As a result of Fitch’s latest mortgage stress tests, they argue on one hand that in a mild down turn the banks will not be seriously impacted, but then talk about scenarios where unemployment or interest rates rise, in which case, things turn more serious. CBA and Westpac would be worst hit. Nicely sitting in the fence?
A stress test published by Fitch Ratings shows that the mortgage portfolios of Australia’s four major banks could withstand a significant housing market downturn without experiencing losses that – in isolation – threaten the banks’ viability. However, ratings would be likely to come under pressure in severe scenarios where banks also suffer from large second-order economic effects, including a fall in consumer spending and higher losses from banks’ business loan portfolios.
We examined the capital impact of a point-in-time stress across a range of scenarios, with house-price declines of 20%-60% and default rates of 10%-20%. The Irish housing market collapse that began in 2007 was used as a reference point; this which involved house-price declines of 43% and a peak default rate of 13%. Even the moderate scenarios in our stress test are severe relative to Australia’s most recent recession in the late-1980s and early-1990s, when default rates peaked at 3%.
The tests showed that the banks’ ratings would be resilient to the moderate scenarios, reflecting adequate capital buffers and strong profitability. The severe scenarios would involve a negative shift in Fitch’s view of the operating environment for Australian banks, as well as our assessment of asset quality, capitalisation, profitability and, potentially, funding. These factors combined would be more likely to lead to downgrades.
CBA and Westpac have experienced the largest losses, reflecting their higher exposure to Australian mortgages. However, the proportionally larger commercial exposures of ANZ and NAB would render them vulnerable in a broader stress event.
The stress test was undertaken as risks within the household sector have continued to grow; and Australian banks, including the four majors, have large exposures to residential mortgages.
Our central scenario is not a sharp or substantial correction in Australia’s housing market, and we believe the outlook for economic growth and unemployment is relatively benign. House-price growth should moderate further through 2018, as banks continue to tighten underwriting standards for mortgages; interest-only loans convert to amortising repayments; and additional housing supply comes on to the market. A rapid rise 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 high household debt.
