Banking system faces significantly raised credit risk

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July 10 2020
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The banking sector’s commitment to extend loan repayment holidays for distressed mortgage-holders could deteriorate the system’s credit quality and require higher loan loss provisions.

Earlier this week, the Australian Banking Association (ABA) confirmed that it would continue to support Australian mortgage-holders through the COVID-19 pandemic.

The banks, including the big four lenders, agreed to extend loan repayment holidays by up to four months (no later than 31 March 2021) for customers unable to meet their obligations due to income loss linked to COVID-19.

For most lenders, extensions of the repayment holiday will only be considered upon the expiry of current deferral periods (most of which expire in September) and on a case-by-case basis.

According to the ABA, approximately 800,000 borrowers have deferred repayments on their loan since the onset of the COVID-19 crisis, of which, residential mortgages make up over 61 per cent.

Internal data from Australia’s major banks suggests that approximately 20 per cent of mortgage-holders on repayment holidays have since resumed loan repayments; however, management firm Morgan Stanley estimates that a further 20 per cent of such borrowers would default on their debt, triggering a $4.3-billion rise in credit losses across the big four banks alone.

Moody’s Investors Service stated that the action highlights the extent of the economic damage caused by the COVID-19 crisis, “significantly raising risk for Australian banks’ asset quality”.

Morgan Stanley analyst Richard Wiles shares similar views, warning that loan deferral extensions could “require a reassessment of COVID-19 overlays”.

Mr Wiles acknowledged that repayment holidays could “mitigate risks to the economy” by “avoiding unnecessary hardship and foreclosures”, but noted they would also extend the credit loss cycle, which he said would now be more likely to peak in the second half of the 2021 financial year.

The analyst added that the extensions would “drive higher probability of default”, and “higher expected loss” in the internal models of Australia’s banks, “even where default is avoided”.

As a result, loan deferral extensions are expected to “increase the probability” that the banking sector will defer dividend payments to shareholders, as they reassess their capital position.

So far, the big four banks have set aside over $7.2 billion in credit provisions in anticipation of a COVID-induced deterioration in credit quality.

The banks have been dealt an additional blow with many Australians looking to refinance at the same time as them facing a two-decade low in new mortgages.

The value of new loan commitments for owner-occupiers fell -10.2 per cent. The value of new loan commitments to investors fell -15.6 per cent, reaching its lowest level since November 2002. The number of owner-occupier first home buyer loan commitments fell -9.3 per cent from the month prior.

Owner-occupier first home buyer loan commitments accounted for 31.7 per cent of all owner-occupier commitments (excluding refinancing), in original terms.

“Australians are battening down for the financial storm, making savings on their financial commitments. On Monday, the Reserve Bank announced there had been an all-time record for debt wiped off credit cards. Today, it is the ABS reporting that refinancing of home loans for May 2020 is up 91.6 per cent on the same month last year,” said Canstar’s finance expert, Steve Mickenbecker.

“The news is not so great on the value of new loans, down 11.6 per cent on April. Investors in particular continue to be bearish with new commitments at their lowest level since November 2002.”

About the author

Cameron is a journalist for Momentum Media's nestegg and Smart Property Investment. He enjoys giving Aussies practical financial tips and tricks to help grow their wealth and achieve financial independence. As a self-confessed finance nerd, Cameron enjoys chatting with industry experts and commentators to leverage their insights to grow your portfolio.

About the author

Cameron is a journalist for Momentum Media's nestegg and Smart Property Investment. He enjoys giving Aussies practical financial tips and tricks to help grow their wealth and achieve financial independence. As a self-confessed finance nerd, Cameron enjoys chatting with industry experts and commentators to leverage their insights to grow your portfolio.

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