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Deferral extensions ‘significantly raise’ credit quality risks

The banking sector’s commitment to extend loan repayment holidays for distressed borrowers could prolong the deterioration in credit quality and require higher loan loss provisions, according to analysts.

Earlier this week, the Australian Banking Association (ABA) confirmed that members will be implementing a new phase of support for borrowers impacted by the COVID-19 crisis.

Following discussions with APRA and ASIC, the banks, including the big four, agreed to extend loan repayment holidays by up to four months (no later than 31 March 2021) for customers unable to meet their obligations due to income loss linked to COVID-19.

For most lenders, extensions of the repayment holiday will only be considered upon the expiry of current deferral periods (most of which expire in September) and on a case-by-case basis.

According to the ABA, approximately 800,000 borrowers have deferred repayments on their loan since the onset of the COVID-19 crisis, of which, residential mortgages make up over 61 per cent.

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Internal data from Australia’s major banks suggests that approximately 20 per cent of mortgage-holders on repayment holidays have since resumed loan repayments; however, management firm Morgan Stanley estimates that a further 20 per cent of such borrowers would default on their debt, triggering a $4.3-billion rise in credit losses across the big four banks alone.

Reacting to the ABA’s announcement, Moody’s Investors Service stated that the action highlights the extent of the economic damage caused by the COVID-19 crisis, “significantly raising risk for Australian banks’ asset quality”.

This sentiment was shared by Morgan Stanley analyst Richard Wiles, who has warned that loan deferral extensions could “require a reassessment of COVID-19 overlays”.

Mr Wiles acknowledged that repayment holidays could “mitigate risks to the economy” by “avoiding unnecessary hardship and foreclosures”, but noted they would also extend the credit loss cycle, which he said would now be more likely to peak in the second half of the 2021 financial year (2H21).  

The analyst added that the extensions would “drive higher probability of default”, and “higher expected loss” in the internal models of Australia’s banks, “even where default is avoided”.  

As a result, loan deferral extensions are expected to “increase the probability” of a further dividend deferrals in 2H20, as banks reassess their capital strength.

Thus far, the big four banks have set aside over $7.2 billion in credit provisions in anticipation of a COVID-induced deterioration in credit quality.

[Related: Banks announce expanded loan deferral policies]

Deferral extensions ‘significantly raise’ credit quality risks
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