Bad bank loans to weigh on banks, as Citi warns pandemic borrowers performing the worst

A rising tide of bad home loans could trigger a sell-off in bank shares, Citi analysts have warned.

Bank data shows many borrowers who had taken out loans between 2020 and 2022 had ’overleveraged’, borrowing too much to buy homes

A rising tide of bad home loans could trigger a sell-off in bank shares, Citi analysts have warned, with the investment bank tellinginvestors new delinquencies may be brewing.

In a note to investors, Citi analyst Brendan Sproules said bank data was showing many borrowers who had taken out loans between 2020 and 2022 had “overleveraged”, borrowing too much to buy homes.

Mr Sproules said this was due to many borrowers being tested on less stringent borrowing benchmarks, manifesting in a “spike in arrears in most recent vintages”.

“To our mind, there is a significant amount of leverage that was taken on by a cohort of borrowers during 2020 to early 2021,” he said.

“They were spurred on by low rates, comfort in fixed rates, and a central bank that was encouraging them with (in hindsight) shortsighted guidance.”

At its recent update, Westpac revealed 1.18 per cent of its total portfolio was in hardship, up from 0.71 per cent in September last year.

Commonwealth Bank reported that 0.65 per cent of its home loan book was in arrears.

Mr Sproules pointed to many borrowers who took out loans and were now unable to refinance under new service ability tests.

Australian Prudential Regulation Authority data shows nearly 25 per cent of new loans written in mid-2022 had a debt-to-income ratio of six times or more.

Between mid-2020 and mid-2022, almost 40 per cent of new loans were also written at loan-to-value ratios of 80 per cent or more.

Mr Sproules said many of these borrowers had refinanced in 2023 and 2024, with banks lowering serviceability buffers, but banks had slipped on their standards for writing the new loans.

“Buffers were lowered, and exceptions were made. These borrowers are now driving arrears higher,” he said.

He said APRA data showed the issue of rising arrears was “largely a major bank issue”.

“Smaller and regional banks have seen more negligible movements in arrears, due to lower fixed-rate take-up and lower debt-to-income appetite,” Mr Sproules said.

Any significant rise in arrears is not expected without a significant lift in unemployment, currently tracking at 4.2 per cent.

“While we think the actual loss outcomes are limited here, a housing book that continues to deteriorate is at some point going to be very negative for sentiment,” Mr Sproules said.

He said the sell-off could come despite banks entering this choppy economic period with hefty loan loss provisions. This could see “very little likelihood of material losses over and above what has been anticipated”.

“While the banks are forewarned and forearmed, it is another thing to remain that confident when impairments and losses start to build,” he said.

But Mr Sproules said investors should look at the experience of June 2022, when bank shares slumped by 15 per cent amid concern over rising arrears.

“At the end of the day, with valuations this stretched, there is very little allowance for bad news in current shares prices,” he said.

Canstar data insights director Sally Tindall said arrears had lifted for the sixth consecutive ­quarter, and added that owner-occupiers were far more likely to slip into areas compared to ­investors.

“An investor is far more likely to sell because they don’t have to conquer the problem of having to move,” she said.

But Ms Tindall said owner-occupiers faced a more difficult decision around their homes.

“They’re more likely to go into arrears for that reason, as well they’re far less likely to pull a lever investors would pull,” she said.

Ms Tindall also said bank hardship policies and loan repayment abatements were clouding a complete picture of financial distress.