Investors cautioned against rolling IO loans

Ensure your customers “have got the capacity and the cash flow” for not just the interest-only period, the Australian Prudential Regulation Authority (APRA) has reminded lenders, at the House of Representatives standing committee on economics’ first public hearing on Tuesday (11 October).

APRA was asked if there was any link between tightening investment loan criteria and now significant rental rates across parts of Australia.

Outgoing APRA chair Wayne Byres clarified APRA’s position, stating: “What we’ve done is to ensure that… ultimately loans need to be repaid, so it is important as banks make loans that they are thinking about a customer’s ability not just to pay the repayments during the interest only period, but also — at some point — to repay the loan.

“While I know there will be some investors who will say ‘well, my means of repaying the loan is to sell the property and pay the debt off’, it’s not good banking to be relying on that sort of practice.

“You should make sure your customers have got the capacity and the cash flow, so that has been our focus.”

Mr Byres clarified to the committee that while the regulator had not put any limit on the maximum term of a interest-only period (“there’s nothing in our guidance that says ‘thou shall not provide an interest-only period not more than x years’,” he said) - he said that banks should know extend for longer periods if they really thought it was good practice.

“My final point is just to make is that while we do require — because we think it is sensible practice for a bank to assess a customer’s serviceability for a loan on the basis of their ability to afford a principal and interest loan once the interest-only period is up,” he continued.

“There’s nothing that precludes the customer, when they get towards the end of that interest-only period, from rolling over their loan into a new interest-only loan, or refinancing into a new interest-only loan.

“The only requirement is simply that the banks will do a new credit assessment at that point to make sure that the customer can still… and has the circumstances and has the cashflow to afford a new interest-only loan.

“We are… wary of a suggestion that somehow there’s a blanket limit and people are locked in to a particular loan because that’s not the case,” he told the committee.

Who was borrowing during the pandemic?

In terms of what type of borrowers were seeking loans during the pandemic, Mr Byres explained that through 2021 and early 2022 housing loan commitments to owner occupiers were high and steady, but investors were the ones seemingly driving growth in new credit.

“So investors [were] coming back into the market, as I think [there was] maybe a sense the pandemic was over, or seemed to be the worst of it was.”

“Interest rates [were] still very low, housing prices were starting to accelerate... And so housing looked particularly attractive for investors at the time.”

He added: “Now the investor sector tends to have high levels of debt relative to income than owner occupiers, and so … they will behave differently, in terms of their response to high interest rates than maybe the owner occupiers, so there's behavioural differences there.”

Small business borrower challenges ahead

Mr Byres had earlier highlighted to the standing committee that while there was no discernible trend in loan defaults and arrears now, this was coming - and that a sizeable segment of fixed-rate borrowers whose loan terms mature next year will face significant ‘repayment shock’.

Asked how such an environment might affect small businesses (a highly varied segment) in this light, Mr Byres outlined that the pandemic had affected small businesses either positively or negatively, but now: “What we can see thus far as the story on small business is … arrears are higher than in housing already, so we start from a higher level of arrears. But at this stage, the data shows that they're not trending up yet,” he said.

APRA deputy chair John Lonsdale said: “With a couple more interest rate rises that we've seen, I think you'd expect that to move up as well.”

“In terms of new lending, the banks are saying, anecdotally, they're still lending.

“You know, there's money there to lend for good business opportunities, but for new business - like I think if you look at the credit growth numbers on small business - they are affected.

“That sort of says not just [the] non-performing ones, [but] the new ones actually coming in that are struggling as well,” he said.

Asked if APRA expected that segment's struggles to rise, Mr Lonsdale replied: “Yes, we would expect that to continue to rise.”

“We don't forecast it, but if you think that you can see credit growth starting to plateau, you can see interest rate rises starting to bite, you would expect that to continue - as a normal part of the cycle.”

[Related: ‘Big shock coming’: fixed-rate refinancers warned]