‘High risk’ loan originations rise but interventions still unlikely

By Bianca Dabu

March 23 2021
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Rapidly rising home values have not led to a ‘major deterioration’ in lending standards, with the need for intervention unlikely, an expert has revealed.

‘High risk’ loan originations rise but interventions still unlikely

As of January 2021, borrowing for the purchase of residential property has hit a record high of $28.8 billion – 34.8 per cent higher than the decade average – which in turn lifted housing values to a new record high, CoreLogic’s head of research, Eliza Owen, explained.

Further, recent data from the Australian Prudential Regulation Authority (APRA) showed that the proportion of loan originations that could be deemed higher risk has increased during the December 2020 quarter.

However, despite these trends, CoreLogic’s most recent research paper has suggested there is lack of evidence supporting material relaxation in lending standards. As such, the level of worry is low.

Lending still stable

But despite her confidence in current lending standards, Ms Owen cited several high-risk loan originations that could ultimately influence lending regulations, based on the December 2020 data from APRA.

Interest-only lending

According to APRA’s data, the share of interest loans increased to 19.2 per cent in the December quarter, up from 18.5 per cent in the previous quarter. But despite a slight spike, the figure does remain close to the two-year average of 18.7 per cent and well below the record-high of 45.6 per cent recorded in the June 2015 quarter.

Interest-only lending has been deemed a potential risk to financial stability in the years up to 2017, as more borrowers delayed paying down their loan principals at a time when house prices were booming and household debts were rising.

But while interest-only loans are increasing once more as house prices soar, Ms Owen explained that the current relatively low level of investor activity mitigates the risk.

“Interest-only loan structures have generally been more popular among investors, who are eligible for tax deductions on their interest payments.

“Considering investors remain around record lows as a share of total lending, the risk to financial stability from interest only lending to this segment of the market remains low,” the researcher explained.

Debt-to-income ratio

In the December 2020 quarter, APRA found that the portion of new home loans originated on a loan-to-income ratio of greater than, or equal to 6 times reached 7.0 per cent of loans over the December 2020 quarter – the highest across the series, which commences in March 2019.

Further, loans originated with a debt-to-income ratio of 6 or more made up 17.2 per cent of mortgages, which was also a series high.

However, APRA said that these metrics are not necessarily cause for concern as the share of debt-to-income lending remains within the historical average.

Moving forward, Ms Owen predicted that the increased demand in Sydney and Melbourne could test debt-to-income ratios.

“This is because the house price-to-income ratio across Sydney has averaged around 8.5 since 2013, and has averaged 7.5 across Melbourne since 2015.

“As housing prices rise at a time when incomes are expected to remain relatively flat, there is the potential for both loan-to-income and debt-to-income ratios to lift further, which is likely to be seen as a riskier outcome by regulators,” she explained.

Loan-to-value ratio

New home loans with a loan-to-value ratio (LVR) of 80 per cent or more have increased to 42 per cent across all borrowers – both owner-occupiers and investors – during the December 2020 quarter, the data from APRA revealed. This was up from 39.9 per cent in the previous quarter and the highest proportion recorded since March 2019.

The owner-occupier space saw a greater jump, with 45.7 per cent of loans originating on an LVR greater than or equal to 80 per cent, and 14.1 per cent of loans with LVRs greater than or equal to 90 per cent.

As such, Ms Owen judged that, with first home buyers accessing housing through loan guarantors and government support programs such as the First Home Loan Deposit Scheme today, the risk of low deposit home loans is generally reduced.

Looking ahead

While the metrics that influence lending regulations are on a general upward trend, along with property prices, Ms Owen believes that “there is no blowout of risk in mortgage lending”.

In fact, Reserve Bank of Australia (RBA) governor Philip Lowe has reiterated on numerous occasions that the cash rate is very likely to remain at the current record low for at least another three years. This could, in turn, support housing demand, according to the researcher.

Moving forward, Ms Owen said there are several strategies that could mitigate the deterioration in lending standards, including tightening serviceability assessment rates, loan sizes relative to incomes or debt (LTI or DTI ratios) or loan sizes relative to home valuations (LVR).

“While APRA’s December quarter statistics show a trend towards ‘riskier’ styles of lending, the magnitude is not likely to be large enough to trigger a regulatory response.

“But if this trend continues, or indeed accelerates, it becomes more likely we will see a regulatory intervention aimed at curbing financial stability risks related to the housing sector,” she concluded.

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