CICC: How to Adjust Mortgage Interest Rates for Existing Loans?

According to the information obtained from the Zhongtong Finance APP, Zhongjin Securities has released a research report stating how to adjust mortgage interest rates. The bank predicts the following characteristics: 1) Targeted reduction of existing mortgage interest rates by "adding points" rather than a general reduction based on the Loan Prime Rate (LPR); 2) The "market-oriented principle" implies that the extent of rate reduction may not be uniform across cities, but rather based on the new lending rates formed by local market conditions. Therefore, the reduction in existing rates and the effect of replacing them with new loans will be equivalent. Third- and fourth-tier cities, where the new lending rates have a higher reduction, will experience a larger decrease in rates compared to first-tier cities, where the reduction will be relatively smaller; 3) The "replacement of existing loans with new loans" means that there is a possibility of interbank mortgage transfers (other banks replacing the current bank's mortgage with a new loan). However, the terms "in accordance with the law" and "in an orderly manner" indicate that the process of opening up may be cautious to avoid excessive competition between banks.

Event: On August 1st, the People's Bank of China and the State Administration of Foreign Exchange held a work conference for the second half of 2023, mentioning the "guidance for commercial banks to adjust personal housing loan rates in accordance with the law and in an orderly manner."

The central bank once again sets the tone for mortgage rate cuts. The bank believes that the statements made during this central bank work conference reaffirm the policy direction for adjusting existing mortgage rates. Previously, on July 14th, the central bank mentioned that for residential mortgage loans, "according to market-oriented and rule-of-law principles, it supports and encourages commercial banks and borrowers to autonomously negotiate changes to contract terms or replace existing loans with new ones." Based on the bank's understanding, "autonomously negotiate changes to contract terms" means allowing adjustments to the added points of existing rates through negotiations between banks and borrowers. "Replace existing loans with new ones" means allowing the replacement of higher-rate existing mortgage loans with lower-rate new loans. These two changes are expected to lead to a potential reduction in bank mortgage rates.

How will mortgage rates be adjusted? Although there is still uncertainty about the specific plan, the bank predicts the following characteristics based on the central bank's statements: 1) Targeted reduction of existing mortgage interest rates by "adding points" rather than a general reduction based on the Loan Prime Rate (LPR); 2) The "market-oriented principle" implies that the extent of rate reduction may not be uniform across cities, but rather based on the new lending rates formed by local market conditions. Therefore, the reduction in existing rates and the effect of replacing them with new loans will be equivalent. Third- and fourth-tier cities, where the new lending rates have a higher reduction, will experience a larger decrease in rates compared to first-tier cities, where the reduction will be relatively smaller; 3) The "replacement of existing loans with new loans" means that there is a possibility of interbank mortgage transfers (other banks replacing the current bank's mortgage with a new loan). However, the terms "in accordance with the law" and "in an orderly manner" indicate that the process of opening up may be cautious to avoid excessive competition between banks.

In line with the guidance of the Political Bureau meeting. On July 24th, the Political Bureau meeting mentioned "expanding consumption by increasing residents' income." Reducing the interest burden on homebuyers and increasing their willingness to consume by lowering existing mortgage rates is in line with the policy direction. Currently, bank mortgage rates are around 4.7%. Assuming a 70 basis point reduction in existing mortgage rates to a level of around 4.0% for new loans, based on a calculation of a 1 million yuan mortgage loan with equal principal and interest payments, the bank estimates that borrowers' monthly payments can be reduced by approximately 400 yuan (about 7%). The entire industry can reduce housing loan interest by about 300 billion yuan per year, which is equivalent to 0.7% of the total retail sales of consumer goods in 2022 if all of it is used for consumption; the savings in social interest expenses are equivalent to a 1.4-time (14bp) reduction in the loan prime rate (LPR).

Impact assessment on banks. Considering the uncertainty of the reduction ratio, the bank conducted analysis based on three hypothetical scenarios: 1) Assuming a 70bp reduction in 30% of outstanding mortgage rates, the bank estimates that it would have a -3bp/-1%/-3% (annualized) impact on the bank's net interest margin, operating income, and net profit in 2023, respectively; 2) Assuming a 70bp reduction in 50% of outstanding mortgage rates, the bank estimates that it would have a -5bp/-2%/-4% (annualized) impact on the bank's net interest margin, operating income, and net profit in 2023, respectively; 3) Assuming a 70bp reduction in mortgage rates for 100% of outstanding mortgage loans, the bank estimates that it would have a -9bp/-4%/-9% (annualized) impact on the bank's net interest margin, operating income, and net profit in 2023, respectively. In 2022, the proportion of mortgage loans in the entire industry/national banks/joint-stock banks/regional banks was 21%/28%/17%/13% respectively. The reduction in outstanding mortgages would have a greater impact on national banks with a higher proportion of mortgage exposure and a smaller impact on regional banks. Considering that the adjustment process may take some time to gradually implement, the impact on bank revenue may be relatively moderate.

Early repayment is also expected to decrease. The bank believes that this early repayment is a deleveraging behavior caused by the low expectations of household income and the decline in investment returns. After the reduction in mortgage rates, the interest rate differential between outstanding loans and financial product yields narrows, and the arbitrage space for using operating loans for refinancing is also compressed. The bank believes that early repayment by residents is expected to decrease. From an accounting perspective, early repayment by residents reduces both loans and deposits, reducing the bank's loan interest income and deposit interest expenses. The bank assumes a 2.5ppt interest rate differential between outstanding mortgage loans and deposits, and estimates the positive contribution of early repayment to bank revenue in three scenarios: 1) Assuming a 1ppt decrease in the early repayment rate, it would contribute +0.3bp/+0.1%/+0.3% (annualized) to the bank's net interest margin, operating income, and net profit, respectively; 2) Assuming a 3ppt decrease in the early repayment rate, it would contribute +1bp/+0.4%/+1% (annualized) to the bank's net interest margin, operating income, and net profit, respectively; 3) Assuming a 5ppt decrease in the early repayment rate, the bank estimates that it would have a +2bp/+1%/+2% (annualized) impact on the bank's net interest margin, operating income, and net profit.

It is necessary to lower deposit rates for hedging. In order to maintain a reasonable level of return on equity (ROE) and interest margin for banks to achieve the "2035 target," the bank believes that it is necessary to consider hedging the impact on bank profits through measures such as lowering deposit rates and using central bank's structural monetary tools. The bank believes that there is a downward space of about 20bp for the average deposit rate of banks in the next 1-2 years. Without considering the impact of deposit liquidity, it is estimated that a reduction in deposit rates can save the bank's liability costs by about 700 billion yuan, contributing positively to the net interest margin, revenue, and net profit of listed banks by 17bp/8%/16%. New mortgage interest rate floor is expected to be lowered. The central bank also mentioned at the meeting that it will "continue to guide the downward adjustment of personal housing loan interest rates and down payment ratios." The wording of the down payment ratio adjustment is consistent with the statement made by the Ministry of Housing and Urban-Rural Development on July 27, which is in line with expectations. The wording of "guiding the downward adjustment of personal housing loan interest rates" exceeds expectations. The new mortgage interest rate is determined by "LPR + spread," with the spread following the national minimum interest rate regulations issued in May 2022 and the phased relaxation of interest rate floors introduced in September 2022 (changed to a long-term mechanism by the end of December 2022 [). The specific regulations are as follows: 1) The national minimum interest rate for first-time homebuyers is LPR minus 20 basis points, and for second-time homebuyers, it is LPR plus 60 basis points; 2) Cities where housing prices have declined on a month-on-month and year-on-year basis for three consecutive months are allowed to lower or cancel the local minimum interest rate for first-time homebuyers. The bank believes that the central bank's new statement implies that if LPR remains unchanged, there may be adjustments to the relevant regulations on the new mortgage interest rate floor in order to guide its downward adjustment. The specific form may be a nationwide reduction in the minimum mortgage interest rate or a relaxation of the requirement to cancel the interest rate floor in certain cities, expanding the scope of cities where the interest rate floor is canceled.

The impact of lowering existing mortgage rates on banks is limited. Overall, although the downward adjustment of existing mortgage interest rates may have a certain impact on bank profitability, the reduction in prepayment and the potential downward adjustment of deposit rates are expected to fully offset the negative impact. The adjustment of existing mortgage interest rates also reflects a clear policy orientation towards stable growth. Considering the stimulating effect on the macroeconomy and consumption, the negative impact of lowering existing mortgage rates on banks is limited. Taking into account the market's previous expectations for a reduction in existing mortgage rates, the valuation still being at historical lows, and the expected support from future growth-stabilizing policies, the bank maintains a positive view on bank stocks.

Risk Warning: Uncertainty in policy implementation may lead to measurement errors.