November 4, 2010 / 4:06 AM / 9 years ago

Q+A-Will a big exposure to mortgages hurt Australian banks?

SYDNEY, Nov 4 (Reuters) - Australian banks are among the healthiest in the world but some investors fear they could suffer a shake-up if lofty property prices at home turn south and cause loan losses to spike.

Already among the least affordable in the world, Australian homes are getting costlier with prices near all-time highs.

Record prices have brought on record debt levels, sounding alarms of a property price bubble and stirring concerns about Australia’s top four banks, which own 80 percent of mortgages.

Fitch said in September so many of its clients are worried about Australian mortgages, it is stress testing the market.

For a special report on Australia's economy: link.reuters.com/gas39p

HOW EXPOSED ARE BANKS TO THE PROPERTY MARKET?

Mortgages drive overall loan growth at National Australia Bank (NAB.AX), Commonwealth Bank of Australia (CBA.AX), Westpac (WBC.AX) and Australia and New Zealand Banking Group (ANZ.AX).

Between them, they have lent A$1.1 trillion worth of home loans, the equivalent of 60 percent of their loan books. This compares with about 15 percent among U.S. and UK banks, but that is an understated exposure as it excludes securitised mortgages.

Australian banks call mortgages their best asset. Arrears at 0.7 percent are among the lowest in the developed world and banks say their average mortgage exposure is worth less than 50 percent of present home values. So prices can drop over 50 percent before banks start fretting about surging loan losses.

And unlike their U.S. peers, Australian banks are better protected if borrowers default. They can seize all of a borrower’s assets including savings and future earnings, whereas U.S. banks can only seize the unpaid home.

HOW FROTHY ARE HOME PRICES?

Household debt at a record 1.7 times of household income is the biggest threat to the market. If income or home prices fall, or interest rates rise, borrowers could struggle to repay loans.

The Reserve Bank of Australia (RBA) also frets about debt levels, but it says households are not likely to default: 50 percent repay faster than they need to; two-thirds use under 30 percent of income for repayments, and income is growing at its fastest in 10 years, according to the central bank.

Whether or not investors think there is a bubble, no one thinks the property market is on the verge of a collapse, not with domestic economic growth at its highest in three years.

Strong immigration — a record in 2009 — and a chronic housing shortage also argue for home prices to stay high.

But how high? The Economist magazine said last month Australian homes were the most over-valued among major economies. Prices are 63 percent over “fair value”, well ahead of China’s 18 percent, Spain’s 48 percent, and the United States’ 5 percent.

WHAT COULD TRIGGER A CRISIS?

The worse-case scenario imagined by most banks is based on the domestic economy hitting a wall. Unemployment doubles to 10 percent, economic growth in top export market China stalls, and Australia’s government cannot afford fiscal stimulus.

So home prices plunge 40 percent, resulting in A$10 billion of loan losses. That is 0.4 percent of the four banks’ total assets, and less than the A$120 billion they raised last year to guard against a threatening rise in bad debts.

The base-case scenario assumed by banks is for home prices to grow more slowly by between 5-10 percent in the next year as interest rates rise and affordability falls. Prices had jumped 14 percent in 2009.

John Buonaccorsi, an RBS analyst, sees growth in home loans easing to 7 percent by mid to late 2011, down from over 8 percent now and the average 14 percent in the past decade to 2009.

IS THERE A SUB-PRIME MESS?

Fortunately, no.

Unlike U.S. banks which lent many sub-prime loans that caused the 2008 financial crisis, Australian banks are more prudent.

The RBA, which lifted interest rates this week, says Australian sub-prime loans, or loans made to borrowers deemed likely to default, make up just 0.3 percent of total loans. “Low-documentation” loans issued at laxer standards account for 8 percent.

Vigilant lending has kept the default rate at about 0.5 percent of outstanding loans, or an equivalent of A$400 million for the four banks. It is expected to go up by 4 to 5 basis points over the next year. (Editing by Dhara Ranasinghe)

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