Banks risk blowback on Chinese burns

The AustralianMay 16, 2016 8:57am

Robert Gottliebsen

Why have the Chinese suddenly turned their back on the Sydney apartment market, with Melbourne and other markets set to follow?

The answer is simple. We are hitting our largest trading partner with an unprecedented series of blows at a time when they are undergoing fundamental change. We had better brace ourselves for the consequences because they will not be pleasant.

And what is clearly the biggest development in the Australian economy for a long time is being ignored by our politicians who have no plans for the completely different world facing them in 2016-17.

The 50 per cent fall in Chinese and other foreign buyers in the Sydney apartment market was announced by Sydney’s largest apartment developer Meriton’s Harry Triguboff last week (Dramatic shifts herald a new era in residential property, May 12).

It has been partly offset by a rise in buying by Australians who now believe that superannuation has been destroyed as a long-term savings mechanism by the Coalition and are now going for negatively-geared apartments.

Chinese buying of apartments was one of the biggest forces that enabled Australia to avoid going into recession following the dramatic decline in mining investment.

If the current dramatic decline in Chinese apartment buying continues, in the absence of some other offsetting factor, it could easily lead to a recession in Australia. Australian bank profits are not in the front line of vulnerability but they will be hit.

Before we start on the Australian blows, we need to recognise that the Chinese are now making it much harder for their nationals to take money out of China. Nevertheless, Chinese nationals can normally get a 10 per cent deposit on an apartment out of the country — although sometimes it can take credit card gymnastics. That means they have the required deposit for an ‘off the plan’ purchase and they can normally get another 20 per cent out of China on settlement so that they have a 30 per cent deposit when the apartment is completed.

Previously, they could get the remaining 70 per cent required on settlement out of China. Now that’s much harder.

So, just when the Chinese are under pressure, at the urging of APRA, the big Australian banks have lowered their loan to valuation ratio from 70 per cent to 60 per cent and have stated that they will no longer recognise self-employed income from overseas.

The Chinese have been wonderful borrowers but the questions we ask on the bank lending forms do not correspond with the way they make their money, so, in the past, many bank loan executives have encouraged them to answer questions about their income sources with what are at best half-truths.

Some banks are now announcing that they have discovered these ‘half-truths’. The real truth is that everyone knew the game that was being played and almost all the loans now being investigated are being serviced on time.

Not only are we using a 60 per cent valuation but also, in markets like Melbourne, there is a market for ‘used’ apartments that is well below the ‘new’ apartment pricing.

The lower levels are now being used in bank valuations for a “60 per cent of valuation” loan. Accordingly, bank loans are now often down to a small fraction of the purchase price, although the rise in apartment prices makes settlement of old transactions easier.

The Chinese can see the problems ahead and have slashed their purchases.

The situation has been made worse by a series of other events that have annoyed the Chinese. They include the rejection of the Chinese bid for the Kidman cattle empire and the giant Chinese conglomerate AUX Group abandoning its plan to make a $2.7 billion investment in Australia’s second largest private hospital operator, Healthscope, because of delayed FIRB approval. To that we can add the problems in the South China Sea.

The Chinese boost to Australia has come not just via apartments but also through education and tourism. Education and tourism are closely linked to the buying of apartments. At the moment, education and tourism are booming but if that changes then we are headed for very hard times.

When you look around the inner suburbs of our major cities you will see many cranes building apartments for the Chinese who have bought a vast numbers on a 10 per cent deposit with the balance required on settlement. They were given comfort but no legally binding contract that the local banks would fund the purchases.

Now, given the foreign capital restrictions in China, we have effectively blocked them completing the purchase. Harry Triguboff announced that he has repaid all his debts, so my guess is that he will fund much of the “off the plan” purchases made by Chinese from Meriton. But few other developers have such a balance sheet to fund the purchases.

Accordingly, vast numbers of Chinese purchases are in danger of lapsing. If that happens, it will send property developers to the wall. They are funded to about 50 per cent of the cost of building an Australian apartment block by banks and the balance by second mortgage lenders — some of whom get their money from banks.

Unsecured suppliers who borrow from banks also fund developers.

The great danger is that, in about 18 months, parts of the Australian building industry will be drowning in a sea of red ink. And the blame can be laid squarely on APRA and the banks that backed the developers but then turned their backs on the developers’ customers. These are kindergarten errors by our banks.

The looming ASIC inquiry/Royal Commission into banks will take place around the time of the crisis. A very different banking system may come out of whatever sort of inquiry we get