Higher bank margins could be "swamped" by impaired loans

"This may be the first credit cycle in over 50 years to be led by households," expert says

Higher bank margins could be "swamped" by impaired loans

While Australian banks are on track for solid earnings this reporting season, they’re facing a slowdown in credit growth as interest rates rise.

Barrenjoey’s Jonathan Mott predicts that banks’ net interest margins will rise 11 basis points by the second half of 2023 as lending rates rise faster than deposit rates, according to The Australian. While that will give profits a boost in the short term, however, Mott said a rapid deceleration of credit growth and deteriorating asset quality are “inevitable” and impaired loan charges will offset the rise in margins.

Mott said that higher net interest margins would be “swamped” by asset quality concerns. About $250 billion in mortgages – approximately 10% of all outstanding mortgages in Australia and New Zealand – were given to customers at or close to their maximum borrowing capacity since the pandemic. Those mortgages are at risk of falling into delinquency if the Reserve Bank hikes the cash rate to 3% by year’s end, as it is expected to do.

The central bank raised the cash rate by 50 basis points to 1.85% this week, the latest in a series of hikes since May that boosted the rate from a record low 0.1%.

“This may be the first credit cycle in over 50 years to be led by households,” Mott told The Australian. “If the cash rate rises to about 300 basis points, a large proportion of these customers are likely to become delinquent, especially if rates do not fall by late 2023. This is likely to hit home as fixed rates mature in calendar year 2023.”

Read next: More rate hikes on the way, says RBA boss

Mott said that much of the interest rate leverage banks enjoy over mortgage brokers – who now account for about 70% of mortgage flows – is likely to be “competed away” over the next few years.

“In effect, higher interest rates leverage is a ‘sugar hit’ for the banks which is likely to be unwound over time,” he told The Australian. “However, given the increased speed and extent of interest rate rises, we have increased our net interest margin forecasts for the banks, especially in the near term.”

Mott said the rise in mortgage commitments over the past two years – a 70% surge – is the second-fastest on record.

“We believe it is a common misconception that housing credit growth is generally tied to GDP growth and is a function of population growth and the demand and supply of properties,” Mott said. “We believe housing credit growth is mainly driven by interest rates and lending underwriting standards.”

In line with “more significant corrections” seen in past markets, Mott told The Australian that he expects mortgage commitments to fall between 30% and 25% from peak to trough, slowing credit growth to almost zero by late next year.

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