Is the Banking System at Risk from Property?

The residential property mortgage market in New Zealand is dominated by the major trading banks. These are owned by their Australian parent banks. These large Australian banks, NAB, Westpac, ANZ, and CBA, dominate the residential mortgage market in Australia. Collectively, they have a huge exposure to the residential property market on both sides of the Tasman.

We have seen how these banks coped with the global financial crisis (GFC). Their problem was sourcing funding, of which a large percentage was traditionally arranged off shore with borrowing from other banks. This funding source virtually dried up, as the lending banks became credit strapped themselves because of lending defaults from the likes of Lehman Brothers. Both the Australian and New Zealand governments stepped in to provide guarantees for the banks, provided certain obligations were met.

Regardless of this governmental action, the availability of credit was somewhat less than prior to the GFC. Banks in Australia and New Zealand had to somewhat tighten their lending criteria, with businesses in particular finding that their credit lines were often somewhat reduced. Mortgage lending also tightened up, with new mortgages having to meet tighter loan to valuation ratios, as well as lower debt servicing levels.

Some people are asking the question “What if the Australian property market tanks, what will be the impact on the banks here?” For years the Australian property market has seemed to be very expensive, particularly in Sydney. Australian residential property prices are higher than what the USA ones were at their peak, and household debt is also higher than in the USA. Despite massive corrections (politically correct language for falls) in the United States and some European countries, the Australian market has been very resilient. While the time taken to sell property on average may have increased by a significant number of days, prices have not decreased to any extent.

Unlike in America, if you run out of equity in a house and the bank forecloses with the property becoming bank owned (the borrower hands the banks the keys), in Australia and New Zealand there would be a mortgagee sale, with the borrower still being liable for the balance. In this situation the borrower may declare bankruptcy in order to have the debt reduced.

Australian bank data suggests that only 16% of loans have a Loan to Value Ratio (LVR) of greater than 80%, and only 5% have LVR’s of greater than 90%. A 30% fall in value indicates that 11% of the portfolio would be 15% in negative equity, while 5% would have 25% negative equity. If all these borrowers defaulted, the banks would lose an amount equivalent to 2.9% of their portfolio. The reality is that maybe 10% of the borrowers may not service their loans so the banks would make a loss of around 0.29% of their loan book. Add in some additional losses, and this may rise to 0.4%. This compares to bank margins of 1.5% to 2%. Because of this, it is unlikely that the Australian owned banks will be brought down by a collapse in the housing market.