LENDING & CREDIT | Staff Reporter, Australia

How will the new regulatory measures impact Aussie banks?

Regulators issued new limits on interest-only mortgages.

Moody's Investors Service says that new measures introduced by the Australian Prudential Regulation Authority (APRA) and the Australian Securities Investments Commission (ASIC) to restrict interest-only mortgage lending are credit positive for Australian banks, residential mortgage-backed securities (RMBS), and covered bonds.

"The effect of the measures will be credit positive because they will curb the growth in riskier mortgage loans against the current backdrop of rising house prices and high household indebtedness," says Daniel Yu, a Moody's Vice President and Senior Analyst.

"Furthermore, we expect the banks to also raise interest rates on interest-only loans to reduce growth in this segment and, importantly, support their net interest margin from ongoing price competition for lower-risk loans and stable deposits, a further credit positive," adds Yu.

Moody's conclusions were contained in a just-released report, "New Limits on Interest-Only Mortgages Will Curb Riskier Lending".

The report looks at the implications for Australian banks, RMBS and covered bonds. It was authored by Yu, Georgij Ludmirskij, a Moody's Assistant Vice President and Analyst, and John Paul Truijens, a Moody's Vice President and Senior Analyst.

Here's more from Moody's:

The latest measures include limiting the flow of new interest-only mortgages from banks to 30% of total new residential mortgage lending and instructions from APRA to the banks to ensure that growth in housing investment mortgages remains "comfortably" below the 10% limit introduced in December 2014, and which until now has not been a hard target.

As such, APRA has advised that the banks will no longer be afforded any tolerance to exceed this growth speed limit and that any breach will immediately prompt a review of the offending bank's capital requirements.

As part of the new measures, APRA also announced that it would monitor the warehouse facilities that the banks use to fund non-bank lenders. Non-bank lenders are regulated by ASIC, not APRA, but APRA's monitoring of these facilities will in effect allow it to influence mortgage underwriting standards in the non-bank market, thereby promoting the overall stability of the financial system.

APRA has stated that it would be concerned if warehouse facilities grew "materially faster" than the banks' own housing loan portfolio and has informed them that it expects lending standards within these facilities to be consistent with sound industry practices.

"Although the measures announced by APRA and ASIC to strengthen mortgage underwriting add a layer of protection for the banks, RMBS and covered bonds in the event of a house price correction, it remains to be seen on how effective they will be in moderating house price appreciation, particularly when low interest rates continue to support housing demand," says Yu.

"In summary, while the latest measures and interest rate increases by the banks on interest-only loans will have some impact on demand for housing, we continue to expect upward pressure on house prices in Australia in an environment of low interest rates," says Yu.

"Furthermore, although low interest rates will also continue to support the capability of borrowers to service their debt, we view rising house prices, in combination with high household leverage and low wage growth, as increasing tail risks for the Australian government, banks and RMBS," adds Yu.

At more than 120% of GDP, Australia's household debt is substantially higher than in most other advanced countries and it has risen markedly in recent years. As a result, the housing market remains a risk to economic growth, given that highly leveraged households tend to cut back spending more sharply in the event of an economic downturn.

If successful, these new measures will support financial stability, which is in turn supportive of Australia's sovereign credit profile.

Interest-only loans accounted for 38% of total housing loan approvals in December 2016 and have accounted for more than 30% of total housing loan approvals every month since June 2009. Housing investment mortgages, which are often interest-only loans, also account for a significant proportion (35% as of December 2016) of total housing loan approvals. In the RMBS sector, interest-only loans account for 35% of the mortgages backing the deals we rate.

The Australian Prudential Regulation Authority (APRA) announced its latest measures on 31 March, while the Australian Securities and Investments Commission (ASIC) announced its on 3 April.

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