Does air quality in Beijing have anything to do with the property market in Australia? The answer is probably yes.
Life in Australia, with its promises of clean air, abundant sunshine, quality education and universal healthcare, has attracted people from around the world. This demographic trend has had profound effects on the country’s housing market in recent years ‒ and, by extension, its major banks.
Today, 28% of the Australian population was born elsewhere, up from 18% half a century ago. Australian residents born in China, for example, have more than doubled in number over the past decade alone. As the country’s population has grown, demand for housing has increased, and home prices have appreciated significantly across major cities – Sydney prices have risen more than 60% since 2011. Housing itself has also evolved: While detached houses remain the traditional choice, city apartments have proliferated. Apartment construction now makes up almost 50% of new dwelling approvals in Australia, up from less than 20% historically.
The state of the housing market has important ramifications for the financial sector not least because housing loans constitute about 60% of lending at the major Australian banks. Keeping housing risks in check has therefore been high on policymakers’ agenda recently.
The Reserve Bank of Australia (RBA) has lately held the policy rate steady at 1.5% in part to avoid inflating the housing market with lower rates. In addition, the banking system is aiming to dial back appetite for property. The Australian Prudential Regulation Authority, the banking regulator, introduced a 10% speed limit on the growth of investor housing loans in December 2014 and raised the cost of regulatory capital for mortgages by imposing higher risk weights in July 2016. Banks have also tightened their underwriting standards; investors with income only from outside Australia would now find it very difficult to obtain mortgages from the major banks, and new mortgages with loan-to-value ratios higher than 90% have declined significantly. Residential property development loans, a riskier form of commercial property lending, remain below 2% of system exposure.
Australian banks resilient
Looking ahead, we expect Australian banks to remain resilient as the housing market cools.
Appreciation in housing prices should moderate to between flat and low single digits this year. A heavy pipeline of new city apartments is expected in 2017 and beyond, which may create oversupply in localized areas, weighing on prices and adding to settlement risk. The wealth effect on consumers will likely diminish accordingly, partially offsetting the impact from improving national income dynamics and keeping household consumption modest.
While we expect the RBA to remain on hold in 2017, banks may raise mortgage rates in an effort to recoup an increase in their funding costs due to higher rates in offshore wholesale funding markets. This will likely add somewhat to the debt service burden of Australian households, whose total debt stock is already 130% of GDP.
Finally, we expect the credit profiles of major Australian banks to stay resilient. Credit costs will likely normalize from current low levels, but the impact can be absorbed, principally through softer profits. Our stress tests show that the major Australian banks have adequate capital to withstand severe economic stress (last seen in Australia during the 1990s). Major banks also operate in a collaborative manner with one another and the regulatory agencies, providing a positive backdrop.
Within the Australian bank capital structure, we find Tier-2 instruments currently offer the best risk-adjusted return potential and senior securities present opportunities for high credit quality investments.
Taosha Wang is a credit analyst in Hong Kong, Aaditya Thakur is a portfolio manager in Sydney.