Despite continuing reservations about bank lending to investors in the private housing market, as well as the commercial property sector, the Reserve Bank reckons the Australian financial system remains solid.
In fact the central bank believes the financial stability of Australian businesses is improving as companies watch spending and borrow less, bank bad debts fall and their funding costs ease.
"(T)he Australian financial system continues to perform strongly. Banks’ asset performance improved further over the second half of 2014, while their profitability remained robust,” the bank said in the first Financial Stability review of the year, released yesterday.
February’s rate cut has helped relieve stress for businesses and private borrowers and helped banks by taking pressure of their more troubled customers. In fact the Stability Review reveals financial stress for Australian businesses is falling.
Debt levels remain near historical lows, having fallen sharply after the financial crisis and remain in check since. This, combined with record low interest rates, has left businesses in a good financial position.
“Business finances appear generally in good shape," the RBA said. "Like households, businesses remain fairly cautious in their spending and borrowing decisions, despite the low interest rates," the report said.
But difficulties have appeared in the commercial property, and mining and resources sectors, according to the RBA’s review.
High investor activity in property is pushing up prices and construction, which has created oversupply worries, particularly in the Perth and Brisbane office markets.
And the sharper falls in commodity prices have reduced the profitability of mining and resource companies, and made it harder to service debts.
However the financial positions of the largest resource companies remain strong, the RBA said, posing little risk to the banks.
Property – both housing and commercial – remains the main concerns, but apart from these, the bank seems almost relaxed.
"Outside of the property markets, risks in the non-financial business sector appear relatively low. Measures of distress such as non-performing loans and business failures have been declining and gearing ratios remain lower than those prevailing before the financial crisis," the bank said.
"Some resources and mining services firms are facing more difficult trading conditions now that the mining investment boom is winding down and some commodity prices have fallen sharply. However, firms in these industries typically carry less debt than similarly sized firms in other industries, and much of their borrowing is from outside the domestic banking system.”
Looking at property, the bank said it is bit early to see the impact, if any, of the moves by regulators (mostly APRA, the Australian Prudential Regulation Authority) late last year, into this year, to try and ease pressures in the home ending market.
‘’It is too early to expect a material slowing in investor loan approvals or credit growth in response to APRA’s (Australian Prudential Regulation Authority) measures,’’ the Reserve Bank said.
"Household sector risks continue to revolve largely around the housing and mortgage markets. At this stage, competitive pressures have not induced a material easing in non-price housing lending standards. The composition of new mortgage finance remains skewed to investors, however, particularly in the largest cities.
"Ongoing strong speculative demand would tend to amplify the run-up in housing prices and increase the risk that prices in at least some regions might fall significantly later on.
"In the first instance, the consequences of such a downturn in prices are more likely to be macroeconomic in nature because the effects on household wealth and spending would be spread more broadly than just on the recent property purchasers.
"However, the further housing prices fall in that scenario, the greater the chance that lenders would incur losses on their housing loans.
"At the margin, the recent decline in mortgage interest rates can be expected to boost demand for housing further, though it will also make it easier for existing borrowers to service their debts. Indicators of household stress are currently at low levels, but could start to increase if labour market conditions weaken further than currently envisaged."
And on commercial property (which also includes large scale home unit construction) the Reserve Bank noted that easy monetary policy globally is spurring demand for Australian office buildings, even as vacancies climb and rents fall, raising risks of a future price slump.
‘’Prices have continued to rise at a national level, driven in particular by investors’ search for yield in the global environment of low interest rates and ample liquidity, with the lower Australian dollar also likely to be adding some impetus to foreign demand,’’ the central bank wrote.
‘‘The risk of a large repricing and associated market dislocation in the commercial property sector has increased.’’
"The total value of office, industrial and retail property transactions has risen sharply recently, with a notable increase in the share of transactions involving foreign purchasers, particularly in Sydney,’’ the Reserve Bank noted.
And commercial property holds special interest for bank regulators such as APRA and the RBA because that’s where property bubbles and busts have hurt banks in the past – the big recession of the early 1990’s saw Westpac and the ANZ skate close to collapse, while state banks in Victoria, South Australia and Western Australia were brought down by dud commercial property deals and huge loan losses.
In comparison, home lending has been much safer, and its woes have tended to follow on from a property bust in the commercial sector which has usually been sparked by tightening credit conditions and slowing economic activity.
We have the latter now (hence the bank’s warning about a sharper than expected rise in unemployment), but credit markets are far more relaxed with interest rates at record lows.
