ANZ’S COMBO PLUS (COST OF FUNDS) PEG
What Is It?
Launched on 1 October 2015, ANZ defined this new mortgage loan peg as the average of the bank’s 3-month and 12-month cost of funds (COF) for the SGD rate (the bank also has COF for Aussie lending and deposits, etc) on the first business day of the month which will also be published on the bank’s website. All loans disbursed within the month will be set at this rate.
How Does It Work?
The key value proposition of Combo Plus is – the 12-month COF component in the peg is fixed for next 12 months, or in other words for the next 3 cycles of interest rate-setting.
Just like in the typical case of 3-month Sibor where most are familiar, the interest rate and hence the monthly repayment amount is always reset every 3 months for Combo Plus. However during each reset, only the new 3-month COF is factored in, as the 12-month COF component is held steady for the next 12 months, essentially giving it an effect of a “1-year fixed rate”. As a result, any rise in the 3-month COF is halved at every round rate-setting and the full effects of a rate increase will only come in a year later when both the 3-month and 12-month COF get adjusted to the prevailing rate, in the same way a fixed rate mortgage reverts to floating when the fixed term ends. We will use an example below to illustrate this.
Assuming the respective 3M and 12M COF (cost of funds) for ANZ Bank on the 1st business day of Jan, Apr, Jul and Oct are as illustrated above, this gives rise to Combo Plus rate (ave of 3M and 12M COF) of 1.38 for the month of January, 1.50 for the month of April and so on. Here we are also assuming an increase of 0.25% p.a. per quarter throughout the year for 3M COF.
Assuming one places fixed deposits of $150,000 and joins ANZ’s Priority Banking (they pay one of the highest deposit interest rate consistently anyway), his new Combo Plus Loan (at launch month of October 2015) starts off at Combo Plus rate +0.45 in Year 1, +0.60 in Year 2, and +0.75 thereafters. We will now use the spread of 0.45 for his 1st year to illustrate the “halving effect on rising interest”. Assuming his new loan is disbursed on 15th of January, hence Combo Plus rate for January will be used to set his interest for the 1st 3-month cycle (1.38+0.45 = 1.83%), and so on for the subsequent round of rate-setting in April, July and October. This is shown in the next chart.
Notice that although in our example the 3M COF goes up by 0.25% per quarter in rate hawkish environment, one’s final interest rate only goes up by half this increase, ie. 0.125% per quarter (from 1.83 to 1.95, from 1.95 to 2.08, etc) This is due to the halving effect of rising interest when holding the other 50% of 12M COF component constant throughout next 12 months.
How Does Combo Plus Benefit You?
In our opinion it does benefit borrowers in 3 ways.
1. JUST & EQUITABLE LOAN PEG
First and foremost, using the bank’s cost of funds (COF) for pegging one’s home loan, which will be published by the bank monthly on its website going forward, is a very fair basis for pricing mortgages. As the bank sources for SGD funding be it from retail deposits or borrowing from interbank using Sor or Sibor, it has every incentive to want to keep its overall COF low (remember the bank also lends out SGD for other loans besides mortgage). This is unlike pegging to say only one source of funding like fixed deposits per se for example. You do not know exactly how the bank’s Treasuries work in terms of funding strategies which might change course over time. Also pricing on COF means whatever spread the bank levies above this peg is truly how much the bank makes in terms of gross interest margin. Compare this to board- or sibor-based loans where the interest margin the bank makes is not so transparent.
One negative aspect though of Combo Plus peg, in our view, is the likely higher COF base of a foreign bank like ANZ as opposed to local banks flushed with SGD from their much larger branch network. However this might be mitigated by the lower-than-usual spreads offered by ANZ Bank especially in the first two years of the loan. Based on launch month October rates of 1.29 and 1.22 for Combo Plus and ave of 3M and 12M Sibor respectively, the difference in this “higher COF base” is only about 7 basis points which is very much acceptable.
2. “ULTRA-LOW” SPREADS
As explained above, to appreciate the true benefit of Combo Plus peg it must be taken together with it’s ultra-low spreads as a total package for borrowers. The bank is probably able to offer such low spreads especially in the first two years precisely because this is the bank’s “base line” in terms of funding costs. There is nothing to hide or “inflate” as profits hence giving it that “market-based” transparency, unlike board rate increases which is determined solely by the bank.
Even the “thereafter” spread from year 3 onwards is a low 0.75 (for Priority Banking clients). This is a discount of 50 basis points from the usual thereafter spreads of 1.25 for most Sibor packages. In fact even if you compare it with 3-month Sibor loans with constant spreads of 0.90 (lowest in market now) throughout the entire tenure of the loan, there is still a gap of 15 basis points savings which more than compensate for the highest cost base of ANZ Bank.
3. “50%” EFFECT OF A 1-YEAR FIXED RATE MORTGAGE
We have elaborated this point at length. The way Combo Plus peg works is akin to giving homeowners a 50% benefit of a 1-Year Fixed Rate Home Loan, yet without the need to be locked in at all. In fact one might not need to refinance so often after the lower promotional spreads end in two years as the thereafter spread at 0.75 is still relatively attractive especially for Priority customers of ANZ. This is what we like most about Combo Plus peg, just like DBS FHR peg.