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Mortgage default rate of 10% not improbable but ‘unlikely’

A considerable spike in home loan defaults is “not outside the realms of possibility” in the current environment but would not be probable given the introduction of relief assistance, according to a new analysis.

Portfolio manager at Nikko Asset Management Chris Rands has published a new analysis of the impact of the current COVID-19-induced crisis on the residential mortgage-backed securities (RMBS) market in Australia.

Drawing on RMBS ratings assumptions from S&P Global Ratings, Mr Rands noted the group’s forecast for a 10 per cent default rate across AAA-rates RMBS transactions.

Mr Rands acknowledged that while such assumptions are “quite high by historical standards”, they are not improbable in the current economic climate.

However, the analyst stated that the unemployment rate would need to surge well beyond current market expectations.

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“In Australia, about 50 per cent of households are home owners, and if we make the oversimplified assumption that any increase in unemployment here will cause the mortgagee to default on their loan, then we would need unemployment to rise 20 per cent from its current 5 per cent level,” he said.

“In the current environment, we wouldn’t put it outside the realm of possibilities, but we currently don’t believe it’s likely.”

Like most analysts, Mr Rands said he is expecting the unemployment rate to increase to approximately 10 per cent, with relief assistance from the federal government and the banking sector helping to offset the spike in defaults.

“The experience of Australia in the early 1990s and both the UK and US in their respective crises suggest that our default rate for home loans should not rise to 10 per cent, which makes the AAA assumption that 10 per cent of a mortgage pool must default a tough one to break,” he continued.

“It is also worth noting that for Australian transactions during the GFC period, securities were all money good (i.e. they will repay on time and not default) even at very subordinated levels (at the time when subordination levels were set much lower).”

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But according to the portfolio manager, the one “caveat” to his forecast is that Australia’s household debt is “higher than it has ever been in the past 20 years” and could “contribute to a poorer outcome than we currently expect”.

Nonetheless, the mortgage industry is preparing for a material rise in credit losses, with several banks, non-banks and mortgage insurance providers recently tightening their serviceability criteria for new lending.

As a result, ratings agencies have downgraded their issuer credit ratings for Australian banks, including the big four.

Fitch Ratings and Moody’s Investors Service have also revised their outlooks on the operating environment for banks in both Australia and New Zealand from “stable” to “negative”.

[Related: Credit losses to ‘more than triple’: S&P]

Mortgage default rate of 10% not improbable but ‘unlikely’
Chris Rands
mortgagebusiness

Charbel Kadib

Charbel Kadib is the news editor on the mortgages titles at Momentum Media.

Before joining the team in 2017, Charbel completed internships with public relations agency Fifty Acres, and the Department of Communications and the Arts.

You can email Charbel on: This email address is being protected from spambots. You need JavaScript enabled to view it.

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