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Australia: Australia Banking

2011/06/06

 

 

 

Australia Banking

A steep drop in Australian property prices will have dire consequences for the country's heavily leveraged banking industry, with Commonwealth Bank of Australia (CBA) serving as a case in point. We are concerned about the vulnerability of the Australian banking sector to the property sector over the next few quarters - a concern that still appears to be at the fringes of the world consensus view.

A sudden drop in housing prices may lead to widespread defaults that could wipe out large portions of financial institutions' balance sheets, presenting severe downside risks for the ASX 200 financial index, particularly for some of the majority exposed institutions. Unlike their peers elsewhere in the Asia Pacific region, with the exception of New Zealand and perhaps South Korea, Australian banks rely heavily on foreign financing, posing the additional risk of capital flight in the event of a severe banking crisis. At worst, a government bailout of the industry may become necessary to prevent contagion to other parts of the Australian economy.

A closer look at the numbers show that the 'large' - CBA, Westpac Banking Corporation, Australia And New Zealand Banking Group (ANZ) and National Australia Bank (NAB) - are amount heavily exposed to the real estate market, as mortgages make up 61.8% of their collective Australian loans and advances. The assets of these banks have expanded significantly due to an increase in financial support by the government for property buyers following the world financial crisis in 2008-2009, which compensated for the fall in commercial lending as businesses continued to deleverage over the same period. This government support for (mostly first-time) home buyers has, in our view, delayed a sizeable mean-reversion in Australian consumers' debt-to-income ratios.

Property Prices: What Goes Up Must Come Down The final leg of the property boom was fuelled by the government's increase of the first home owner grant (FHOG) and the existing home owners' grant to AUD21,000 and AUD14,000 respectively in October 2008. The grants encouraged a lot of lower-income Australians, who would otherwise not afford to buy a home, to prop up the bubble. This led to a further nationwide increase in established home prices, which rose by 18.4% year-on-year in June 2010. As a result, we estimate that home affordability plummeted as places such as Sydney saw the median home price-to-household income ratio exceed 9.0. The figure for affordable homes should be closer to 3.0.

The public policy consultancy Demographia lists Australian cities, including Sydney, Melbourne and Brisbane, in the top 10 least affordable places to live in the world, which underlines our concern. Apart from the withdrawal of expansionary fiscal measures, prospective home buyers will need to contend with much higher mortgage rates. The standard variable mortgage rate is currently around 7.40%, or 160 basis points, higher than the 5.80% level it was at in September 2009, before the Reserve bank of Australia started to hike interest rates.

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