S&P Global shares latest forecasts
Prime and non-conforming residential mortgage-backed security loan arrears have already started to rise – and this trend is expected to continue as interest rate rises flow through, according to S&P Global Ratings.
At an Australia New Zealand structured finance webinar on January 31, facilitated by S&P Global managing director and analytical manager structured finance ratings Kate Thomson, analysts discussed a range of topics, including an expected rise in RMBS loan arrears, fixed rate rollovers within the RMBS market and the wider economic outlook.
RMBS loans are described as being funded by a securitisation and constitute 10% to 12% of total residential mortgages outstanding in Australia, S&P Global confirmed.
The webinar followed confirmation of Australia’s credit rating of AAA (long-term) and A-1+ (short-term) on January 30, in which S&P Global said the long-term AAA rating was “stable”.
S&P Ratings said it expected Australia to avoid recession and expand over the next three years: a reflection of low unemployment (3.5% in the December quarter) and high commodity prices.
Responding to the affirmed rating, Treasurer Jim Chalmers said despite the challenging global environment, the report highlighted the country’s historically low unemployment, elevated commodity prices and “the beginnings of wages growth” after decades of stagnant wages.
S&P Global director structured finance ratings Erin Kitson (pictured above left) described the return of immigration as a “silver lining” for lenders.
“This will lead to increased home loan demand in the coming years, as new migrants embark on their home ownership journey,” Kitson said.
Commenting on the likely impact of interest rate rises on the structured finance sector (with a focus on RMBS) Kitson said non-conforming arrears were already rising, and prime arrears had also started their ascent.
She also noted that there were likely to be differences in arrears performance across loan originators, and that older transactions were generally less exposed to arrears increases.
“Non-conforming arrears started their upward arrears journey in the second half of last year, and prime arrears are [up] in quarter four,” Kitson said.
Arrears expected to advance from mid-2023
S&P Global expects prime arrears to increase meaningfully in quarter one, and Kitson said that more advanced arrears were “unlikely to surface until the second half of this year”.
“Given the low seasoning of the non-bank sector, we are expecting arrears increases to be more pronounced here, but off very low levels, as non-banks in the prime space have been at the lower end of the arrears spectrum for some time,” Kitson said.
On the positive side, redraw capacity and a build-up in offset balances are expected to assist borrowers, she said. Kitson also said she expected credit support build up across many transactions to assist in moderating the level of arrears across the board.
“Lower exposure to fixed rate loans and first homeowners across the RBMS sector may afford some protection to transactions, but larger loan sizes in recent transactions do add risk,” Kitson said.
Within the non-conforming sector, where arrears had started to flow through first, a review of around 44 transactions showed arrears were more pronounced where borrowers had prior credit events.
“As the non-conforming sector is a specialist lend, I think underwriting standards will be a key arrears differentiator here,” Kitson said.
Property price falls may push up arrears in NSW
Compared to other states within Australia, arrears in NSW had typically sat at the lower end of the spectrum. This reflected its larger, more diverse economy and resulting increased job mobility, and strong property price growth, Kitson said.
Property price declines in Sydney could start to affect more indebted households, pushing up the arrears level, she said.
“This position may be altered over the next 12 months as more overstretched borrowers (particularly new homeowners with limited equity build-up) have to contend with rising mortgage repayments and falling home values,” Kitson said.
Fixed rate mortgage roll-off exposures considered low
Commenting on the roll-off of residential fixed rate mortgages in Australia, S&P Global noted the largest portion were due to roll off in the second half of the fiscal year (October to March). Kitson said fixed rate exposures for RBMS were around 16%.
“For non-bank transactions (non-bank issuance has been the dominant form of issuance in the last few years), fixed rate exposures are very low,” Kitson said.
“We are expecting arrears pressure in the second half of the year but in terms of how that’s likely to trickle through and cause ratings pressure, probably not so much in this space, because the volume of those loans is not as significant compared to the broader mortgage market.”
More widely, interest rate roll-offs would likely have impacts across pre-payment behaviour across originators, as lenders gear up for the heightened refinance period, she said.
“We think there’ll be a bit of a jump in the short-term in pre-payment rates as a result of that, but probably less noise on the arrears front given the exposure to fixed rate loans across this sector is not significant.”
Economic growth expected to slow in 2023 and 2024
S&P Global senior director and sector lead, structured finance ratings Narelle Coneybeare (pictured above right) said the broader economic outlook was mainly positive. This was despite the expectation of slower growth in Australia, which S&P Global forecasts show will reach 1.5% in 2024 (ending June 30).
Unemployment in Australia (3.5% in the December quarter) is forecast to average 4.2% for the year, which Coneybeare said reflected the forecast of a slowdown in economic activity, and normalisation in labour markets as immigration resumes.
“Growth is expected to slow this year and into 2024 and that’s after some very strong conditions in 2022 … our GDP expectations for Australia are 1.7% for this year,” Coneybeare said.
Wage growth is expected to become more apparent over the year in Australia, she said. She also noted how wage growth could influence inflation which may delay efforts to bring inflation back within the RBA’s 2% to 3% target range.
“Generally from a collateral performance perspective for borrowers, we see wage growth as a positive trend generally,” Coneybeare said.
Property prices are expected to continue to move downwards in 2023, and S&P Global’s view is that the peak-to-trough movement will be around 15% to 20%, she said.
Do you envisage a significant increase in mortgage arrears this year? Share your thoughts in the comment section below.