Fixed-rate loan switch could be ‘Achilles heel’ for RBA: Citi

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While fixed rates protect borrowers against higher repayments, mitigating the initial effect of rate hikes, when fixed-rate loans expiring in the second half of next year are rolled over, annual interest repayments of around $27,600 on an average mortgage of $620,000 at a rate of 2% would increase to an annual repayment of $34,600 assuming a variable rate of 3.75%.

If the RBA raises rates too quickly, 40% of the pound could take a brutal hit as their fixed term expires.

— Brendan Sproules, Citi

The Australian mortgage market saw a dramatic structural shift towards fixed rate lending when the Reserve Bank introduced the Term Funding Facility in 2020 to provide low cost three year funding to banks. The facility encouraged banks to take their allocation and offer term-bound loans.

Before the pandemic, about 60% of new mortgages were variable rate and 40% fixed rate. But that has risen to around 80% of new fixed-rate loans over the past year. A relatively large amount of banks’ global mortgage portfolios have been created over the past 18 months as refinancing has surged.

“Therein lies the conundrum for Dr. Lowe,” Mr. Sproules wrote to Citi clients over the weekend. “If the RBA raises rates too quickly, 40% of the pound could suffer a sharp shock as their fixed term (usually two years) expires.”

The market expects the RBA to start raising rates in the third quarter of this calendar year, with a total of four rate hikes expected by the end of December. But there is considerable debate over the size of the RBA adjustments.

During the banking earnings season last month, bank bosses called for a cautious approach to rate hikes to reduce the risk of shocks to the economy.

The level of mortgage debt in Australia “provides an additional curve for the RBA this time around”, Mr Sproules said.

“This is a very significant change in composition in the context of a $2 trillion mortgage market and likely to have serious implications for the RBA’s rising cash rate trajectory in the future. over the next 12 to 18 months.”

Bank stocks have struggled over the past week as investors continue to worry about margins and geopolitical instability. Westpac is down 5% over the past week, ANZ is down 4.6%, NAB is down 3% and Commonwealth Bank is flat.

But while rising rates could put pressure on customers, Macquarie analyst Victor German said pressures on bank margins would ease as rates begin to rise. “We continue to expect banks to outperform early in the rate hike cycle,” he said last week.

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