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Banks exposed to looming property disaster
- The Australian
- April 11, 2016
Over the weekend the Foreign Investment Review Board issued its annual report. It should have been a routine document, but instead, the figures buried in the text reveal that Australia faces a potential banking crisis similar to the one that occurred in 1990. But that warning comes with an important caveat — Chinese and Australian banks are going to share the disaster and we don’t know the relative ‘market share’.
The worst of the Australian-bank portion of the potential disaster can be avoided if the bank regulator, APRA, understands the looming crisis. Prior to the FIRB data, I altered readers to the structural crisis in two commentaries: A nasty crisis is brewing, and Credit squeeze threatens more than just apartments. Rather than bombard you with FIRB figures, I have asked Callam Pickering’s CP Economics to prepare three graphs, which I publish below:...........
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graph 1
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graph 2
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graph 3
The third graph shows that foreign residential approval investment has trebled over five years. When investment trebles in any market it should raise warning signs. But then look at the second graph — Australian approvals for new residential construction — and we see that, while foreign approvals were very high in 2013-14, they skyrocketed in 2014-15. The approvals were concentrated in Sydney and Melbourne apartments.
Not all of those approvals will have led to a construction start, but a look at the cranes around Sydney and Melbourne shows that a big chunk of the more than $65 billion in approvals in 2013-14 and 2014-15 has now been initiated. Even given that construction delay caveat, $65bn is a huge number and without precedent, especially as it is concentrated in two cities. The Australian mining investment boom was generally said to be worth about $100bn.
I had assumed that the bulk of the funding for the developers was coming from overseas banks. But last week, Australia’s biggest and best-funded developer, Harry Triguboff (Meriton), warned readers that the local banks have funded a significant proportion of this enormous figure.
In past statements the Reserve Bank has warned of Australian banks’ exposure to property development. The problem is that the security for these development loans is usually not the developer’s balance sheet but the forward sales. With local investors, the banks usually require a 10 per cent deposit and with overseas buyers it can be up to 30 per cent. The vast majority of these sales contracts do not have an agreement from a bank to provide the funding.
Unfortunately, it is now much harder to get money out if China and Australian banks are being squeezed by APRA. Our local banks have started pricing apartments at valuations significantly lower than the original purchase price when loaning for settlements. So, while Australian banks might be concerned about their $1bn exposure to Arrium, it’s nothing compared to the risks it appears they have taken on in the apartment market. I hope that Harry Triguboff is wrong and that the Australian banks have only a token exposure to the $65bn developer market. But I am very confident he is right.
The full crisis is still one to two years away, but shareholders will need to know their bank’s exposure. In Sydney, there is a strong rental market and if the banks fund the apartment buyers a crisis may be averted. In Melbourne, it can also be greatly reduced if the banks fund the buyers. But bankers don’t act like that and because they have no agreement to lend they will say: “Why should we?”
The problem is that another part of the bank has loaned billions to developers. In 1990, the banks ended up effectively owning or controlling large amounts of real estate, which they usually sold at a loss. While the total developer exposure may be less than $65bn, it is still enormous and Chinese banks hold a big chunk. We may need to ask the Chinese to help fund some of the buyers of the apartments they have funded.
We are now into complex issues. I think Bill Shorten has a good case for a banking royal commission, but given the potential disaster we face, it’s the wrong time. Assuming that the FIRB figures are right and that our banks have a big share of the developer exposure, all our efforts must now be directed to getting our banking system through this crisis.