Rising interest rates to squeeze borrowers

Arrears to spike but defaults kept in check, says S&P Global

Rising interest rates to squeeze borrowers

Prime residential mortgage arrears are at record lows, but the squeeze on borrowers is coming, with a rise in arrears expected to kick in from the third quarter, S&P Global says in its latest quarterly report.

Economists previously told MPA that there is around a three-month lag before changes in the official cash rate flow through to variable rate mortgages. With 250-basis points of official cash rate hikes so far this year, indications show borrowers would start to feel the pinch by Christmas.

According to the S&P Global RMBS (Residential Mortgage-Backed Securities) Performance Watch Australia report released in October, arrears hit a post-GFC low of 0.64% in Q2, 2022.

The report captures data on “pools of mortgage loans” issued by financial institutions, including the big banks, and non-bank lenders.  RMBS pools make up almost 10% of home loans issued in Australia, S&P Global confirmed.

Read next: When will home repayment buffers run dry?

Given interest rate rises and the high proportion of variable rate loans in the RMBS sector, the ratings provider expects arrears to rise in the third quarter, with “more advanced arrears unlikely to surface until 2023”.

But despite mortgage stress being inevitable for some borrowers, low unemployment and rising wage growth are likely to temper the transition from arrears to defaults, S&P Global said in the report.

S&P said it expects strong competition for prime-quality borrowers to drive up prepayment rates over coming quarters.  This will come as lenders brace for a strong rise in refinancing activity, with the upcoming roll over of many ultra-low fixed rate home loans, it said.

According to the report, non-bank outstandings now make up “just under 50% of prime loan outstandings” (excluding non-capital market issuance), with the remainder made up of major banks (18%), other banks (17%), regional banks (11%), and non-banks financial institutions (4%).

Prime non-bank arrears are at a record low 0.29% (Q2, 2022), and non-bank arrears have fallen at a faster rate than their prime peers, it said.

S&P Global Ratings director, sector specialist research, structured finance Erin Kitson (pictured above) said banks had pulled away from securitization markets in recent years, because they could access cheaper funding through the RBA’s term funding facility.  

“New issuance levels have declined compared to the first half of this year when issuance was very strong. This reflects higher funding costs and volatility in markets driven by global events and monetary policy tightening,” Kitson said.

The decline in non-bank arrears reflects several factors, she said.  These include the typically lower seasoning levels in the non-bank sector, larger exposure to investor loans, which typically demonstrate lower arrears due to the greater income-servicing capacity of many investors, and general strengthening in loan underwriting criteria since the financial crisis,” Kitson said.

Additionally, compared to the broader prime RMBS market, non-banks tend to have slightly lower exposure to non-metropolitan areas, she said.

“This has insulated them a little more from some of the higher arrears in regional areas impacted by the downturn in mining investment, drought and other localized events where the impact on debt serviceability can be more pronounced due to less diversity of employment,” Kitson said.

S&P Global said it expects house prices to fall up to 18% from their peaks over the next 12-18 months.  The modest LTV ratio profile of most RMBS transactions would provide a buffer against falling house prices, it said.

According to the report, as at June 30, 2022, the 10 worst-performing postcodes for loans in arrears (in terms of percentage of total mortgage holders) were:

  • Ballajura (WA) (6066) - 4.38%
  • Forrestfield (WA) (6058) - 4.17%
  • Bankstown (NSW) (2200) - 3.56%
  • Yagoona (NSW) (2199 - 3.37%
  • Sandown Village (VIC) (3171) - 3.37%
  • Alpine (NSW) (2575) - 3.36%
  • Barkly (QLD) (4825) - 3.29%
  • Binduli (WA) (6430) - 3.21%
  • Acton (TAS) (7320) - 3.18%
  • Bayview (NT) (820) – 3.16%

Auswide Bank managing director Martin Barrett said in October that as of June 30, 2022, arrears represented 0.18% of the bank’s loan book, while Beyond Bank general manager customer experience Nick May said customer arrears remained stable. Big four bank CBA said in its FY22 results home loan arrears over 90 days (as at June 2022) sat at 0.49%.

Read next: RBA delivers interest rate verdict

Economists have previously told MPA that there is around a three-month lag before changes in the official cash rate flow through to variable rate mortgages, indicating borrowers would start to feel the pinch of the six rate hikes by Christmas.