Banks, APRA to cushion impact as loan ‘cliff’ looms

With the current deferral scheme and government support packages due to expire at the end of September, the Morrison government, regulators and the banks are desperate to avoid the catastrophic impact on the economy and the property market of a wave of foreclosures, particularly in the lead-up to Christmas.

Negotiations are considered likely to bear fruit before the end of July, after the Australian Prudential Regulation Authority gathers more data from the banks conducting check-ins with customers three months after loan deferrals began in mid-March.

However, an industry insider cautioned against “counting your regulatory chickens before they’re hatched”, as bank support for repayment deferrals for another six months mostly depended on the capital treatment of their medium-risk loans.

“APRA is rightly cautious about capital relief,” the source said.

“There was blanket relief for customers on the way in (to the deferral scheme), but it’s not going to be like that on the way out.

“Other solutions will be examined, like lengthening the term of the loan, using redraw facilities, refinancing at a lower rate, or interest-only repayments.”

The supervisory regime in Australia also had to “stack up” globally.

For example, if the nation’s banks were seen by investors to be undercapitalised compared to global peers, it could have unintended consequences for stability.

APRA chairman Wayne Byres told a Senate committee last month that some bank customers would clearly be unable to repay their loans once their repayment deferrals expired.

“But equally we don’t want to put pressure on a large group of customers at the wrong point of the cycle,” Mr Byres said.

“We often talk of the cliff, which is when everything ends in six months’ time.

“No one has an interest in going off the cliff, so we have to work out what the next phase is going to be and that will be dependent on the economic situation at the time.”

When the banks agreed to defer loan repayments for up to six months, APRA followed up with a new regulatory treatment which said deferrals were not to be treated as a period of arrears for capital purposes.

This was critical for the banks: a massive spike in loan impairments would have hit their common equity tier one capital ratios.

At the time, the hope was that the crisis would recede or new policy initiatives would be introduced when the deferral periods expired.

Since then, 779,458 loans worth $237bn have been deferred, including $176bn in mortgages and $60bn in business loans, according to Australian Banking Association data.

The banks, as required, have recently started customer check-ins to see if their circumstances have improved or deteriorated.

National Australia Bank chief executive Ross McEwan has said about 10-15% of customers on deferrals had reversed their earlier decisions and resumed repayments.

These customers were classified as the lowest-risk of four customer categories when discussions started between APRA and the banks about extended loan deferrals.

No capital relief was sought because the loans were performing.

The two medium-risk categories, to which the banks would argue the special capital treatment should apply, included customers who had resumed work but not full-time employment, and those who had reasonable prospects of returning to work once the current lockdown and border controls were withdrawn.

The final, high-risk category included people who were out of work and unlikely to return to paid employment.

Loans to these customers were impaired, requiring hardship support from their banks and the normal capital treatment because deferral would not make any difference to their situations.

“Deferral can’t go on forever; the music has to stop somewhere,” a senior banker said.

The four customer categories formed part of early discussions between APRA and the banks, as a way of coming to grips with the looming cliff.

However, the categories had no formal status in bank datasets and have since been abandoned.

Citi analyst Brendan Sproules said in a note on Monday that capital relief would provide time for stressed borrowers to work through solutions.

“With five cash rate cuts in the last 12 months and record low fixed-rate mortgages, affordability and access to credit is potentially unrivalled in history for the vast majority of borrowers and potential borrowers,” he said.

This article originally appeared on www.theaustralian.com.au/property.