Here's what would happen to Australia's big four banks in an 'Ireland scenario' housing meltdown

Photo by Jes Aznar/Getty Images
  • Ratings agency Fitch says Australia’s big four banks would be able to withstand a severe housing downturn.
  • The report doesn’t take into account risks to other areas of the economy from a house price correction, such as domestic consumption.
  • However, the ratings agency said house prices in Australia are unlikely to collapse.

Australia’s major banks are likely to remain resilient in the face of a cooling housing market, according to research from credit rating agency Fitch.

The findings were based on scenario analysis used to stress-test the mortgage books of the big four banks — which account for around 80% of the $1.6 trillion worth of outstanding mortgages in Australia.

The analysts used scenarios ranging from benign to more extreme to assess how the credit ratings of the big banks would be affected if mortgage defaults increased and house prices fell.

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At the more extreme end of their calculations, the analysts made reference to an “Ireland scenario”, based on the Irish housing crisis in 2007.

The market collapse in Ireland saw house price declines of 43%, as 13% of borrowers defaulted on their mortgage.

Here’s how the big four banks compare in an “Ireland scenario”:

“Fitch Ratings’ stress test shows that these portfolios are unlikely to experience losses that in isolation threaten the viability of the banks, even in a severe housing market downturn,” the report said.

To reach their conclusion, Fitch crunched the numbers for the loan-to-value (LVR) splits for each of the big four banks’ mortgage portfolios.

An LVR above 80% is deemed to be more risky, because the loan makes up more than 80% of the underlying asset. They also factored in a corresponding buffer from lenders’ mortgage insurance on loans that defaulted.

“CBA experiences the biggest loss as a result of the largest exposure to Australian mortgages, as well as the highest proportion of mortgages with a dynamic LVR above 80%,” Fitch said.

However, even in an extreme-negative scenario, the total dollar-value loss (highlighted in pink) for all banks remains under 2% of their total mortgage exposures.

“ANZ’s and CBA’s weighting toward higher dynamic LVR mortgages is likely to be a reflection of these banks having a lower proportion of investor mortgages than NAB and Westpac,” Fitch said.

But that risk is partially offset by the fact that ANZ and CBA also benefit the most from mortgage insurance recoveries.

The analysis also showed that in a worst-case scenario, none of the big four banks’ CET1 capital ratios would fall below 9%:

That’s below the 10.5% that bank regulator APRA said will be necessary for the banks to meet the definition of “unquestionably strong” capital buffers by January 2020.

But it’s still above the 8% threshold which Fitch deemed to represent the “capital conservation buffer”.

Fitch added that the report doesn’t take into account other negative economic shocks that would stem from a sustained downturn, such as reduced domestic consumption — the biggest component of GDP.

And such a possibility still presents a key risk to the outlook for bank profitability.

“The stress test does not incorporate broader second-order economic impacts, such as a reduction in consumption or losses from other loan portfolios, which we think could have a greater impact on bank asset quality, capitalisation, profitability and ratings,” the report said.

But ultimately, the ratings agency said a full-scale housing meltdown in Australia is unlikely, pointing to underlying strength in other areas of the economy.

“Fitch does not expect a sharp or substantial correction in Australia’s housing market, with the outlook for economic growth and unemployment remaining relatively benign.”

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