With global cash rates rising but a smidge behind these volcanic inflationary pressures, a ratings agency – one which knows a thing or two about what happens to over-leveraged banks – says the big four Aussie banks should be just hunky-dory during this wee housing downturn.

All good. That is unless mortgage defaults hit 5% and house prices fell by circa 30%.

It’s crazy talk. It’ll never happen.

Although, we should add that if defaults were to top 5% – Fitch says the banks’ standalone viability ratings (VRs) could come under pressure – which is another way to say all bets are off.

They’re big bets too.

Last month, Australia’s residential housing market topped $10 trillion for the first time.

Now there’s a startling number.

The Australian Bureau of Statistics says the 10.8 million residential dwellings (homes, let’s call them homes) rose by $221.2 billion in the three months to March, lifting the total housing value to $10.2 trillion.

According to Michelle Marquardt, the Bureau’s Princess of Price Statistics, the combined value of homes went up by almost $2 trillion in the last year.

With by far the most skin in the game, the Commonwealth Bank – which reacted like Usain Bolt of Passing on Rate Hikes following the RBA’s July move – sees the average Aussie mortgage paying an extra $1000 by the end of the year.

CommSec’s chief of scary numbers Craig James, reckons the RBA will lift by 25 basis points in August, again in September (pause for a breath in October) before going again in November.

That takes CommSec’s call on the cash rate to 2.1% by year’s end. Comparatively conservative, I believe.

And if the Craig James theory of Rate-ivity – 3 x 25 bps hikes before Christmas stand up – the average Australian mortgage of $615,000, will pay an extra $991 on their repayments between now and December 1 – based on someone with a 30-year-loan (me), with the average Australian variable interest rate of 3.93 per cent (me again!).

“We can expect further interest rate hikes in coming months. This is the most aggressive the Reserve Bank has ever been – we’ve had three interest rate hikes in a row and the last two were 50 basis,” James says.

CreditorWatch CEO Patrick Coghlan who keeps an eye on payments going awry says he continues to see a “disturbing rise in trade payment defaults, our leading indicator for future business insolvencies.”

“Court actions are also back to pre-COVID levels, reflecting that the banks are back to their regular collection activity after the ‘loan holidays’ that they provided during the peak of the pandemic.”

But mortgages are the big daddy.

The largest single-sector lending category of Australia’s four largest banks, says Fitch Ratings.

The general feeling among banking analysts since the latest run on the Aussie property market began as the cash rate hit – and stayed – at those record lows we’ve been borrowing on, is that the four banks’ $3 trillion plus mortgage balance sheet is a problem.

It’s a lot of money in the one pot and it’s a pot banks can’t really seem to easily diversify – or redirect, into say – business banking.

Back in 1986 it was all business banking, some 66% of all Aussie loans were for business.

Now its the home loans at two-thirds.

Since the 2017 royal commission the banks have just been waylaid in their slight attempts to build out growth businesses and fallen back on the easiest sweetest of low-hanging, large-teeted cash cows in our modern history – mortgages.

And there’s not yet much reason to change their ways.

So, who has the most mortgages on their books?

It’s also the biggest – the Commonwealth bank of Australia – which lays claim to the greatest exposure to defaults (ANZ has the lowest.)
Regardless, Fitch says, all four banks should be able to cope with the largely moderate downturn where default rates peak “well below” 2%.

Fitch ran a timely bunch of housing stress tests which tells them – and they in turn suggest to us – that the ratings for Australia’s four largest banks should be just fine if the looming cycle of mortgage default rates remain sub 2% as most expect.

But the test indicates that the banks’ standalone viability ratings (VRs) could come under pressure if defaults approach 5 per cent and house prices fall by over 30%.

Such a scenario could also stress asset quality in non-mortgage lending, and affect earnings and capitalisation, the ratings agency says.
Fitch’s senior director, financial institutions, Tim Roche notes: “Non-mortgage loans remain a more likely source of significant losses than residential mortgages for Australian banks.”

As house prices stall, the central bank and then the lenders themselves lift the cost of cash that default number is impressively small.
Although – we should also add that according to new data from the stress tests, right now Aussie households are “highly-leveraged.”

The credit rating agency, which brought us such hits as the GFC, flagged our super-toppy, record debt-to-income ratio (it’s at an impressive 143.7%) with a very, very large portion of mortgages on variable interest rates.

Now, putting these factors in a mixer with some sugar and then chucking them in the Australian 2022 economic oven, Fitch says at the right rates temperature that’s actually the recipe, at which borrowers become vulnerable.

But, as if that’d happen!

“Our base-case assumption is that continued economic growth and low unemployment will cushion housing-market stress,” Fitch says. “Banks also have substantial buffers and lenders’ mortgage insurance that should limit losses.”

Diana Mousina at AMP Invest says here in Australia, the term for fixed home loans is usually for a period of 1-5 years. That’s a heaps different mortgage world to the States, where you can fix for 30 years and refinance in between if interest rates fall which is a good deal for mortgage holders).

“CBA analysis of their lending book suggests that the largest share of these loans expire in the second half of 2023 which means that households will roll onto a variable mortgage rate that could be 2-3 times their current fixed rate,” Mousina says.

Diana warns, that a large chunk of home loans that have been recently fixed at ultra-low rates will roll onto a variable mortgage rate that is 2-3 times higher.

“This is a downside risk for consumer spending, despite the positive offsets of high accumulated savings and housing pre-payments.”

Fitch stress tests show that CBA suffers the largest losses of the banks across all scenarios, while the ANZ suffers the second-largest for lower price-decline scenarios, partly because it has the highest proportion of mortgages in the 80%+ loan-to-value buckets.

Fitch’s scenarios involved house-price declines of up to 60% and default rates up to 20%. Downgrade sensitivities are likely to be triggered for most, if not all, four banks in the more severe scenarios, potentially involving multiple-notch VR downgrades.

However, downgrades to the banks’ Long-Term Issuer Default Ratings (all currently A+/Stable) would be limited to one notch unless the Government Support Ratings (all currently at ‘a’) were also downgraded.

But someone should point out to messrs Fitch and CommSec – somehow these things never play out the way they’re thinking.