Home Brokerage Are Australian Bank Lending Practices Creating a Property Bubble?

Are Australian Bank Lending Practices Creating a Property Bubble?

by internationalbanker

By Elizabeth Frasier-Nelson, International Banker

At the beginning of April, Governor Philip Lowe of the Reserve Bank of Australia (RBA) delivered a speech in which he directed much criticism at the lending practices of the country’s banking industry. In particular, he took aim at what he described as the “unusual” levels of approvals of interest-only loans, which are preferred by borrowers looking to capitalise on tax breaks on property investments. According to the Australian Prudential Regulation Authority (APRA), such loans today account for almost 40 percent of residential mortgages, which the regulator considers to be “quite high” by global standards. Indeed, the governor highlighted the trend of purchasing residential property purely for investment purposes and reaping capital gains as being particularly concerning for future house-price inflation.

Concern has been mounting in recent years over the country’s red-hot housing market, which some believe is now approaching “bubble” territory in certain parts of the country. According to a Demographia International Housing Affordability survey, median prices in Sydney and Melbourne are respectively 12.2 and 9.5 times average earnings, while home prices in Sydney have more than doubled in the last eight years. The OECD (Organisation for Economic Co-operation and Development) has warned of the likelihood of a “rout” in Australian house prices taking place, and that prices and household debt levels are at “unprecedented highs”. Research from the organisation states that prices have surged by 250 percent from their 1990s levels, and have done so in a significantly more pronounced fashion in the past few years. It also recently signalled that further housing-market heating created by both investors and owners “may end in a significant downward correction that spreads to the rest of the economy”.

The reasons behind the housing boom currently being witnessed are relatively straightforward. A lack of supply of new houses in major cities has combined with attractively low interest rates and sustained economic growth over many years to send prices soaring. Much of the demand side is also populated by investors, who have benefited from tax breaks known as negative gearing, which has allowed landlords who own loss-generating rental properties to claim deductions on their tax bills. Those who buy an investment property and hold it for more than 12 months, moreover, are entitled to a 50-percent discount on the amount of capital-gains tax that they are required to pay. Such factors have provided sufficient incentive for house prices to skyrocket.

Australian economist and founder of research firm LF Economics Lindsay David, meanwhile, recently stated that much evidence exists to support the contention that a housing bubble has already taken hold. David recently emphasised the fact that over the last 20 years, “Australian house prices have risen in real terms by 131 percent, whereas real wages have risen by about 38 percent…and real rents have only increased by about 20 percent”. The biggest problem currently exists in Melbourne, according to David, where house prices have risen by 214 percent during the same period, but real rents have only risen by 12 percent—an issue that he calls “probably the biggest mis-match that you will ever see in probably any city in the world”.

UBS, meanwhile, announced that it was “calling the top” of the housing market in late April, suggesting that the housing market had already peaked. The Swiss banking giant did, however, forecast that prices would only experience a sharp correction rather than an outright crash, predicting growth to slow to 7 percent this year from its current seven-year high of 13 percent, and to then decline significantly to 0 to 3 percent in 2018 as a result of higher interest rates and tighter mortgage rules. Investment bank Citi echoed this sentiment in early May, stating that a crackdown by banking regulators could begin to dampen lending, meaning that “there could be a partial correction in house prices during the course of the next two years”.

Indeed, that mortgage-lending crackdown already appears to have commenced. In March, the APRA tightened lending regulations on banks, restricting their provisions of interest-only loans to 30 percent of total new residential mortgages (from the 40-percent level currently being observed). The Australian Securities and Investments Commission (ASIC) chairman, Greg Medcraft, also claimed that the housing market is “bubbly” and that he was “really concerned consumers don’t put themselves in above their heads”, while the central bank’s assistant governor, Michele Bullock, also suggested that regulators were “prepared to do more if needed” to contain housing-market risk. As such, more regulatory action could well be on the horizon.

Banks have taken some measures themselves to prevent an unsustainable housing-market boom. They have almost completely halted providing housing loans to those borrowers who are dependent on offshore income, as well as reducing high loan-to-value lending. Tax surcharges on purchases by overseas investors have also been introduced in some Australian states. The banks themselves also largely disagree with projections of an impending bubble. Speaking in early March, the chief executives of National Australia Bank, Westpac and Commonwealth Bank almost uniformly posited that house prices are not excessive at present, despite acknowledging the presence of potential speculative risks. For instance, Westpac’s chief executive, Brian Hartzer, said that he would “draw the distinction between a speculative bubble in prices and prices beyond what fundamentals would justify”, while National Australia Bank’s chief executive, Andrew Thorburn, believes “the answer is no” when asked whether houses in Sydney and Melbourne are overpriced. Furthermore in late 2016, the CEO of the other “Big Four” lender ANZ, Shayne Elliott, stated that he was not expecting “a calamity or a disaster”.

Perhaps the banks have some justification. According to property analytics firm CoreLogic, house prices across Australia’s five largest capital cities only grew by 0.3 percent between March 20 and April 20, which is less than one-third the average 1-percent capital growth rate per month witnessed over the previous six months. Indeed, Sydney performed the worst of the five with a flat rate over the period—comprehensively less than the 14-percent growth that has been seen on average since October 2016. It is also worth pointing out that while the housing markets in Sydney and Melbourne are undoubtedly of serious concern, prices in other parts of the country have not experienced similar gains. Indeed, prices in some regions have even declined over the last few years, particularly in mining areas in which the commodities sell-off has impacted local economies. The value of a Perth home, for instance, has lost 10 percent since December 2014. This imbalance highlights why the central bank is unable to raise interest rates to curb housing demand.

The banks themselves appear to be in good shape at present. Although they are not quite generating the levels of profitability of three years ago, they continue to perform solidly across a range of financial metrics. Nevertheless, concerns over the housing market could begin to weigh heavily on Australian banking stocks; indeed, the ASX’s (Australian Securities Exchange’s) financials sector lost around 3 percent for the week ended May 5, largely over such concerns. According to Jonathan Tepper of investment research firm Variant Perception, ““No other banking system I’ve seen is so exposed to housing lending. It is the only game in town in Australia. Most Aussie wealth is tied up in housing, and then in shares of banks that lend to homebuyers”. Such sentiment implies that a sharp housing-market correction could trigger heavy sell-offs in Australian banking shares.

It seems likely, therefore, that the housing market—Sydney and Melbourne included—will cool in the near future. Much debate continues over whether to label the current situation as a bubble. Rising debt levels, flat income growth and the problem of bank-lending practices whereby in the words of RBA Governor Lowe, “too many loans are still made where the borrower has the skinniest of income buffers after interest payments”, would suggest that a bubble is not far off at the very least. As such, both Australian banking and the economy as a whole have much of which to be wary over the coming few years.


Related Articles

Leave a Comment

This site is protected by reCAPTCHA and the Google Privacy Policy and Terms of Service apply.