Property and the Big Four Australian Banks

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There is an increasing amount of focus on the Australian residential property market. Last week, outgoing BHP Chairman Don Argus said: ‘I think the Australian Banking Sector has gone too far. You can look at some of them now as giant building societies.’ He was referring to the large exposure that the big four Australian banks have to residential property.

Last Monday morning, RBA Governor Glen Stevens took the unprecedented step of appearing on Sunrise, the popular breakfast program to, among other things, warn people against speculating on house price appreciation. ‘I think it is a mistake to assume that a riskless, easy guaranteed way to prosperity is just to be leveraged up into property. It isn’t going to be that easy.’

Stevens’ comments, and Argus’ for that matter, both reflect concern over the potential outcome of Australia’s multi-year infatuation with property. These two men join a long line of commentators who, over the past few years, have warned about the sustainability of rising house prices and their effect on the economy.

Despite this, the market refuses to buckle. The warnings are roundly ignored. Now, just a year ‘after’ the global financial crisis, things are apparently back to normal and house prices are surging around the country again.

But like the boy who cried wolf, the warning that you should have listened to will be ignored. This warning will more than likely turn out to be Stevens’, delivered on 29 March 2010. We shall see.

Property bulls cite a number of reasons why the market has solid fundamentals behind it. Strong demand driven by population growth and lack of supply (caused by government meddling at the local and state level) are the main ones.

What is mentioned less by the property bulls is the seemingly endless availability of credit supplied to the property market by the banks. As we have seen over the past few years, property price declines occurred in the US, UK, Ireland etc, because of a restriction of credit.

Indeed, as credit was drying up in Australia in 2008, house prices were beginning to register falls across the board. But plummeting interest rates (which fell to 3%) and taxpayer guarantees for bank borrowing ensured that the supply of credit remained plentiful. To absorb that supply, the government handed out up to $21,000 to first homeowners.

The policy was a resounding success. But success in economic matters depends on timeframes. A politicians’ timeframe is roughly to the next election. That is, the pollies are interested in short-term success. Unfortunately, a focus on short-term success can lead to long-term problems.

Here is one of our favourite quotes on the matter:

“Economics…is a science of recognising secondary consequences. It is also a science of seeing general consequences. It is the science of tracing the effects of some proposed or existing policy not only on some special interest in the short run, but on the general interest in the long run.”

Henry Hazlitt – Economics in One Lesson

So we await the long run secondary consequences of the government bailing out property owners (the special interest) in the short run. It should be interesting.

With so much space being devoted to the pace of interest rate rises and their effect on property prices, we thought you should know how exposed the big four banks are to the housing market.

We have gone through the big four’s balance sheets to come up with the data in the accompanying table. The National Australia Bank (ASX:NAB) is the largest bank by assets, followed by the Commonwealth Bank (CBA), Westpac (WBC) and ANZ (ANZ).

As you can see, loans and advances are a banks’ largest asset. In the table below we focus on Australian domiciled loans. The other main asset components are listed in the table.

 

We further break down the Australian Loans and Advances data to show Australian housing loans.

The ratios produced from this data are interesting indeed.

As shown in Australian lending as a % of total assets, WBC and CBA are most leveraged to the Australian economy with nearly 70% of their lending assets based in Australia. ANZ is next and NAB, with its large UK exposure, has less than 40% of lending assets in Australia.

Housing as a % of Australian Lending shows all four banks have around 60% of their local lending books exposed to residential property. From a broader risk perspective, both CBA and WBC appear highly exposed to property, with 45% and 43% of their total assets respectively comprising Australian residential property. ANZ and NAB have a greater strategic focus on offshore markets and so are less exposed to the local property market.

There are a number of reasons why the banks (especially CBA and WBC) have such large exposures to housing. According to the recently released Financial Stability Review conducted by the RBA, in the early 1990s business lending accounted for about 60% of total credit outstanding.

The deep recession at the time saw banks suffer heavily as high interest rates pushed businesses to the wall. Ever since the banks have been increasing their exposure to housing at the expense of business.

You shouldn’t be surprised though. The regulatory system makes it more profitable for banks to lend against housing than against a business.

Here’s how it works.

Regulators require banks to hold capital against their assets. This is the Tier 1 and Tier 2 capital ratio’s that banks mention when discussing their ‘capital adequacy’. However they don’t hold capital against their total assets. Rather, they are required to do so against their ‘risk weighted assets’.

In determining the value of risk-weighted assets, the banks are only required to include 50% of the value of a residential mortgage loan. (This assumes a loan to value ratio of 80-90% and no mortgage insurance). In other cases the requirement is only 35%. For business loans, banks need to include 100% of the loan value in their risk-weighted asset calculation.

So it’s far more capital efficient (and therefore profitable) for the banks to make housing rather than business loans. And surprise surprise, that’s what the banks have been doing.

Housing loans only require around 50% of their value to be included in the risk-weighted asset calculation because they are considered a very low credit risk. And that has historically been the case. Funnily enough, this was also the claim to justify the huge amount of speculation in the US housing market a few years ago.

As the great US economist Hyman Minsky was famous for saying, ‘stability breeds instability’. In effect the stability and ‘safeness’ of residential mortgages has led to this asset class being rewarded with a larger and larger amount of credit. This in turn has pushed up property prices, which has increased demand for property and credit.

If the past is prologue, then Glen Stevens’ warning will be widely ignored. It is the availability of credit that has the largest bearing on asset price bubbles, not the words of the man who tries to put a price on that credit each month. Even returning interest rates to ‘normal’, which is around 5% may not be enough to halt the renewed speculation around housing. 5% interest rates are hardly likely to deter the banks from continuing to extend housing credit either. As we will see, that is what underwrites their profits.

Our best guess is that an external credit shock will turn the tide for the property sector. We saw this in 2008 when foreigners were reluctant to continue lending to Australian banks to fund property purchases. We have little doubt that in a deleveraging global economy, another such episode will occur. (See the next essay for a discussion on Australia’s foreign debt and the role of banks).

The bulls will retort that the government will step in again, guarantee debt and support asset prices. We have no doubt the government will meddle again. But financial markets rarely respond the same way twice and we doubt that property investors will get lucky the next time the flow of global credit dries up.

But in the meantime, the banks are benefitting handsomely from the relentless rise of the property market. You can see from the expected profitability levels (see consensus ROE in the table) that CBA and WBC are the standouts. This is no doubt a reflection of their exposure to Australia and in particular the Australian mortgage market.

Even ANZ and NAB’s latest results show their Australian operations as the standout performer. However their different strategies (ANZ: Asian expansion, NAB: wealth management focus, large UK exposure) sees the market expect lower profitability from them compared to CBA and WBC.

So what does all this mean?

Well, this analysis clearly shows why CBA and WBC have been the standout profiteers in the banking sector. With a large focus on the booming Australian housing market, it’s no wonder their profits and valuations (see price to book measures in the table) are at a premium to their peers.

But it also suggests why you need to be cautious on the sector as a whole. At some point the abundant credit now enjoyed by the housing market will diminish. This will put pressure on prices and for the banks, loan volumes will decline, which will in turn lower profitability.

Greg Canavan
for The Daily Reckoning Australia

Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.
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42 Comments on "Property and the Big Four Australian Banks"

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Sambo
Guest

Nice article Greg :)

chris
Guest

I totally agree. But do you think that the Australian government would be so cheeky as to give investors from China unlimited access to buying Australian houses, so as to prevent the bubble popping for another few years. They wouldn’t dare- would they???

Firebug
Guest

I’m not sure about this Chinese buying Aussie houses thing.

When (note not if) Chinese yuan goes up in value, A$ should decline against it. This would make Chinese who have already bought houses here lose money.

I think the Chinese who have bought here probably also believe in this myth of Aussie houses never go down in value. As our housing bubble bursts, there would be less incentives for Chinese to buy.

Do we hear much about Chinese buying houses in the US, even though houses are much cheaper over there?

Realist
Guest
Chris, i hate to be a pessimist about this but Krudd has proven he will do anything, no matter how far fetched, to keep housing and investing going. I have no doubt in my mind that he will do a US style bail out of the banks if this all turns to crap. I heard in the news this morning that he (Krudd) cancelled his Washington trip due later this month so he could concentrate on his health care bill. Does this sound familiar?? He is like a dorky white version of Obama and about as original as modern denim… Read more »
John
Guest

We’re helpless at the mercy of a cruel, unforgiving world. We are powerless to prevent an epidemic of catastrophes about to engulf us. And every day, somewhere in the world, a woman is giving birth.

We have to find that woman and stop her.

Coffee Addict
Guest

Great post Greg. It’s all been said before of course BUT I agree with your key point about an external trigger being required to bring down the card deck.

In a round about way, taxpayers in the US and Europe are funding the property bulls (though the bank loan books) with continued low interest rate policies. Do they want to do this? NO! For how long will they do it? God only knows. Other triggers? There are plenty. For starters try POO approaching USD100 by the end of the year.

cheers

89peterg
Guest

“You can look at some of them now as giant building societies.”
yea, except for the building part.
maybe the government could meddle more and require that 50% of the housing loans go on new (net) housing.
and re chinese investors might get stung paying premium, I reckon that many are seeing it as their swiss accounts if things go pear shaped in china, kind of like a new taiwan for ex “communists”.
it good to be old enough and remember the eary 90’s when interest rates were sky high… never happen again though, heh?

Bertie
Guest
A lot of folk who got burnt recently in the stockmarket and such are now putting their money into housing! The sort of folk who bough Telstra shares. You can double yr money in housing in 7 years, why not! These ‘investors’ are putting the biggest pressure on demand, there does have to be some equilibrium between property values and rents(wages), if not there will be a correction sooner or later. The U.S. housing market crashed in a big part due to bad loans and over supply, Australia had neither of those so for the life of me I can’t… Read more »
Justin
Guest
Take anything Stevens says with a grain of salt. The RBA has been inflating the currency for ever, they still are, just not so much at the moment. The RBA is ‘wholly owned by the Australian Government’ so they just apply the governments’ policy, which is to inflate. The government cannot sit back and allow the money market to fail. The AUD is a bearer cheque drawn by a commercial bank on the RBA. In effect a dollar bill (of whatever denomination) is the RBA saying “there is on deposit at the RBA (insert number)$”. I can tell you now,… Read more »
Chris Y
Guest

If I am to believe some property analysts, a few of our big cities are ripe for rises, and big ones, too.
Foreign property purchasing may not be new, but if foreign buying comes in to the local metro real estate market on a big scale, it would be the joker in the pack. It will push real estate all the way up, but also set a time-bomb that could bring the whole market down some day. So the outcome may not depend entirely on interest rates.

Stillgotshoeson
Guest
The RBA does not set the value of the dollar.. they at times try to support it but it is for the most part set by economic forces.. WHEN China fall over you will see our resource based currency valuation take a dive.. and a big one at that, if the USA mange to get hold of their economy and start raising rates.. our dollar will be dumped and a run on the USD will ensue.. the RBA may react to these events but it certainly can not control them. The signals to watch for over the coming 12 to… Read more »
Bertie
Guest

Stevens has got a mandate to keep inflation within a certain range, he does not work in tandem with the government but is independent, his prime concern will be his own legacy and will do what it takes to keep inflation in check by raising rate to what level he feel necessary.

The RBA does not set exchange rates

Don
Guest

Please call the first home owners grant by its proper name, that is a federal subsidy to the states to offset the stamp duty on the property transfer. Geez.

Keith
Guest

The RBA is powerless with regard to interest rates. They merely follow the bond market, and announce the target rate for all to see. Exactly how this is a public service, or of economic value is anyone’s guess. Banks need to obtain funding, so they must pay the going rate, and this rate will be factored into the mortgage rates on offer, irrespective of fulminations from our clueless Treasurer.

Biker Pete
Guest

“Housing as a % of Australian Lending shows all four banks have around 60% of their local lending books exposed to residential property.”

Those foolish banks! They’ll all be rooned!!~ ;)

Justin
Guest

Yes Bertie, he has got a mandate to keep inflation within a certain range and that range is up!

john
Guest

There is really no evidence that house prices are rising all that fast.

House prices in rural areas have fallen in actual terms (not just real) over the last 3 years, they’ve only been kept up in the cities by restricting supply and zoning laws.

The supply of credit and wages are the key determinants of house prices. Credit supply is not rising fast enough to create a price surge, and wages have been _falling_ over the last 2 years, and are still falling now.

Biker Pete
Guest

John: “There is really no evidence that house prices are rising all that fast.”

I agree. Talk of a bubble is silly, isn’t it?!~

John: “House prices in rural areas have fallen in actual terms…”

Agreed again. Expect to see these areas rise in WA, particularly.
Prices here fell by as much as 8%. No bubbling there! :)

John: “…wages have been _falling_ over the last 2 years…”

Holy Cow, John! Where… and in which occupations?

John
Guest

89peterg: “…it good to be old enough and remember the early 90s when interest rates were sky high… never happen again though, heh?”

Ahh, but what about the daze when shire councils helped us strata title big Special Rurals for multiple dwellings, PeteG? Probably never happen again though, heh?!~ ;)

Davo
Guest

Brisbane real estate isn’t going gangbusters at present, from what I see. Certainly nothing like the Melbourne market.
I am biased, being a born and bred QLDer, but what is so wonderful about Melbourne that is attracting all those buyers?
To quote Pauline, please explain, somebody.

Chris Y
Guest

The US used to be the big story, and now it is China. But actually, it must be both those countries, for how can China prosper if it can’t sell ship-loads of goods to the USA? Answer: with great difficulty.
Yes, the party ain’t yet over, and I’m being too pessimistic, but if China is unable to sell so much to the USA, do you think the Chinese will go on buying in record volumes from Australia?

Kohl
Guest

A summary of the Changes to Foreign Investment Policy – Residential Real Estate can be found at the FIRB website.

http://www.firb.gov.au/content/policy.asp?NavID=1

realist
Guest

People,

The time is the best judge !
And by that logic be sure the property will not fall !
May be 5-10% but no more !
This not help anybody who missed the chance to buy in last year

If it goes up say 30% and then get adjusted back by 5% it is hardly called a loss

Any thoughts

Stillgotshoeson
Guest

Houses in some areas will fall by far greater than 5% of 10%, some may not fall at all..and some may even go up….

$300000 house that has increased 50% to $450000 suffers a 30% fall in value goes back to $315000.. all gains effectively wiped out.. 40 or 50 percent sees that house go negative..

In some suburbs of Melbourne and Sydney this is a strong possibility.

Lachlan
Guest

Timely point re oil CA. Some factual data on Chinas Aus property investment would be good…unless I missed it.

Joe
Guest
If the big 4 banks are now the pillar of our economy and their fortunes are all tied up in our housing market, it seems to me Australia ‘is’ putting all of its’ eggs into one basket. Sooner or later the housing market will become unsustainable, and the impact of a decline in demand to own, with a cycle of diminishing values, and you will see what happened in the E.U and U.S damage our ‘4 pillars’ so much that the government will have to buck the market again. They have done this in the U.S and U.K to stop… Read more »
Lachlan
Guest

Crumbs AUD has a sharp spike up this morning to yearly resistance…maybe needs a pullback now but looks like it could break into 94s soon. Have to see how it holds up from here.

Lachlan
Guest

AUD bears must have capitulated so a pullback now could be inverse H and S followed by rally up. US gold up sharply too and if pullback now Im getting longer. Interesting days.

Ross
Guest
Lachlan, the important piece is that this “informs” us. With the Greek resolution yesterday look at the AUD-CAD cross. Both being commodity currencies but you can see which of the two currencies is the greater risk & carry currency. So the bulls will have it until such time as a deleveraging event occurs. Greek safety if you will for now but there are events lurking in all corners in the world of sovereign debt. You have to give it to the EU in terms of a neat short term fix, with the guarantee only to be used if they can’t… Read more »
FreddyC
Guest

Hi Greg,

In trying to work out where is the safest place to be storing my savings, I would be VERY interested in knowing the LVR profiles of each of the banks. eg. if a property crash occured in Australia what amount of bank loans would be in a Negative Equity scenario and likely to contribute to bank impairments.

Average LVR really don’t tell me much because mortgage holders with more than 50% equity in their homes would not contribute to bank impairments.

Lachlan
Guest

Thankyou for your info Ross. I am just amazed at how this story unfolds and at least any decent pullback in equities here (AU was getting there I know)and US would have me breathing easier…but the ability of global markets to be held in suspended animation by the big boys has just staggered me. Markets keep rising on low vols forever, making and breaking the hopes of shortsellers. The CAD is something I need to learn more about so will get on to that one tonight…and the Greek res. also. Its the best soap opera in town but :)

Biker Pete
Guest

From 8th April- John: “…wages have been _falling_ over the last 2 years.”

Holy Cow, John! Where… and in which occupations?

This question remains unanswered, John. _Where_ in Australia is this happening… and in which occupations?

Don
Guest

I can tell you Biker – in North Queensland, at the mine I am working at, no wage rises for the last two years :)

Lachlan
Guest

But cost of living has gone up Don.

Biker Pete
Guest

Don: “I can tell you Biker – in North Queensland, at the mine I am working at, no wage rises for the last two years :)”

Great you can still smile about it, Don. Ever thought of following the real money? Could be a WAy to get WAy ahead… .

Lachlan: “But cost of living has gone up Don.”

Well, _that_ I admit, is a new phenomenon! :)

Don
Guest

I should qualify that statement, sure the money has not gone up but it is far too interesting a job right now to leave. I am also happy on the money and conditions I am on as well so that combo has been hard to find.

As far as working in WA goes….pass on that one for now. Had enough of fly-in fly-out capers for a while.

Regarding cost of living – tell me about it, our horrid landlord raised the rent by 5 bucks a week! The swine :)

Lachlan
Guest

Gidday Don..I suppose very few staff are turned over in small gold mines or is that untrue? Can I ask what you do you like so much?

Lachlan
Guest

Just to clarify.. do staff in small Au mines stick with jobs or cycle through is what Im trying to say..from what you’ve seen around.

Don
Guest
I am a project engineer working for a base metal miner in Queensland. In the area I work in you get small high grade deposits around the place which are certainly interesting to treat but you don’t really get a lot of meat to play with. Always moving on to the next one just to keep things afloat. Recently we managed to come up with a process to treat a deposit that several other high end laboratories couldn’t figure out what to do with and it looks like it will save our bacon – very satisfying although we had help… Read more »
Biker Pete
Guest

Agree FIFO sucks, Don. The people who appear to enjoy it most are couples employed by the same mining company. We know a young couple in their mid-twenties who own their home outright, after four years’ FIFO. They’ll now use it as equity/a rental, to step up to the next… . :)

Mining in WA pays so well, that many non-mining families here _bitterly_ resent the good fortune of people prepared to sacrifice a few years to get ahead.

I guess there will always be resentment of that kind.

Lachlan
Guest
Arghh..my inner market-orientated alarm clock just woke me up to see the NY action. Don..great post and thanks for informative reply. I collect native plant seed which goes into mining reveg and its a market I want to expand after the recent rains produce crops inland. I often look at green grass at the other end of the equation (high paid mining jobs) and ponder…a mid life career change…horticulture to mining? And my kids are spending more time with their mum so its all possible. So if you were my neighbour Don Id have a million questions but maybe not… Read more »
Stillgotshoeson
Guest
From the REIV (Real Estate Insitute Victoria) Website. 12-May-2010 * Last weekend: 871 auctions, clearance rate of 76 per cent. * This weekend last year: 451 auctions, clearance rate of 83 per cent. * This weekend 2008: 578 auctions, clearance rate of 64 per cent. Comment The REIV is expecting around 700 auctions this weekend followed by 800 next weekend and around 950 in two weeks time. The cumulative impact of 6 interest rate increases, concerns about affordability and more significantly the very high number of auctions were significant factors behind last weekend’s lower than average clearance rate. As it… Read more »
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