Property price declines to weigh on refinancing prospects: S&P

Indeed, Australian borrowers have been supported by low interest rates, rising house prices, and a competitive lending environment over the last few years, but as that period draws to a close with the Reserve Bank of Australia (RBA) on a tightening path to fight multi-decade high inflation, mortgage arrears are expected to increase. 

The credit ratings agency S&P Global Ratings’ RMBS Performance Watch report (as at September 2022) estimated property prices to decline by 15–20 per cent over the next 12–18 months. 

While prime home loans are at record low rates, cracks are beginning to show with non-conforming home loans to be the first impacted. 

Indeed, borrowers who bought at the peak of the property cycle in areas where property price declines have been more pronounced at higher levels of leverage will be more exposed to rising loan-to-value (LTV) ratios, S&P analyst, Erin Kitson, said.

“Property price declines will hurt some borrowers’ refinancing prospects, which will affect arrears,” Ms Kitson said.

“Lenders look more favorably on modest LTV ratios when refinancing loans; it could diminish some borrowers’ refinancing prospects.

“Refinancing is a common way for borrowers to self-manage their way out of potential mortgage stress. 

“Such borrowers might also be less likely to benefit from refinancing onto a more competitive mortgage rate, thereby adding to debt-serviceability pressures.”

The report also found the 3 per cent debt-serviceability buffer was “being eroded” and could have hit the inflection point.

Moreover, several lenders including major banks have been reducing their DTI thresholds this year.

Meanwhile, the Australian Prudential Regulation Authority’s (APRA) quarterly Authorised Deposit-taking Institution (ADI) Performance report showed that lenders are tightening up their risk characteristics when it comes to mortgages. 

APRA deems mortgages with a DTI of six or more to be “riskier” and has been keeping a close eye on DTI, but the latest stats for the September 2022 quarter found 17.1 per cent of total new mortgages had a DTI that was more or equal to six (in volume terms), down substantially from 23.3 per cent in the same quarter last year.

New lending at high loan-to-valuation ratios (over 90 per cent) also declined, falling from 7.5 per cent in September 2021 to 6.2 per cent in September 2022. 

The fall in new residential mortgage lending with high DTI lending has in part been driven by interest rate increases impacting maximum loan size and loan repayments.

Despite banks tightening lending, S&P ratings agency expects prime arrears to increase in the first quarter of 2023, particularly when fixed-rate loans roll off in the first half of the year.

But, as rates are expected to soften towards the end of 2024, arrears could follow suit and fall around the same time.

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