Interest-only loans ‘to end in tears’: Ex-NAB boss Don Argus

Ex-NAB boss Don Argus has added to warnings about interest-only loans, declaring it will ‘lead to tears’.

Don Argus, former NAB chief executive and BHP Billiton chairman.

Former National Australia Bank boss Don Argus has added to warnings about the overreliance of interest-only loans, declaring it is going to “lead to tears” as interest rates eventually move higher.

After a widely expected decision by the Reserve Bank to leave its official cash rate unchanged at a record low 1.5 per cent at its monthly board meeting yesterday, Mr Argus declared that borrowers had “forgotten” the cyclical nature of interest rates.

“You can only hope that some of these dizzy values that you see people paying for houses now, you hope that they stand up on any correction, any economic ­correction,” Mr Argus told The Australian.

Backing a tightening of so-called macroprudential controls on home lending announced by the Australian Prudential Regulation Authority last week, Mr Argus, a former BHP Billiton chairman, said the capacity of borrowers to repay loans “was always a primary concern in housing loans of yesteryear”.

“If you progressed to just an interest-only environment, that’s only going to lead to tears.”

However, in a speech given in Melbourne last night, RBA governor Philip Lowe took aim at banks and other lenders for making overly generous serviceability ­assessments.

“Despite the focus on this area over recent times, too many loans are still made where the borrower has the skinniest of income buffers after interest payments,” Dr Lowe said.

“In some cases, lenders are assuming that people can live more frugally than in practice they can, leaving little buffer if things go wrong. So APRA quite rightly has said lenders can expect a strong supervisory focus on loans with a very low net income surplus.”

Dr Lowe also noted that the prevalence of interest-only lending was “unusual” globally.

“A reduced reliance on interest-only loans in Australia would be a positive development and would help improve our resilience. With interest rates so low, now is a good time for us to move in this direction,” he said.

Almost 40 per cent of residential mortgage lending in Australia is interest-only, where the borrower pays off the interest rather than the principal.

This week, the Australian ­Securities & Investments Commission announced a probe into the handling of interest-only loans by banks and mortgage brokers. On Friday, APRA told banks to confine interest-only lending to 30 per cent of new mortgages, and stay “comfortably below” a previously imposed 10 per cent cap on investor loans.

“I think people are seduced by the low interest-rate environment and they’ve forgotten interest rates are cyclical and they go with the economy,” Mr Argus said.

People who lived through the economic environment in 1989 and 1990, when mortgage interest rates hit high double-digits, “understand that well”, he said.

Mr Argus also hit out at banks allocating too much of their lending to the housing market, saying his warning raised in 2010 that big banks risked becoming “giant building societies” still stood.

GRAPHIC: RBA statement

His comments came as financial markets pared their bets of an eventual increase in official interest rates this year and the dollar fell after the RBA said the recently announced supervisory measures should help address the risks associated with high and rising levels of household debt.

Money markets are tipping cash rates to be on hold for the foreseeable future following yesterday’s RBA board meeting.

Credit Suisse’s gauge of the probability of the official cash rate rising from the current record low of 1.5 per cent within a year slipped to 20 per cent yesterday, from 32 per cent a day earlier. The dollar dived to a three-week low of US75.62c after briefly rising to US76.15c following the release of stronger-than-expected international trade data.

Australia’s monthly trade balance swelled to a near-record $3.57 billion in February — surpassing economists’ expectation of a $1.9bn surplus — as resource export values boomed amid surging commodity prices.

Looking ahead, coal exports would take a $2bn hit from Cyclone Debbie, implying a large net export drag on first-quarter economic growth, UBS economists warned.

Goldman Sachs and TD Securities are the only major firms predicting an interest-rate increase this year. JPMorgan, Morgan Stanley and Royal Bank of Canada expect cuts, while the four major banks expect steady monetary policy before the start of rate rises in 2018 or 2019.

In his statement yesterday, Dr Lowe said “household borrowing, which was largely to purchase housing, continues to outpace growth in household income (and) lenders need to ensure that the serviceability metrics that they use are appropriate for current conditions”. Reduced reliance on interest-only housing loans “would also be a positive development”, he added.

While recent data is consistent with ongoing moderate growth in the economy, “some indicators of conditions in the labour market have softened recently (and) wage growth remains low.”

Westpac chief economist Bill Evans said the risk of reigniting house prices would prevent the RBA from cutting interest rates any further, despite stubbornly high unemployment, low wages growth and tepid consumer price inflation. But “we do expect that macroprudential and banks’ self-regulatory policies will be successful in taking most of the heat out of the housing market this year”, he said.

In assessing the outlook for the cash rate, the central bank saw data since its March meeting as being consistent with “ongoing moderate growth”. Its biggest concern appeared reserved for the labour market given its inflation projections were left unchanged. The prior perception of a mixed jobs market has shifted to one that is now weakening.

“Some indicators of conditions in the labour market have softened recently,” Dr Lowe said.

Additional reporting: Michael Bennet