Risky mortgages to drop by $36 billion

Following the clampdown on interest-only mortgages a couple of weeks back, new figures reveal that the big four banks will collectively see a $36 billion drop in approvals for this type of home loan.

In a bid to cool the hot property market, the prudential regulator introduced measures that capped these mortgages at 30 per cent of new home loan business.

Australia’s heavy use of interest-only home loans is underlined by Morgan Stanley's numbers, which showed that these loans have made up 38 per cent of the major banks' new home loan approvals for the past seven years.

Remarkably, the interest-only share of residential mortgages jumped to 44 per cent in 2015 before easing back to 39 per cent in 2016 due to the speed limit on investment property loans. 

At the same time, loans with a loan-to-value ratio of 90 per cent still make up 9 per cent of approvals, the investment banker noted.

All else being equal, Australia Prudential Regulatory Authority's limit will lead to a 12 per cent fall in new loans, although the credit squeeze won't be as large if more borrowers choose to repay principal on their loan, according to Morgan Stanley analyst, Richard Wiles.

Assuming no increase in principal and interest repayment loan approvals, the major banks new investor-only loan approvals would need to fall by $36 billion to $77 billion in 2017, back in line with the 2009 to 2012 levels, which were between 32 per cent and 37 per cent respectively.

“In practice, we would expect a pick up in principle-and-interest loans so the contraction in credit is unlikely to be this large," said Wiles.

Re-pricing tailwind

The analyst noted that every 5 per cent or $8 billion increase in new principle-and-interest approvals would allow an extra $4 billion of new interest-only loans. All up, Wiles is expecting the big four lenders to experience a back-book re-pricing tailwind and a front-book headwind.

“All else equal, we estimate that variable rate re-pricing since the start of the year adds 2 per cent to the major banks' revenue on a full year basis," he said. "However, we think the mix shift towards principle-and-interest loans could dilute some of this benefit over time, while a potential slow-down in investment property loan growth could lead to more discounting on new principle-and-interest loans."

Seperately, TD Securties analyst, Annette Beacher, noted that the latest semi-annual Financial Stability Report mentions ‘interest-only’ lending 17 times, earning a special analysis box. 

The prior report mentioned ‘interest-only’ four times. She has concluded this report is a not-too-subtle threat against rising ‘risky’ investor mortgages.   

"Recent regulatory policies mean well but are poorly targeted, as interest-only macroprudential policies leave the bulk of mortgages unaffected, and hence doesn’t dent the relentless rise in owner-occupied household debt," she argued.

"Whilst cooling investor appetite for housing is welcome, a change in the tax laws would be a far more effective way to eliminate the appetite for interest-only investor loans.

"We see record owner-occupied household debt being a far bigger threat to macroeconomic stability down the track."

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