Australia’s mortgage crunch is about to get worse

The mortgage squeeze that is already hammering parts of Sydney is about to get much worse.

A new report from Moody’s Investors Service claims that out-of-cycle rises in the home loan rates of 16 small and midsize Australian banks over the last few months has cleared the path for Australia’s Big Four banks to follow suit:

Given that the four major banks have traditionally been the first-movers on headline home loan rates, we see smaller lenders’ willingness and ability to increase rates as credit-positive evidence that they retain pricing power independent of the current challenges confronting the major banks.

Moreover, public comments by NAB’s chief executive on Tuesday that its rates are “under constant review”, suggest that the rate hikes by the smaller banks may be paving the way for the major banks to raise their rates and preserve margins, despite the politically charged environment…

Higher home loan rates will offset higher wholesale funding costs, with short-term funding costs being particularly affected in 2018 (see Exhibit 2)…

Morgan Stanley recently cited two factors at play that are driving-up bank funding costs, namely:

1. Upward pressure on the Bank Bill Swap Rate (BBSW); and
2. The ongoing decline in household deposit growth:

There’s another factor, as well. International deposits have pulled-out of Australia, driven in part by the less favourable spread between Australian interest rates and those overseas, replaced by more expensive wholesale sources of funding:

Earlier this month, Martin North from Digital Finance Analytics warned that small increases in mortgage rates – to the tune of just 10 to 15 basis points – could push roughly a million Australians into mortgage default:

“Today 975,000 households across Australia with owner-occupier mortgages are right on the edge now”…

“And there are around 50,000 who are already over the edge and are looking like they could default.

“If rates went up by 0.15 percentage points, that would go up closer to the round million”…

With no sign of an end to price falls, an ongoing reset for interest-only loans for another three years, rising bank funding costs and mortgage rates, a fading economy with no inflation nor wage rises, plus an aged cycle heading into some kind external shock, the whole system is about to be tested. And this is before you factor in Labor’s negative gearing and capital gains tax restrictions in the likely event that it wins the upcoming federal election.

The only saving grace is that the RBA will probably be forced to cut rates some time next year. But with the cash rate already at just 1.5%, and the banks certain to keep half of any cut, they are unlikely to stem the pain.