There are hopeful signs despite rate increases and soaring inflation, analyst says
With interest rates and inflation on the upswing, one of the sharemarket’s biggest fears is that banks will face a wave of bad mortgage debts and loan defaults.
This fear is a key reason why share prices for the big four banks plummeted between 13% and 19% last month, according to a report by The Sydney Morning Herald.
However, some analysts say that bank profits are unlikely to be hobbled by a rising tide of mortgage defaults. Reasons for optimism include the likelihood of households cutting expenses, high savings levels, low unemployment, and the large provisions for bad debts that banks are already holding, the Herald reported.
According to the Reserve Bank of Australia, “the average customer” is well ahead on their mortgage payments, and households have amassed more than $250 billion in savings.
The market, however, is more worried about risky borrowers, such as those with large debts or irregular incomes.
Jarden chief economist Carlos Cacho analyzed how borrowers most heavily in debt – more than six times their annual income – would fare if the official cash rate rose to 2.5%. He told the Herald that repayments for that group could spike to as high as 50% of their income. However, Cacho said he wasn’t worried about a sharp spike in mortgage defaults.
Cacho told the publication that when banks approve a mortgage, they assume that, if necessary, borrowers could cut their spending to a certain minimum, determined by a tool called the Household Expenditure Measure (HEM).
The typical family of four has annual consumption of around $81,000, Cacho said. However, the HEM suggests that such a family could get by spending only $51,000.
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“While higher rates represent a financial challenge for many households and will likely see consumers cut back on discretionary spending, we are not concerned about a significant rise in mortgage defaults at this stage,” Cacho said.
Banks also have multibillion-dollar “rainy day funds” amassed during the COVID-19 pandemic to help mitigate defaults, the Herald reported. Major banks added billions of dollars to their provisions for bad debts during the pandemic amid fears that COVID would kick off a crippling financial crisis. That didn’t happen, but banks have made only small cuts in their provision balances, which are still higher than they were before the pandemic.
The big four banks had about $20 billion in provisions in the latest half, the Herald reported.
