Deferral expiry to push up non-performing loans: Moody’s

Moody’s Investor Service expects that bank loan losses and non-performing loans (NPL) in Australia, along with the UK and US, will rise as the economy contracts in 2020.

“The scale of the increase is unpredictable, given the moderating effect of government support and bank forbearance, and uncertainty over the pace of the economic recovery,” the report said.

The research and ratings firm’s latest analysis on the extent to which pandemic-induced credit losses are set to rise noted that on 31 March 2021, a regulatory measure that has allowed Australian banks to treat loans subject to repayment deferrals as performing is set to expire.

Australian banks have allowed individuals and small businesses affected by the coronavirus pandemic to either defer loan repayments for 10 months or until 31 March 2020, depending on which comes first.

Banks will not treat customers opting for payment holidays as being in arrears during the deferral period.

However, once this expires, Moody’s expects “the change to fuel a significant increase in NPLs as some borrowers currently benefiting from deferrals will be unable to go back to full repayment”.

“In practice, the acceleration in Australian banks’ NPL formation will likely begin towards the end of 2020, when we expect the lenders to start pre-emptively applying more rigorous credit assessment processes when considering requests for repayment deferrals, or their extensions,” the report said.

“This is in contrast to the start of the outbreak, when six-month repayment deferrals, or a three-month extension after an initial three-month deferral, were available at the customer’s request.”

On average, around 10 per cent of mortgages and 18 per cent of SME loans on the major banks’ loan books were subject to deferrals at the end of August, with the number of mortgage deferrals falling since June.

According to Moody’s report, whose sample of Australian banks included the Commonwealth Bank of Australia (CBA), National Australia Bank (NAB), ANZ, and Westpac Banking Corporation, the NPL ratio of the four major banks rose by 15 bps on average to 0.77 per cent at the end of June 2020 compared with six months earlier.

Westpac led the pack, with an increase of 38 bps to 1.03 per cent, with mortgages overdue more than 90 days driving the deterioration at the bank.

“This reflects an increase in the number of customers who, instead of receiving the bank's COVID-19 relief package, which would allow them to avoid being categorised as delinquent, were granted hardship assistance instead,” Moody’s report said.

“Customers that requested assistance prior to the availability of COVID-19 packages, or who were not up to date with their repayments when they requested assistance, were placed on the bank’s existing hardship programs instead.

“Banks have also chosen to provide hardship assistance instead of COVID-19 packages to some customers as this allows for closer monitoring by the bank.”

The report noted that similar to other countries, some financially stable borrowers in Australia applied for loan deferrals in the early stages of the COVID-19 crisis, illustrating the wide availability of bank forbearance at that time.

It said that because of this, the proportion of bank customers benefiting from COVID-19 relief is not necessarily a strong indication of the stress that the loan book is under.

Among the big four banks, Westpac’s share of mortgage loan deferrals was at 7 per cent, the smallest share of its peer group.

“Differences in deferrals outstanding could, in part, be a reflection of whether the bank granted six or three-month deferrals, given that customers on shorter deferral periods are likely to have had more opportunities to resume full repayment,” Moody’s report stated.

The report has also predicted that the expiry of the JobKeeper payment will drive a spike in NPLs and keep bank provision charges elevated. Furthermore, Australia’s high household debt of around 186 per cent of disposable income will worsen this increase.

“While loss rates for Australian residential mortgages have been historically low, household resilience to an economic downturn at such high levels of debt has never been tested,” the report said.

Moody’s data revealed that payments under the program fell by 20 per cent in September 2020, and are due to decline by a further 17 per cent on 4 January 2021.

“Should the financial position of borrowers reliant on these payments to service their loans not improve by the expiration of the program, there is likely to be a surge in delinquencies,” Moody’s report stated.

The increase in provisioning charges has been more moderate in Australian banks compared with their peers in the US and UK, although their exposure to at-risk sectors is higher.

“This reflects their greater focus on residential mortgages, which account for around 63 per cent of their loan book,” the report said.

With the current average loan-to-value ratio sitting at around 53 per cent, the report stated that the mortgage book is well collateralised.

“This provides a degree of protection against the pandemic, as very significant falls in house prices would be required for banks to incur losses on their housing loans.”

[Related: Lender to pay trail on loans with extended deferrals]