Finance Market Update – 10 April 20
Hundreds of thousands of people have already applied for a half year repayment pause for personal or business loans with the major banks and we are not even at the worst point yet. We talk about how bad this could get for banks in this update.
Let’s take a break
For many people adversely impacted by the virus taking a 6-month repayment break on their mortgage, personal debts or business loans will be a welcome relief.
Most banks and lenders are offering this and from looking at the initial numbers hundreds of thousands of people have decided to take up this offer.
That is quite worrisome.
It shows that many people are close to or already financially stressed out enough that they either are seeking financial hardship assistance, the most extreme option, or trying to manage costs by pausing repayments on debts.
At the moment these types of requests are so frequent and difficult for banks to deal with that they have staff working extra hours to manage it all and taking a lot longer to respond than usual.
It is very likely that these types of requests will continue to rise, especially as unemployment rises, which in a worst-case scenario could see a jobless rate of ~20%+.
Further to that the lingering consequences of taking the break are very costly.
The ‘pause’ in repayments does not get borrowers off the hook for the debt or the interest owed on the debt, it simply kicks the can down the road.
All of the interest that would have normally been paid each month, say $1,500 on a $600k mortgage, is ‘capitalised’ onto the loan balance after the 6-month term. That means the $1,500 of interest of 6-months equalling $9,000 is added to your loan’s principal balance, making the ‘new’ loan balance $609k after the half year break.
This means after the 6-month break the loan amount and the repayments will both be higher going forward.
The particularly stinging aspect about this is that you would end up paying interest on interest i.e. the $9k added to the loan balance you would pay interest on in your on-going repayments going forward.
An alternative to pausing repayments is to switch to ‘Interest Only’ repayments.
ASIC has advised lenders that during this crisis allowing a customer to switch from ‘Principal & Interest’ (P&I) repayments to ‘Interest Only’ (IO) does not breach responsible lending laws and customers should be able to do it to weather the virus crisis.
Most banks will make this process fairly straight forward and could be the better alternative if you have the cashflow to support it.
Similar to the above example, you would still be charged the $1,500 per month in interest but you would be paying that each month, it would not be added to your loan balance in 6-months’ time, would not ultimately make your debt more expensive and ultimately save you money.
Skyward Financial is talking to many people about these options and other alternatives so if you or anyone you know want to see what options are available let’s talk. And remember we offer a $400 gift card for any successful referral.
SME loans and bank profits
As unemployment rises so will defaults on mortgages, credit card, car loans and other personal debts. This will directly impact the losses at banks and subsequently a reduction in profit.
The 31st March was the financial half year for ANZ, NAB and Westpac and the end of financial year for Macquarie.
It is notable this year because the disclosures released afterwards will show how much they are putting aside as provisions for bad debts i.e. how much they think they will lose in the pending recession.
The provision figures will be telling to see how pessimistic the banks are right now.
And seeing as hundreds of thousands of people have contacted the big banks for hardship or repayment pauses already, they would rightly be rather pessimistic, or at least, overly cautious, to have a buffer for losses.
This will also directly impact their profit, which I forecast would decline in 2020 in the 2019 end of year update, from remediation of exiting bad debts and issues from the royal commission, which are only set to increase from the virus crisis.
Further, the all important Net Interest Margin (NIM) which we have talked about before and is the difference between how much a bank can borrow for and lend for, will come under more pressure likely resulting in decreased profits. And the longer this virus crisis goes on the lower the profits.
APRA also advised the banks to drop their dividends which will hurt their share price. The planned $7 Billion due to be paid out from the aforementioned banks will very likely be deferred.
But new initiatives from the government like the small business unsecured loan and funding program could be a welcome boost to their bottom line.
Under one of the many and newly established programs the government is subsidising the banks to lend money for businesses.
This money is strictly for working capital and is intended to help a business hibernate or make it across to the other side when the economy opens back up for business.
While the banks are able to lend up to $250k under the newly proposed scheme so far in this initial round of applications the average loan amount is only $81k, substantially below the maximum amount, but only early days.
This could move up (or down) over the coming months but I suspect a smaller portion of these loans to be at the upper quintile while most will be in the lower half.
This means many small businesses are going to have cash flow issues even if they can get a loan.
Clearer deal with commercial property
In a quick note following on from last week’s update on the grey area and disputes commercial tenants and landlords are facing, the national cabinet and government have released a ‘Mandatory Code of Conduct’ which outlines the expected benefits to each side and behaviour.
This has since been made a bit clearer but unfortunately has not eliminated the potential for disagreements completely.
Further, it is likely values of commercial property, particularly the larger A grade premium office towers will face sharp price corrections.
The fall in prices will be reflecting the lower rents, particularly as there has been a lot of delivery of stock and space which will be more than demand in the future, and the withdraw and loss of risk appetite from institutional investors.
A few key points.
The code disallows a landlord to terminate a tenancy or draw on their security if that tenant’s revenue has been adversely impacted during the pandemic. Landlords cannot terminate a lease and kick a tenant out.
It also says there should be reasonable waivers and deferrals that are proportionate to the loss of revenue the tenant has experienced. Sharing the benefits and the pain.
Rental waivers must make up no less than 50% of the proportion of which the qualifying tenant’s revenue has decreased by.
Landlords are also expected to pass on benefits and reductions they get on their mortgage freezes, reduced council/statutory fees including land tax and insurance premiums. Further, if a landlord fails to negotiate with a tenant they will lose access to the concessions available such as relief on land and council taxes and bank repayment holidays.
All of which should motivate a landlord to work with their tenant, and hopefully keep the tenant in business till the market opens back up.
Wishing you all a safe, happy and relaxing Easter break!!