Alarm bells should be sounding about Australian property lending – not because of the OECD’s warning about a possible fall in Australian house prices (which was all a bit over the top), but because weak management and lending standards have emerged in the historically dangerous area of commercial property, especially in apartments.
Bank regulators such as the Reserve Bank and APRA (the Australian Prudential regulation Authority) have been pointing out for years that property crashes and crunches in this Australia do not start in housing, they start in commercial property. As APRA said in a letter to financial groups yesterday.
That was after reminding them that “Commercial property lending has historically been a source of significant loss for banks, both in Australia and overseas. In response to recent market dynamics and indications that underwriting standards were under competitive pressure, APRA undertook a thematic review of commercial property lending over 2016. As part of this review, APRA assessed the portfolio controls and underwriting standards of a number of larger domestic banks and foreign bank branches.”
It is clear from some of the comments in an attachment to the letter that many of the concerns APRA and the RBA have is with lending to investors and developers for apartments.
It is where the regulators, especially the RBA see the greatest concerns in the next two years for a trigger to set off a property bust – the glut of apartments in parts of Sydney, Melbourne and Brisbane especially.
What APRA is saying they don’t trust banks and other lenders in this area and for the second time in two years will crack down on investor lending especially, and loans to apartment developers, which could, if severe enough, trigger a slide in prices.
All the issues identified by APRA would be enough, over time to trigger an apartment sector shakeout and possible crunch, especially as a glut of finished properties emerges. And that in turn would threaten the financial system as a whole and could end our long period of positive economic growth.
For the Federal government fighting off calls for a royal commission into banks because of weak oversight on their insurance subsidiaries and financial advice, the last thing they will want is a group of moaning investors and developers joining the calls for an inquiry as their deals go south.
That is what we saw in the GFC when bad loans to commercial property in Sydney, Melbourne, Brisbane and especially the Gold Coast and the Cairns area of North Queensland triggered huge losses, and it was the trigger for the crunch in the early 1990’s and the recession we had to have.
The big scandal so far as the banks are concerned that emerged from a plethora of them from the GFC was the Storm Financial mess that ensnared the Commonwealth, Bank of Queensland, Macquarie and others.
In 2015 the regulators, led by APRA close checked home lending (owner occupiers and investors) and found rorts in interest only loans, poor disclosure, inadequate information and knowledge of borrowers by lenders (which include the big four banks and dozens of smaller groups). That led to a significant tightening of standards, especially on investor borrowings, especially by self managed super funds.
Last year, led by APRA, the regulators went through commercial property lending (especially on apartments to investors and developers) and according to a statement this morning by APRA, found enough to give regulators grey hairs and keep them up at night. Now a crack down from APRA, supported by the RBA is about to hit the banks and other lenders as a result from later this year and into 2018.
In the letter to lenders (http://www.apra.gov.au/adi/Documents/CRE-feedback-letter-all-ADIs.pdf) found:
"APRA’s review revealed that the ability of the Board and senior management to fully understand and challenge the risk profile of lending has often been hampered by inadequate data, poor monitoring and incomplete portfolio controls. APRA expects ADIs to improve their capabilities in this area, and has written to individual ADIs with specific requirements in these areas… In current market conditions, it is important that the Boards of ADIs are conscious of the settings for underwriting standards and portfolio controls, and in a position to challenge as appropriate" In particular, Boards should actively challenge whether expectations of growth in commercial property lending are achievable, given the position in the credit cycle, without compromising the quality of lending.”
Among some of the problems that emerged from the review: include lending too much on investment loans; inadequate considering of loan to valuation ratios “in light of recent strong asset growth”, problems with lending to developers, inadequate information on refinancings, problematic standards on presales (and what is a presale) and a major worry (because it happens all the time), lenders using so-called mezzanine finance and rising property values to allow developers to contribute less “hard’ capital to the financing of a project, and a major surprise, the way some lenders have ignored the oldest adage in property ‘location location location with APRA saying it was concerned about “potential marketability issues for properties, such as being poorly located, small apartments lacking in amenities and/or suffering from design issues, was not always evidenced in transaction analysis.”
APRA concluded that it will be having targeted talks with specific institutions and raising its concerns later this year. There will be some worried bank boards and executives awaiting those calls.
