Can non-banks fill the interest-only gap?

Interest-only loans fell sharply to 30.5 per cent in the June quarter as the banks reacted to APRA's cap, which has potentially opened the door for smaller competitors.

APRA's cap on interest-only (IO) lending flow is clearly starting to take effect with the June quarter numbers showing that banks' reported 30.5 per cent of mortgage approvals were for IO loans – down from 37 per cent over the last 12 months.

The figures support data released by Westpac last week which showed home loan customers are swapping out of expensive IO loans into principal-and-interest deals much sooner than the market expected.

Of the major banks, Westpac has the largest proportion of interest-only mortgages - about 50 per cent of Australian mortgages whereas the other three majors have closer to 40 per cent. However, the lender has slashed interest-only loans to 44 per cent in the June quarter, down from 52 per cent in the March quarter.

“This is the lowest percentage of IO approvals since the Financial Crisis. However, in absolute terms IO lending is only back to March 2016 levels,” said UBS analyst Jonathan Mott in a client note on Wednesday.

“That said, it is worth noting that this approvals data is not consistent with the 30 per cent APRA cap, and it is likely the banks still have work to do to get under their Macro Prudential limits - APRA's cap is broader, based on drawdowns (not approvals) and includes bridge facilities, construction loans, lines of credit and limit increases.”

Mortgage repricing

There has also been discussion in the market as to whether the non-banks can fill this IO demand gap left as a result of the APRA caps.

“We do not believe this is the case. Over the last 12 months, the ADIs approved $385bn of mortgages,” said Mott.

“If IO approvals need to fall by $35bn to meet Macro Prudential caps we do not believe the non-banks have the funding capacity via warehouses, RMBS, private investments or other means to fill this gap. Further, the regulators reportedly appear likely to extend their umbrella to capture such flows given the risk to Financial Stability.”

Further, ADIs have been consistently reducing high LVR loans over the last two years with loans with LVR above 90 per cent reduced to 7 per cent of approvals from 12 per cent in December 2014. Loans with LVR between 80 per cent and 90 per cent have stayed relatively consistent over this period at 14 per cent.

“From an earnings perspective the outlook for the banks has improved,” said Mott. “Mortgage repricing has come through offsetting the Bank Levy, asset quality remains sound and the pressure on capital has subsided.

“However, we think the medium-term outlook remains challenged given the highly leveraged consumer, limited household income growth, Sydney and Melbourne housing bubbles and ongoing political and regulatory pressure. This, in our view, is likely to prevent any sustained recovery in share prices.”


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