Australia’s ceaseless love affair with the housing market poses latent risks to investors in bank stocks as banks have become increasingly sensitive to economic deterioration and external shocks.
More than 63% of bank loan portfolios are extended to residential mortgages and the availability of cheap credit has driven house prices sharply higher in key cities like Sydney and Melbourne.
In just 20 years, average house prices have increased fivefold rising to A$1,190,000 in Sydney and A$943,100 in Melbourne.
House prices now stand at 14 times the average annual salary compared to 7.6 times in the UK and 5.4 times in the US.
Economists say Australian households are over-leveraged and vulnerable to changes in financial conditions. Underemployment rates in the country rose to 9% in the first quarter of 2017 and wages growth is at its lowest level ever, according to the Australian Bureau of Statistics.
On the upside, investors in bank stocks are gaining some comfort from a reduction in the exposure to loans with high loan-to-value ratios (LVR). The average dynamic LVR of current mortgages over current valuations remains below 52%, according to analysis by Moody’s.
At the same time banks continue to reduce the share of short-term debt in their overall wholesale funding mix, though they maintain a substantial exposure to global funding conditions.
Looking ahead, credit quality is likely to come under strain. Asset performance worsened towards the end of last year as impaired loans increased for the first time since the global financial crisis.
Domestic impaired and past-due facilities rose to A$12 billion from A$10 billion in 2015.
Moody’s banking analyst Maadhavi Ramanayake worries that if credit quality declines further it will put pressure on risk-weighted assets and teir-1 capital.
“All this, just as the Australian banking regulator gets ready to apply Basel IV rules to domestic banks and advise the market on its stated goal of making the sector stronger,” Ramanayake said.