Real estate ‘vectors of distress’ could bring banks down

Luci Ellis says markets tend to see housing booms ahead of banking crises, however it is “usually not the mortgage book that brings the banks down”.

“If we find a way to cause a disaster in the mortgage book in Australia… that would be the thing that could be very problematic for the banks, precisely because it is so big. But as the banks have said publicly before, it is important because it is big, not because it is particularly risky,” she said.

Ms Ellis made the comments at the Centre for International Finance and Regulation (CIFR) Research Showcase in Sydney last week.

“The thing that has tended to be the causal agent in a banking crisis, even though you saw something go wrong in housing prices, it was the property developers and the commercial real estate,” she said.

“These are the vectors of distress that actually cause a problem for the banking system historically.”

In its latest Financial Stability Review, released in April, the central bank highlighted ongoing risks in the Australian real estate market. 

It warned that these risks stemmed from the significant and geographically concentrated growth in supply of new apartments in Sydney, Melbourne and Brisbane due for completion in the next few years.

“This new supply may weigh on prices and rents in these areas. If that occurs, investors will need to service their mortgages while earning lower rental income, and any households facing difficulties making repayments may not be able to resolve their situation easily by selling the property,” the RBA said.

“This is one reason why it remains important to have prudent lending standards ahead of such a possibility.”

Banks since have tightened lending to developers and non-resident borrowers. However, local builders maintain a strong appetite for new development projects and are eager to secure funding.

Bank of Sydney executive general manager of commercial banking, Fawaz Sankari, said the lender had received an “enormous amount” of inquiries about construction finance.

“There is a huge increase and reliance on foreign investment purchases on the pre-sales side. We have noticed that on the local front, a lot of our long-term solid developers are really struggling to get pre-sales locally,” Mr Sankari told the Vow Financial Commercial Conference on the Gold Coast earlier this month.

“There have been a couple of clients who we have had on 50 per cent pre-sales and they are yet to achieve those. Yes, we want to mitigate our risk, but we also want to help the client mitigate their own risk in terms of biting off more than they can chew,” he said.

“I think a lot of the banks and lenders out there are very concerned about what is going to happen in the next 12 to 18 months.”

The risk appetite for developer finance was diminishing among Australian lenders as cooling property prices, tighter non-resident lending and record numbers of new apartments stoked fears of an oversupply.

Suncorp’s national manager for small business and commercial, Robynne Frost, also spoke at the Vow conference, saying the regional lender did not have a big interest in construction financing.

Her position was echoed by Liberty’s Sof Tsialtas who said, “We have never played in that market and we are still not playing in that market”, while Resicom director Stephen Mitchell admitted that “every lender is getting tighter and tighter”.

[Related: Economists warn of rising risks for off-the-plan market]