The Emergence of Mortgage Defaults

Investing Psychology May 29, 2020 / Reading Time: 2 mins
By Divik Nigam Reading Time: 2 mins

The term ‘mortgage defaults’ may spark fear among many investors as this was a significant player behind the 2008/2009 GFC. In more recent times, CBA has set aside $1.5b for potential defaults, pushing their total provisions to $6.4b in an attempt to resist shocks and sustain during this economic downturn. Westpac, NAB and ANZ have similarly set aside $1.6b, $807m, $1b respectively, for the same reason – provisioning.

Unemployment

Additionally, Australia’s increase in unemployment also plays a major role in mortgage defaults, with approximately 15% of individuals with mortgage buffers being vulnerable to sharp declines in income. Furthermore, research conducted by the RBA highlights that for every 1% increase in unemployment, the nation’s mortgage arrears rate increases by 0.8%. The impacts of unemployment directly contribute to May data, revealing negative sentiments as loans from the major banks total over $200b and an estimated 50% of customers have requested for a deferral in repayments.

Housing Prices

This huge influx of credit risk also takes a toll on the housing market, with a potential slump in house prices of 11% (in the event of a quick recovery ~ next 3 years) and an estimated maximum of 33% (long-term recovery). Additionally, the economic ramifications of COVID-19 make Tasmania stand as the nation’s most financially stressed state as the synergetic effects of high property prices (relative to income) and the closure of tourism, forces more than half (51.5%) of individuals to be under housing stress.

Dividend Payments

Nonetheless, the pressure on the economy introduced by the drop in housing prices is additionally compounded by the reduction in dividend payments from the major banks. Banks which contribute to the cut in dividend involve both Westpac and ANZ, who have removed their dividend payment for the current period, and NAB, who has decreased their dividend by 66%. If Commonwealth is to follow in a significant reduction, this may result in a total loss exceeding $10b for the half-year. Dividend cuts is a major factor which contributes to roughly 3% of affluent households (more leverage used to diversify their income streams), also at risk of defaulting on their mortgage.

Homeowners however, only contribute to half of the story. Rental stress is another going concern for many Australians, with roughly a third of Sydney renters struggling to pay their rent. A similar picture is painted in Victoria where 37.0% of tenants are forecasted to be unable to pay their rent, much like the staggering 61% of rental households in Ballarat, who too, will struggle enormously to meet make ends meet and pay their rent.

With lockdown restrictions easing around the corner and the economy’s cogs shifting again, many investors may seem optimistic about the near future. In the context of mortgage defaults and homeowners feeling financial stress however, this is only the calm before the storm. Predicaments such as mortgage defaults often take time to evolve, and the only facets that act to mitigate their ramifications is an increase in employment i.e., more sources of incomes for homeowners.

Investors should nonetheless realize that a great proxy to use to measure economic strength and recovery during this pandemic, are the adjustments banks are making to resist eventual mortgage defaults.