Reserve Bank and APRA pave way for Australia’s dark days of debt stress

Home owners who have been wrestling with their mortgage repayments are about to find things can get a whole lot worse as the Reserve Bank and the financial regulator hand the big banks two more reasons to hike rates.       

The worst hit will likely be those who waded into frothy capital-city housing markets at the tail end of the boom.  In its latest meeting the RBA warned that as many as eight official rate hikes are on the way as the cash rate heads for a new normal of 3.5 per cent, while the Australian Prudential Regulation Authority has raised bank equity targets by 150 basis points to 10.5 per cent.

This is happening in an environment where the gap between variable mortgage rates and the official RBA cash rate has doubled in 10 years and is the widest it has been since 1994. Experts say this gap is likely to widen.   

The RBA has pegged 3.5 per cent as the new normal for the official cash rate. Photo: Peter Braig

In April the RBA warned in its Financial Stability Review that about one third of Australians had built up little or no buffer to higher interest rates or are less than one month ahead on their repayments. Recent UBS research shows 85-90 per cent of mortgages are variable, so this could see millions feel serious debt stress.  

Add to that several big-name economists calling the peak of capital-city house price growth and the latest NAB research showing a spike in activity from first-time buyers.   

“When funding costs go up a little bit [banks] always claw it back everywhere.”Omkar Joshi, Regal Funds Management

Simply put, if wages growth doesn’t get its act together then bleak times lie ahead.  

Rates on the rise

“You’re going to see higher mortgage rates over time,” UBS economist George Tharenou told Domain.

“It’s not really even, is it? When the RBA cuts we’ve seen mortgage rates fall by less but if the RBA hikes then you would expect banks to follow at least the movement in the cash rate, if not more,” Mr Tharenou said.

A more upbeat read from Tuesday’s RBA minutes saw the Australian dollar spike to a two-year high and market predictions of a May rate hike jump to 91 per cent, from 52 per cent prior to the minutes, with the likelihood of a follow-up increase by August 2018 growing.

The problem is these rate hikes are on the way in a country with household debt sitting at a record-high 190 per cent of income and wages growth wallowing near record-low levels.

A lot of Australians made their bed, financially speaking, towards the end of a once-in-a-lifetime house price boom in Sydney and Melbourne and now won’t be able to afford to sleep in it, especially if banks are being given the chance to out-hike the RBA.

So, how did we land on this path?

The reason in a nutshell? Recent moves to restore some normality to our major housing markets by APRA. By restricting investor and interest-only lending the regulator has effectively pushed banks to reprice those loans, and now all variable rates are seen to be on an upward path.

First, APRA capped investor housing credit growth at 10 per cent year-on-year, then earlier this year it limited new interest-only home loans to a 30 per cent overall share. And looking forward, UBS said “it seems unlikely regulators will quickly reverse course”.

Separately, APRA today announced an increase to banks equity capital ratio. The new requirements will translate to the need for an increase in CET1 capital ratios, on average, of about 100 basis points above their December 2016 levels, APRA said.

That gives banks another reason to tighten the screws on customers.

The moves are understandable considering they came as investor housing finance climbed well above 50 per cent, while first-home buyers in Sydney and Melbourne were an endangered species.

It’s too early to tell for sure if the plan is working, but NAB’s latest property index release showed a 17-point drop for last quarter and said housing sentiment “fell noticeably”.

The ‘targeted’ approach is having more of a blanket effect

“The survey results indicate that while first-home buyers were more active in both new and established property markets in the June quarter, local investors retreated from the market,” NAB chief economist Alan Oster said of last week’s research.

“Clearly, tougher measures on banks announced by regulators to rein in investor lending are being felt in this segment of the market.”

Score one for the regulators! Unfortunately, while the target was investor and interest-only loans, the bullets were sprayed a bit.

“The trend is most visible in investor and interest-only [loans] but you’ve seen it across the board,” Regal Funds Management portfolio manager and banks expert Omkar Joshi said.

“When funding costs go up a little bit [banks] always claw it back everywhere.”

But before we blame the big four, we need to remember the banks were handed this assignment by APRA, according to UBS’s George Tharenou.

“Their actual margins are steady and are not increasing materially,” he points out.

“And that would be a surprise to a lot of people who are saying banks are profiteering or expanding margins – they’re not.”

Caught in the crossfire

Aside from the strong possibility of broad mortgage stress, this could be particularly worrying for first-home buyers who have recently jumped into the market.

The NAB data showed first-timers were the most active segment of both the new and established markets in the June quarter.

First-home-buying owner occupiers accounted for 21.2 per cent of new property sales in the second quarter of 2017 and first-home-buying investors made up 14.4 per cent, according to the NAB research.

In total, first-home buyers grew to 35.7 per cent of all new property sales – the largest share they have taken since NAB began tracking them in late 2014.

That means that, while all this is going on in APRA, RBA and big-bank board rooms, a fleet of young Aussies have just committed to a mortgage at the tail end of the house-price boom and can expect to service a large debt load in a rising interest rate environment, where banks move out of step with the RBA.

If Australians don’t somehow manage to squeeze mass pay rises out of their bosses, we could be heading for serious strife.