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Majors expected to ‘digest’ interest-only loan risks

A banking analyst is confident that Australia’s big four banks can weather the risks of interest-only loan expiries, the effects of regulatory changes and the impact of the royal commission.

Morningstar analyst David Ellis expects that ongoing macro-prudential restrictions will continue to slow the rate of credit growth to around 5 per cent per year.

“We forecast average residential lending growth to slow further to around 4.5 to 5 per cent during the next few years for the major banks,” Mr Ellis said.

“As always, there are plenty of risks to earnings and stock prices for the major banks, not the least being regulatory, economic conditions in Australia, the royal commission, the long-running fear of an economic correction in China and, of course, Australia’s housing markets.

“Risk surrounding residential interest-only loan expiries is overdone, and we expect the major banks to digest the transition during the next five years.”

Last month, the Reserve Bank expressed its concerns about the number of borrowers whose interest-only mortgage terms are set to expire between now and 2022.

RBA assistant governor Michele Bullock warned that the increasing popularity of interest-only loans over recent years meant that, by early 2017, 40 per cent of the debt did not require principal repayments.

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“This presents a potential source of financial stress if a household’s circumstances were to take a negative turn,” Ms Bullock said.

The RBA assistant governor noted that as a “large portion” of principal-free periods begin to expire, some borrowers may therefore struggle to service their mortgages.

She said: “[A] large proportion of interest-only loans are due to expire between 2018 and 2022. Some borrowers in this situation will simply move to principal and interest repayments as originally contracted.

“Others may choose to extend the interest-free period, provided that they meet the current lending standards. There may, however, be some borrowers that do not meet current lending standards for extending their interest-only repayments but would find the step-up to principal and interest repayments difficult to manage.

“This third group might find themselves in some financial stress. While we think this is a relatively small proportion of borrowers, it will be an area to watch.”

Consumer credit and mortgage lending, in particular, will be one of the areas to be probed by the royal commission.

The first round of hearings considered aspects of the treatment of consumers by banking and financial services providers in connection with a number of credit products, including residential mortgages, car finance and credit cards.

It will also consider the arrangements and practices of banking and financial services providers and their intermediaries.

[Related: Mortgage arrears rise for first time in four months]

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