaterial and life charges on as normal. Bank wins, borrower loses.
Reference rates have risen across the banks, and they will continue to do so. It is a process of breaking it down on a case-by-case basis to understand the dynamics playing out with each particular loan, with the encumbered bank and specific client.
- Client risk profile
The annual review always recalibrates your risk rating. The result of an annual review is directly correlated to the interest rate you pay for your borrowings. In any instance where the risk rating deteriorates (and please do not be confused that a record gross revenue translates into an improved risk rating), then there will be definite pressure on your variable rates to increase.
Every business is mandated to make a profit. Even the business clients who borrow money from the bank’s operates under this mandate. So, we cannot discriminate the banks for their ability in manoeuvring the chess pieces to their advantage on an incremental strategic basis to achieve this objective.
It then comes down to the individual borrower to continually make astute investments in time and resources to counterbalance this activity pursued by the banks. It is not a difficult endeavour to do so, but the banks do rely on complacency in the market, and broadly noting that they leverage this trend very well indeed.
It is almost guaranteed that any borrower who has not paid attention to their borrowing structure (you can again blame the limbic system for rational decision making disguised as loyalty for an example) has adopted a very high probability position that they are paying too much for their debt capital.
Don’t blame the banks if you are paying too much for your funding, blame yourself – then action accordingly. We are here to help and enjoy the journey when you do!