JP Morgan explains how falling property prices could affect Australian bank stocks

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  • In forecasting the outlook for Australian bank stocks, JP Morgan compared the sector to banks in Sweden following a 9% decline in Swedish house prices.
  • The analysts said slower mortgage growth will weigh on earnings, but a significant decline in the quality of banks’ loan books is unlikely.
  • JP Morgan has an overweight holding in Westpac and ANZ, with a neutral position on Commonwealth Bank and NAB.

This morning’s December data from CoreLogic shows the Sydney-led slowdown in Australia’s housing market is extending to other capital cities.

The figures showed a quarterly price decline of 0.7% across Australia’s capitals, leaving combined annual growth at just 3.2%.

Now that Australia’s major housing markets are cooling — with research last week showing that Sydney and Melbourne are most at risk of a significant price correction — JP Morgan analysts have assessed the earnings outlook for the big four banks as part of detailed research on the Australian banking sector.

As a framework for their analysis, they said the recent price action in Swedish bank stocks may provide a useful indicator. Here’s JP Morgan on their rationale:

While we do not profess to be experts on the Swedish housing market, we make the comparison due to the similarities we see between the Australian and Swedish banking and housing markets.

Both banking sectors have high return-on-equity (ROE) with good industry structure and a predominance of housing lending. And both housing markets have seen rapid house price growth over a long period of time.

However, the downturn in Sweden’s market has run ahead of Australia — with Swedish home values declining by 9% from their peak:

And Swedish bank stocks have followed suit, with the four major Swedish banks also down by an average of 9% over the last six months.

In determining whether Aussie bank stocks may follow suit, the JP Morgan analysts weighed up two key factors:

1. A slowdown in mortgage growth which weighs on earnings; and

2. Risks to asset quality.

“The last 20 years have seen unprecedented expansion in mortgage loans in Australia, but the pace of growth has slowed significantly in recent years,” the analysts said.

And JP Morgan expects the slowdown will continue, citing slowing house-price growth amid already-stretched household balance sheets, along with stricter lending standards:

While that slowdown will weigh on earnings — given the big four banks’ heavy exposure to home loans — JP Morgan said there may be increased opportunities for more business lending as the economic growth outlook improves.

And from an asset quality perspective, “we do not believe a significant deterioration in losses in the housing portfolios is likely in the near term”.

The analysts noted that a significant proportion of Australian borrowers are ahead on repayments, while many homeowners already have strong equity positions in their home.

The risks of a sharp fall in prices will also be offset by strong population growth, low rental vacancy rates in most cities and Australia’s stricter lending standards.

Although JP Morgan doesn’t expect a market crash, the bank expects annual house-price growth will fall to below 2% over the next two years:

That’s a more optimistic view of price growth than AMP chief economist Shane Oliver.

Oliver posted a chart on Twitter yesterday, which indicates that a 5-10% fall in prices may be in store for the Sydney market, based on the latest auction clearance rates.

Oliver added that auction clearance rates in January need to be treated with a degree of caution, given overall volumes are significantly lower.

Consistently strong growth in Australia’s housing market has become a point of contention among global investors in recent years, with some hedge funds taking short positions in Australian banks due to fears of a housing bubble.

“We do think the cause for concern is justified on house prices today than previously was the case, certainly with respect to Sydney and Melbourne,” the analysts said.

“An almost constant point of discussion on the Australian banking sector in recent years (particularly with international investors) has been potential risks in the housing market,” JP Morgan said.

“This is due to house price growth, which has been running at well above CPI and stretched household balance sheets.”

But while the prospect of falling house prices will weigh on the earnings outlook, JP Morgan isn’t forecasting a sharp decline in Australian bank stocks.

In fact, “we think it would be beneficial for the system for house prices in Sydney and Melbourne to grow below nominal GDP growth and/or disposable household income growth for a number of years”, the analysts said.

This table summarises JP Morgan’s price targets for the big four banks, compared to current prices today at 12pm AEDT:

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