Banks will weather housing downturn better than 2008: Moody’s

Banks are bracing for mortgage arrears to push higher and home loan growth to stagnate. But the sector is in a better position than in the last big downturn, Moody’s analysts say.

Banks are bracing for mortgage arrears to push higher as interest rates rise, and the economy slows, while home loan growth is stagnating as higher rates eat into borrowing capacity. But the sector will weather the challenges better than in the last big downturn, analysts say.

The mortgage market is in a stronger position than during the 2008 financial crisis due to a raft of changes brought in to de-risk the system, but the economic headwinds will still see delinquencies rise as under-pressure borrowers struggle with repayments, Moody’s Investors Service predicted on Tuesday.

“Risky lending has declined, macroprudential policies have improved underwriting standards, and lenders have a greater propensity to support homeowners than in the past,” the credit rating agency said.

“These factors will continue to support mortgage performance as interest rates increase, house prices decline and the economy weakens in the coming months. Nonetheless, some borrowers are more vulnerable than others and we expect mortgage delinquencies to rise from current low levels.”

Australia’s biggest bank is the Commonwealth Bank followed by National Australia Bank, Westpac and ANZ. Others include Bank of Queensland and Bendigo and Adelaide Bank.

Like banks, non-bank mortgage lenders have improved the quality of their home loans in recent years. These non-bank lenders have increasingly targeted prime-quality borrowers over those with adverse credit histories, Moody’s said.

“Alternative documentation loans, where lenders assess incomes based on business activity statements or similar information, have remained relatively high, with a number of non-bank lenders focusing on self-employed borrowers,” the ratings agency noted.

After a period of courting the prime market, non-bank lender Pepper Money last week told The Australian it had stepped back from prime mortgage lending as it takes a conservative view on higher funding costs and uncertainty in the housing sector, instead favouring asset finance and nonconforming loans as it watches for rates to plateau.

Pepper was deliberately aggressive with its home lending in the first six months of 2022, knowing that higher funding costs and a softer market were not far off.

After growing above system in the first half, the lender stepped out of the market to grow at 2.5 times below system, right as major lenders pushed further in with competitive rates and cashback offers.

Those cashback offers and other incentives hit new peaks in recent weeks, with one lender now offering up to $10,000 to customers who make the switch.

But with interest rates set to move even higher, possibly peaking above 4 per cent in a matter of months, analysts at investment bank Morgan Stanley say home loan growth will suffer.

Alongside the looming headwinds, banks took another blow this week when the prudential regulator said existing macroprudential policy settings – that is, the mortgage serviceability buffer of 3 per cent – remained appropriate based on the current risk outlook.

“ In our view, maintenance of the serviceability buffer reduces the potential for a rebound in housing loan growth in the near-term,” Morgan Stanley analysts led by Richard E Wiles said.

“In fact, RBA data suggests that higher rates have reduced borrowing capacity by an average of greater than 25 per cent for principal and interest (P+I) loans.”

This would jump to more than 30 per cent if the cash rate goes above 4 per cent, they warned.

“We forecast average major bank housing loan growth to decline from around 5 per cent in fiscal 2022 to around 3.5 per cent in fiscal 2023,” they added.

As borrowers wade through further financial stress, Moody’s expects banks to be more supportive than in the past and more readily willing to extend hardship assistance to hard-hit customers.

“In addition, as was evident in their responses to the Covid-19 pandemic, federal and state governments have a propensity to support Australian households in times of financial stress.

Government policies, in conjunction with bank support measures, helped alleviate the negative financial impact of the Covid-19 pandemic on mortgage holders, and will continue to help mitigate risks to the extent governments continue to offer support measures during times of future economic stress,” the credit ratings agency said.