Prime home loan arrears steady ‘for now’: S&P

While the Reserve Bank of Australia (RBA) has moved quickly to raise interest rates to curb rising inflation, Australian prime mortgage arrears have remained resilient to multiple interest rate rises in quick succession to date.

The RBA’s eighth consecutive rate hike in December 2022 (up 25 bps) has lifted the cash rate by 300 bps to 3.1 per cent.

As Australian borrowers shake the savings tin amid the hikes, the credit ratings agency S&P Global Ratings’ third quarter 2022 market overview revealed prime mortgage arrears (as at September 2022) remained at “post-financial crisis lows”.

The report said the effect of cumulative rate rises was yet to surface in most transactions, as household savings, repayment buffers, and redraw ability are helping cushion the effect of higher interest rates “for now”.

Prime home loan arrears between 31–60 days were 0.58 per cent as at September 2022. While this is record lows, it has increased from last year’s 0.22 per cent. 

“About 65 per cent of cash rate increases have been passed through to outstanding variable-rate mortgages,” S&P analyst, Erin Kitson, said.

“But due to the lagging effect of interest-rate increases, their effect has not yet fully surfaced.”

Prepayment activity ramps up

Given the speed of rate rises and indications of more to come, home loan prepayments rates increased to 24.8 per cent in Q3 2022, from 21.59 per cent, S&P reported.

“Prepayment rates typically rise in September, but this quarter’s result has been bolstered by strong lending competition,” Ms Kitson said, adding that it was a “foretaste of things to come.”

She added that non-banks and credit unions could see more increases in their prepayment rates as “borrowers take advantage of discounted rates on offer by larger banks” with lower funding costs.

Looking ahead, competitive dynamics among lenders will continue to “influence prepayment rates,” she said.

Cracks in non-conforming loans

According to the report, non-conforming residential mortgage-backed securities (RMBS), which make up a much “smaller part of the broader sector”, are beginning to show “signs of stress”, Ms Kitson said.

“Nonconforming residential mortgage loan arrears have been rising month on month since the July reporting period,” Ms Kitson said.

“We expected these arrears to rise before those in the prime RMBS sector. And we expect the rate of increases to be more pronounced.”

Indeed, given the riskier nature of non-conforming loans, she said the sector’s lower seasoning also means loans have not paid down to the same degree and less equity has been built up than in the prime RMBS sector, which will affect some borrowers’ ability to refinance.

“The arrears cycle typically peaks at the end of the Christmas and summer holiday period. The level of arrears increases at this time should provide us with an early indication of the degree of mortgage stress out there,” Ms Kitson said.

“So far, it has been delayed by factors such as lags in borrower-rate increases, a buildup of household savings, and a strong labor market.”

Household spending increases, despite tight budgets

Indeed, Australia recorded a $2.3 billion current account deficit in the September quarter 2022, following 13 consecutive quarters of a current account surplus, according to the Australian Bureau of Statistics (ABS) indicating some slowing has taken place.

However, the ABS data also revealed Australia’s gross domestic product (GDP) rose 0.6 per cent in the same quarter and by 5.9 per cent through the year, mainly driven by increased household spending.

“The September quarter was the fourth consecutive quarter of economic growth, following a contraction in the September quarter 2021, which was impacted by the COVID-19 delta outbreak,” Sean Crick, ABS head of national accounts, said.

The data showed household spending rose 1.1 per cent for the quarter, weakening the household saving-to-income ratio for the fourth quarter as spending outpaced earnings.

“The household savings ratio continued to decline this quarter, moving towards pre-COVID-19 pandemic levels. Higher levels of spending and increases in interest payable on dwellings detracted from household saving compared to the June quarter,” Mr Crick said.

[Related: Risk characteristics of mortgage lending improving, notes APRA]