Why a $250b mortgage pain wave might be coming

As Mott points out, “in the previous cycle, households tended to default for three reasons: unemployment; family disorders or health problems”. But this cycle is likely to look very different, with unemployment unlikely to rise from historical lows.

Instead, what worries Mott is the speed with which interest rates are rising, and how fast housing debt has accumulated in recent years.

The inflation/tariff story is well known; Expectations for a 0.5 percent rate hike on Tuesday will bring rates to 1.85 percent, from just 0.35 percent in May, and ANZ expects rates to hit 3.35 percent by the end of the year.

Warning from history

But Mott also provides some interesting historical context for how debt has accumulated, looking at the last 10 housing cycles to study the potential impact of rising interest rates on credit growth.

Particularly striking is the magnitude of the growth in mortgage commitments in the two years prior to this housing decline; The 70.1 percent increase in housing commitments seen in the two years prior to the current decline was the second largest jump seen since lending data were first captured during the 1970s, and was only eclipsed by the 131.5 percent increase leading up to the 1988-89 housing decline.

So while the RBA argues that mortgage borrowers look to be in a good position on average, with about 70 percent ahead of their mortgage payments, Mott says that this is meaningless.

“It’s similar to the old adage that ‘if you have your head in the oven and your feet in the freezer, you feel fine, on average’. In banking, it’s the tail that matters, the last 5 percent to 10 percent of borrowers.”

And this group, according to him, has been pushing himself into the market since June 2020.

Maximum borrower

Mott uses Commonwealth Bank estimates that up to 10 percent of borrowers have taken out their maximum mortgage over the past three years (i.e., these borrowers can withstand a 2.5 percent increase in interest rates but will not have excess cash) and estimates a proportion of similar borrowers or slightly larger will approach the maximum number. While he admits his analysis is very rough, he estimates between $200 billion and $250 billion of borrowers will face severe pressure if the cash rate hits 3 percent later this year as expected.

“If interest rates continue to rise sharply, and stay around these levels, there will be a ‘fat tail’ of borrowers who will not be able to pay their mortgages,” Mott said.

“For the first time in decades we are likely to see a wave of fully employed borrowers fall into delinquency because they cannot make ends meet.”

This period of mortgage stress will be exacerbated by the fact that the $800 billion fixed rate mortgages taken in the last two years at the lowest prices will begin to expire over the next 18 months, with borrowers facing sharp increases in borrowing costs; on a $1 million mortgage, monthly interest payments of $19,000 can go above $50,000.

How does all this play into the bad credit provisions of the big banks? Currently, collective terms are at a historical low of $17.4 billion, but if tariffs hit 3 percent and stay there for several years, Mott sees a scenario (although this is not an estimate) where it may need to rise $16.4 billion by the end of the year. the coming years. 2023-24.

For example, he expects the CBA’s outstanding receivables to rise from 2 basis points in the 2022 financial year to 30 basis points in 2024.

It should be noted there is a lot of water to run under the bridge here. Perhaps most notably, the RBA will probably react to the housing market pain and the economic hit caused by mortgage arrears by cutting interest rates.

And to be clear, even if the Mott scenario were to occur, there is no systemic risk to the banking system from this increasing credit decline; the “undoubtedly strong” regime implemented over the last decade underpinned the strength of bank balance sheets.

But the pain will be felt at the bank’s profits, where Mott sees another area of ​​concern.

Historical data shows housing commitments generally fell 20 percent to 35 percent during housing downturns. But due to rapid growth in the past two years, he expects a 35 percent decline in the framework this time around. That could take mortgage loan growth from about 6 percent in 2022 to 2 percent in 2024 (in the overall range between zero and 3 percent growth).

Mott also remains concerned about costs. About 60 percent of bank fees come from wages, which are clearly rising, with IT and property costs also crawling higher. ANZ and NAB abandoned their formal cost-cutting targets earlier this year and Mott has raised his cost forecast for banks again due to the inflation bite.

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