Smaller lenders will bear the brunt of coronavirus crisis home loan losses, says Citi

Smaller lenders will be hardest hit when home loan losses start to rack up later this year, says Citi.

A flight to quality will also benefit the big banks, as will a move by institutional and corporate borrowers to store liquidity as the system ‘grosses up’, Citi predicted. Picture: iStock

Smaller lenders will be hardest hit when home loan losses start to rack up later this year as stimulus measures are rolled back, triggering a “material event” in the fourth quarter, investment bank Citi has warned.

The aggressive push by small lenders to steal market share from the big end of town since 2018 is now working against this cohort as the nation battles through its first recession in three decades, with losses expected to be highest in loans taken out in the most recent years, Citi analysts led by Brendan Sproules wrote in a note to clients.

Major lenders, meanwhile, can expect growth momentum to swing back in their favour as smaller lenders are forced to put their attention to capital demands rather than growth ambitions, Citi predicted.

“Losses are typically higher in stress events among loans that have been originated in preceding years, with less collateral built up and with more susceptible borrowers.

“In the ordinary course, the default curve sees the greatest loan losses in the first three to four years of a loan’s life. Both of these risk factors coincide with aggressive market share gains made by smaller lenders in recent years,” the analysts wrote.

“Yet they are less well equipped to face those challenges. Despite experiencing strong volume growth, this has not translated into strong profit growth, sufficient returns or strong capital generation.”

The lighter provisions carried by small lenders, meanwhile, will need to be topped up as the market corrects, and accelerating risk weight inflation, triggered by house price falls, will add to the pressure, Citi warned.

“With less access to liquid capital markets and sluggish organic capital generation, capital demands will trump growth considerations (for smaller lenders),” the analysts wrote.

The system remains stacked in favour of the majors, they said, with the big banks’ internal ratings-based accreditation producing less risk weight inflation than the standardised model smaller lenders are bound by.

What’s the risk?

Standardised mortgage lenders have an average mortgage risk weight of 36 per cent, and a 10 per cent fall in house prices could drive risk weight inflation up by 10-15 per cent, they warned.

“Loan-to-value ratio ‘lines in the sand’ can quickly see the capital intensity of a loan move from 35 per cent to 50 per cent,” the analysts wrote.

Citi is forecasting 26 basis points of housing losses through this cycle as defaults reach 170 basis points.

A flight to quality will also benefit the big banks, as will a move by institutional and corporate borrowers to store liquidity as the system ‘grosses up’, Citi predicted.

Funding interventions, meanwhile, have also benefited the majors by lowering wholesale funding costs as regional bank spreads and residential mortgage-backed securities remain elevated.

Citi favours the majors and listed regionals in the current landscape, with CBA its top pick.

“Better volumes, mitigation of front/back book competition and widening spreads will favour the majors and listed regionals over smaller lenders in coming years.

“CBA is best placed of the majors, with Westpac less likely to reap the benefits given ongoing reputational, reinvestment and restructuring considerations,” they said.

CBA was the only major lender to be trading in positive territory on the ASX shortly after midday on Monday, climbing 0.4 per cent to $67.59. ANZ was down 0.32 per cent at $18.86, while NAB was 0.48 per cent lower at $18.50 and Westpac had fallen 0.056 per cent to $17.88. Both Bendigo Bank and Bank of Queensland were each down more than 1 per cent.