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Using Ireland’s 2007 housing crisis as a case study, Fitch’s “stress test” assessed the impact that a comparable downturn would have on Australia’s largest lenders. Dwelling values dropped by 43 per cent in Ireland, with 13 per cent of borrowers defaulting on their mortgages.
While Fitch’s Major Bank Mortgage Stress Test noted that adequate capital and strong profitability would save the big four, some would be left worse off than others.
The report found that CBA would incur the greatest loss in such a scenario, followed by Westpac, which the ratings agency claimed reflected the banks’ larger exposure to the $1.6 trillion mortgage market. According to the report, mortgages make up almost half of CBA and Westpac’s exposures at default (EaD), compared to a third of ANZ and NAB’s EaD.
However, Fitch added that ANZ and NAB would incur bigger losses under a broader stress test due to their proportionately larger commercial exposures.
Fitch reported that under an ‘Ireland-like’ stress test, Australia’s major banks would collectively incur losses of approximately $24 billion.
However, Fitch also incorporated the revenue that would be collected by the big four from lenders mortgage insurance (LMI) payouts, reporting that the banks would collectively incur a $19 billion loss after LMI is collected.
The Fitch analysis also found that neither of the banks would fall below the 8 per cent minimum capital requirement imposed by the Australian Prudential Regulation Authority (APRA).
Fitch on interest-only risks
The ratings agency also noted the risk posed by interest-only (IO) borrowers transitioning to principal and interest (p&i) loans, citing data from the Reserve Bank, which indicated that 30 per cent of IO mortgages are set to convert to p&i by 2021.
Fitch noted that Westpac has the largest exposure to such risks, with IO borrowers making up 46 per cent of its mortgage book.
“[Some] borrowers are likely to face financial stress over this period, particularly in light of the tightened regulatory requirements and underwriting standards being implemented by the banks, which has led to a substantial reduction in new interest-only loans being offered,” Fitch noted.
Further tightening of standard to continue
Fitch also stated that it believes that public inquiries into conduct in the banking sector are likely to result in further tightening of underwriting standards.
However, the ratings agency claimed that increased regulatory oversight would reduce the sector’s exposure to a housing market downturn.
“Regulatory scrutiny of mortgage underwriting is likely to continue, and should ultimately result in new mortgages that are more resilient to a downturn in the housing market.”
Housing market to avoid sharp downturn
Fitch noted that Australia’s positive economic outlook suggests that a severe housing market downturn is unlikely.
“Fitch does not expect a sharp or substantial correction in Australia’s housing market, with the outlook for economic growth and unemployment remaining relatively benign.
“Significant external shocks would be the most probable source of any Australian economic shock.
“A rapid increase in the unemployment rate remains the most likely driver of a significant housing market correction, although sharply higher interest rates would also pressure some borrowers – given the level of household debt.”
[Related: ‘Golden age’ of banking is over]
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