Interest-only loans increase bank risk, says Fitch 14 May 2015 3:56PM John Kavanagh Big bank chief executives put a lot of effort last week into arguing that the increase in investor and interest-only loans in their mortgage portfolios was not exposing them to higher risk, but Fitch Ratings was not buying it.Fitch senior director Tim Roche told delegates at the company's Annual Credit Insights Conference in Sydney yesterday that he did not see any evidence of banks weakening their underwriting standards.However, the shift to a higher proportion of investor property loans and interest-only loans had the effect of weakening their mortgage books."It is not a trend we want to see continue," Roche said.Westpac has a high proportion of property investor borrowers, at 46.3 per cent of its mortgage portfolio. The bank's chief financial officer, Peter King, said that when interest-only loan applicants were assessed for loan serviceability the loans were treated as if they were principal and interest loans.King said that the level of prepayment was the same for owner-occupier and investor borrowers and the level of arrears rate was also about the same. Seventy-three per cent of Westpac's customers are ahead of scheduled mortgage repayments, with 23 per cent of those more than two years ahead. The bank has A$26.8 billion in mortgage offset account balances - up from $20.8 billion a year ago.The bank's average loan-to-valuation ratio at origination is 70 per cent and on current balances is 43 per cent. On current balances, 94 per cent of loans are on LVRs below 80 per cent.The other banks told similar stories. ANZ has 934,000 home loan accounts worth $218 billion. Sixty per cent of its mortgage customers are owner-occupiers and the average loan size is $376,000.ANZ's average loan-to valuation ratio at origination is 71 per cent and its "dynamic" LVR (the ratio on current balances and valuations) is 51 per cent. Forty-three per cent of customers are ahead with their repayments.The provisions the bank has made against home loan accounts represent 0.01 per cent of loans, which is half the level of two years ago.Roche said the problem with interest-only loans was that the lender was not getting any of its principal back and this exposed it to greater risk in a downturn.Roche said Fitch did not see rising unemployment as a high risk factor but it was concerned about high household debt levels. "Household debt as a proportion of disposable income was flat from 2006 to 2013 but it has been going up over the past couple of years," he said.Fitch does see some positive signs in the mortgage market. Most notably, the proportion of loans with loan-to-valuation ratios above 90 per cent has been coming down.Moody's Investors Service has a similar view. In a note released yesterday it said lending imbalances, including a decline in the proportion of first-time buyers and a sharp increase in residential investment activity, posed a source of risk.