Could Australia's sharp housing downturn be a blessing in disguise for embattled banks?

Much has been said about slower credit growth but banks could also look forward to improving asset quality.

Australia’s housing downturn could be a hidden boon for the country’s struggling banking players as the slowdown in heated home price growth could be interpreted as a welcome development to improve the banks’ asset quality, according to credit rating agency S&P.

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After a steep price uptrend that has granted several cities in the country with the global distinction as some of the world’s most expensive housing markets, residential property prices have recorded a cumulative 1.9% drop in value since September 2017 amidst falling prices in Sydney and Melbourne.

Analysts have been quick to point out the negative effects this will have on the profit prospects of Australian banks especially since mortgages account for roughly 60% of the country’s loan portfolio with Commonwealth Bank of Australia (CBA) and Westpac at greater risk due to their larger mortgage exposure.  

In fact, Fitch Solutions expects the banks’ headline credit growth figures to drop steeply from 5.1% in March to 4% by end-2018 and 3.5% by 2019.

However, the slowdown in lending could also come with improved asset quality.

“Cooling property prices and a growth slowdown in private sector debt should bolster the banking system's stability,” S&P said in a report. “Risky or speculative lending has slowed due partly to regulatory limits on investment loans and interest-only loans. We expect banks' lending behavior to remain conservative.”

The housing downturn, which has prompted smaller banking players to raise out-of-cycle mortgage rates in an effort to meet profit margins, is not expected to rattle the country’s banking system as lenders have robust buffers built into their home loan serviceability assessments and strong capital positions. 

Also read: Australia's big banks defy mortgage hike trend

Australian banks commonly assess borrowers’ repayment ability based on a minimum interest rate of 7.25%, which is well above the average home loan rate of around 5.25% posted by Australian banks over the past three years.

“Despite the very high level of household leverage in Australia, we do not expect the current round of home loan rate moves to cause a material increase in loan delinquencies or credit costs,” Moody’s Investors Service said in an earlier report.

A stress test scenario by Fitch under the conditions of home price declines ranging from 20-60% and default rates of 10-20% also confirmed the healthy capital situations of Australian banks insulating them from similar market shocks.  

“The tests showed that the banks' ratings would be resilient to the moderate scenarios, reflecting adequate capital buffers and strong profitability,” the credit rating agency said in an earlier report.

Photo from Daniel Falconer - Flickr, CC BY 2.0