The decision by National Australia Bank Ltd. (ASX: NAB) to break from the pack and lift rates on interest-only loans will likely cost it market share but is likely to yield more positive than negative outcomes.
The market might just be waking up to this fact as NAB's shares recovered from an early fall to trade 0.15% higher at $33.96 when the finance sector is trading 0.3% in the red.
The bank said it would lift interest rates by 29 basis points, or 0.29 of a percentage point, on interest only mortgages and lines of credit from August 10.
Interest-only loans are used by investors and owner-occupiers and the decision follows Australia and New Zealand Banking Group's (ASX: ANZ) and Commonwealth Bank of Australia's (ASX: CBA) move to lift rates on investor property loans only.
Westpac Banking Corp (ASX: WBC) would like to follow ANZ's and CBA's move but the Australian Financial Review reports that a computer glitch is preventing Westpac from discerning between investors and owner occupiers, and the blunder is costing Westpac $1 million a day in opportunity cost.
While NAB's decision could prompt some homeowners to switch to another bank, NAB's profit increase from an expanded margin will likely more than offset any ceding of market share.
The fact is interest only loans make up 35% of its lending book with line of credit constituting about 12% of the book. This means the 29 basis point rate increase will have a positive impact on 47% of NAB's book compared with 30% of ANZ's and CBA's book that will be affected by their investor property loan rate decision.
Analysts have upgraded NAB's valuation by around 3% on average even after accounting for customer attrition but there are other positives for the bank that are not captured in the valuation uplift.
The first is that net margins could actually expand further should the Reserve Bank of Australia (RBA) decide to cut rates again over the next two months as most economists are expecting.
Any lowering of the cash rate will probably not be passed on (at least not in full) to NAB's interest-only borrowers and that could add another 1%-2% to the bank's earnings per share.
Further, NAB is derisking its loan book by more than its peers as interest only loans are seen to be riskier under new global banking regulations that dictate capital adequacy ratios for financial institutions.
Lastly, NAB's move (along with CBA and ANZ) indicates a return to more "rational" competition. NAB had been aggressive in its pricing of products as it tries to win market share.
There's no doubt that the headwinds are building against the banking sector, but I think NAB still looks attractive from a valuation perspective with an undemanding 2015-16 price-earnings multiple of 12.5x and yield of around 8.5% when franking credits are included.
