‘Big shock coming’: fixed-rate refinancers warned

A ‘large cohort’ of fixed-rate borrowers whose loan terms mature next year will face significant ‘repayment shock’ that ‘comes in one hit’, the Australian Prudential Regulation Authority (APRA) has cautioned.

Fronting the House of Representatives Standing Committee on Economics’ first public hearings (11 October), APRA was asked if it had noticed any discernible trends in loan defaults given the current rising-rate environment.

Outgoing APRA chair, Wayne Byres, gave initial hope when he answered “no”, but was quick to clarify the context of what many Australian mortgage holders might soon face.

“Short answer is no…”

“Well, I'm giving you a quick answer, but the sort of rates of customers who are in arrears is still actually drifting lower — which I don't think anyone thinks will continue any longer,” he explained.

“And when we… talk to the banks, they certainly think there'll be a reversal in the trend, but at present, the arrears rates are actually still drifting lower.

“So that's obviously pleasing, but probably not a situation that's going to last too much longer,” he added.

APRA deputy chair John Lonsdale proffered insightful statistics to outline the current and anticipated loan-lending situation.

“So the latest stats… from June, and we've got non-performing loans at around point 8 per cent, so that is historically very low, and as Wayne said, it has been drifting lower over the last 12 months,” Mr Lonsdale said.

“It's similar for housing, but for small business [it’s] slightly higher.

“If there's a pressure point, that's probably where it's beginning to show. These are aggregates that we watch very closely, as do the banks — not just the non-performing loans, but actually the surpluses that have been built up and, anecdotally, what we're seeing is that some of those surpluses, while they're still there, they're being drawn down a little bit more.

“So we would expect there to be some elevation as we go forward, but all be it from a very low base.”

Borrowers squeezing the budget to pay their loans

Asked by committee chair, Labor’s Dr Daniel Mulino MP, about the likelihood of their being ‘pockets of stress’ and what was APRA’s expectation that the pockets of stress are likely to coincide with pockets of rising unemployment, Mr Byres replied:

“Yes, obviously unemployment [is] a very significant driver because people… the history of Australian mortgage holders… is that while they have a job, they will keep paying, even if they have to squeeze their budget somewhat.”

“But there comes a point if you no longer have the income, you simply can't pay so unemployment is a key issue.

“When I think about the pockets, though, I think it will be there'll be people who had very low servicing capacity even at low rates; people who borrowed a very high rate, high debt-to-income ratios; and there will be people who took advantage of the very low fixed rates that were on offer in 2020, in the midst of the pandemic.

“Many of those will be sort of two and three-year fixed rate loans, which will over the next 12 months need to be refinanced.

“And for those people, there'll be a significant repayment shock as they have to refinance their fixed rates into higher rates, and the gradual increase in interest rates that variable-rate borrowers have experienced will come in one hit to those fixed-rate borrowers.

“So they're the sort of types of loans that I think will be particularly vulnerable.

“But across the entire borrower cohort, if there are areas of the country or communities or industries where there's a pick-up in unemployment, then that's obviously going to be a vulnerability, as well,” Mr Byres explained.

Pinpointing those most affected by ‘rate shock’

Questioned further if there was a specific geographic area of people coming off fixed interest-rate loans that would be most affected, My Byres answered:

“I don’t think we have the data that would [could] give it to you by geography, but there's no doubt that over the last couple of years, the share of mortgage borrowers — just general share — within the broader community of fixed rates has gone up significantly.”

“That served its purpose at present because those borrowers have been shielded, but… that will come to an end at some period of time…”

Mr Lonsdale commented: “In terms of aggregate, what we're seeing is like 23 per cent of new home lending in 2020 was fixed, and so that's quite a change from traditionally what was the case. We look at when those loans are actually maturing, as well.”

Prior to the pandemic, Mr Lonsdale explained that traditionally, the mortgage market was “dominated by variable rate lending”.

“So there's [some] much higher rate, as Wayne said, of people taking out fixed-rate lending at very low rates in 2020. And so we do have a good picture of when that maturity is in aggregate and around the middle of next year, my recollection is, that’s probably the peak of people coming off fixed-rate loans.

“If you can imagine them refinancing it at [a] significantly higher interest rate, whether that’s variable or fixed, that has the significance of being quite a big shock for those people.”

He clarified: “It’s 23 per cent of fixed rates over a period of two years.

“So if you go back before the pandemic, over 80 per cent of home loans were variable and that dipped to around, just looking at the chart, maybe half, 50 per cent, around July 21 — and that's up now to around 80 per cent. So, it was higher then went lower, then it's gone higher again.”

Marking the occasion with others

APRA appeared in front of the House of Representatives Standing Committee on Economics alongside the Australian Competition and Consumer Commission and the Australian Securities and Investment Commission, following the Reserve Bank of Australia three weeks earlier.

As the prudential supervisor of the financial services industry, APRA currently supervises around 2,000 institutions across authorised deposit-taking institutions (banks, credit unions and building societies), general insurers, life insurers, private health insurers, friendly societies, and most trustees of the superannuation industry. 

In total, these institutions hold about $8 trillion in assets for Australian depositors, policyholders and superannuation fund members. That amount is up by around one-third from just five years ago, highlighting that, notwithstanding the financial and economic ups and downs in recent years, the financial system has continued to grow strongly. 

The hearing was to formally discuss APRA’s Annual Report for the 2020–21 year.

[Related: Banks report lending growth amid rate hikes]