RBA warning that mortgage defaults could pose risks to financial system
Reserve Bank of Australia (RBA) economists warn that because housing loans account for about two-thirds of banks’ total domestic lending, increasing arrears could pose risks to the nation’s financial system if they result in defaults and losses.
The most recent data seen by Macks Advisory shows one in 40 home owner-occupiers with loan-to-value ratios above 80% are already more than 90 days behind in their in their mortgage payments. (Australians live in some 11m homes of which 3.2m have mortgages on them.)
The arrears rate for highly indebted borrowers has risen sharply over the past 18 months, outstripping a modest rise in mortgage delinquencies across the entire pool of owner-occupier loans.
According to RBA economists Ryan Morgan and Elena Ryan, the small buffers of many large borrowers have made them less resilient to changes in their mortgages or budgets, undoubtedly a factor in the Bank’s decision this month to cut the cash rate for the first time in four years.
Three years ago, the Australian Prudential Regulation Authority (APRA) increased the minimum interest rate serviceability buffer rate from 2.5% to 3 percentage points above a bank’s loan product rate –- which meant that if borrowers applied for a loan with a 4% interest rate, they were assessed by the bank on capacity to pay a 7% rate
APRA estimated the 3% buffer rate reduced the maximum borrowing capacity of typical borrowers by about 5%, and that was a problem for some of them in urgent need of money.
Basis of the RBA’s concern
RBA’s economists Morgan and Ryan feared the default rate on home mortgages could “lead to lenders sharply restricting the supply of credit to even very sound borrowers, which would result in a major disruption to the entire economy”.
It’ll therefore be interesting to see to what extent such fear is lessened by this month’s cash rate cut which, for someone with an existing $200,000 bank loan, will result -- where commercial lenders pass on the RBA’s full $0.25% reduction – in a $32 monthly saving and $384 annually.
On a $300,000 mortgage there’ll be a potential annual saving of $575 with increasing graduations in savings of that calibre, up to $2859 on a $1.5m mortgage.
RBA economists attribute increases in arrears, to challenging economic conditions and ageing of the loan pool and foresee a “cumulative chance of borrowers experiencing negative shock increases over the life of their loans”.
The arrears rate among borrowers who took out loans at very low rates during the pandemic has risen rapidly. Such borrowers have long been considered at risk because banks never assessed their ability to withstand an RBA cash rate of 4.35%.
However, Mr Morgan and Ms Ryan say they believe broad risks to the financial system from arrears are so far being “contained” by the banks.
Instances of borrowers being in negative equity are still rare and highly leveraged borrowers remain a small percentage of total current loans.
Only 11% of variable owner-occupier loans are now worth more than four times borrowers’ incomes and just 2% of these have loan-to-value ratios above 80% -- which is why commercial banks are not overly concerned by the state of the economy.
However, it still makes them disinclined to invest freely in home loans, and they are therefore simply making it difficult for people – often would-be borrowers demonstrably capable of servicing it – to get a home loan.
Indeed, the Australian Securities and Investments Commission (ASIC) has taken banks to task for their containment strategy, saying it’s making it unnecessarily difficult for struggling borrowers to get help.
The corporate regulator says about a third of banks’ customers are approaching their home lender for help because they’ re struggling with repayments, and have been dropping out of the hardship process because of delays and information requirements
Wage growth a forlorn hope
Workers hoping that wage increases will help them with mortgage payments can disabuse themselves of that thought.
Macquarie Macro Strategy says the actual and expected slowing in wage growth makes sense in the context of the collapse in job ads and the sharp rise in applicants, given the rate of migration.
Yarra Capital chief economist Tim Toohey says: “Net migration is supplying 1.4 people for every new job created.”
Clearly this is bad news for Australian workers who have already experienced the sharpest decline of real wages in recorded history, which has wiped out 14 years of gains.
Worse, hanging over their heads is the May federal budget forecast that real wages won’t recover to December 2014 levels until mid-2028 – and this means in effect that Australians will still have lost about 14 years of progress in their living standards.
Macquarie economists estimate that based on the current trajectory of real wages it could take about a decade before they recover to their mid-2020 peak.
GDP and living standards
It’s not a happy situation for Australia, exacerbated as it has been by a long-lasting decline in real per capita Gross Domestic Product (GDP).
Treasurer Jim Chalmers in a 5 March statement made much of his belief that the Australian economy is finally “clicking into gear”, even as economists were warning it “remains weak”.
It would seem the Treasurer’s belief the economy has “turned a corner” is bolstered by Australian Bureau of Statistics (ABS) national accounts data issued this month showing 1.3% growth in the past year, and 0.6% GDP growth in the December quarter of the current financial year -- the highest figure since December 2022.
If the next release of ABS data doesn’t show a revert to decline, then the nation’s deepest per capita recession resulting in the longest decline based on records dating back to the early 1970s, will have ended.
Although this ray of sunshine occurs in an economy still weak and expected to remain so in the immediate future, it might nonetheless encourage PM Anthony Albanese to call an early election.
Yet the fact remains Australia’s trend per capita GDP growth has been in consistent decline ever since the federal government more than doubled net overseas immigration in the mid-2000s.
Consequently, there has been pervasive so-called “capital shallowing” and declining productivity growth because population has grown faster than business, infrastructure and housing investment.
What’s to be done to remedy this? It’s Macks Advisory’s view that Australia must break free from reliance on lazy immigration-driven growth and aim to build a productive economy that is concerned more with accommodating basic needs of individual citizens rather than the oligolectic aspirations of large corporations.
