Property exposures update - March quarter 2020

Tuesday, 23 June 2020

Our March quarter publication is prefaced with a short summary of some steps APRA has taken in recent years across the commercial real estate and property development sector to mitigate risk to the Australian financial system. We also briefly review three of the many variables and dynamic factors APRA maintains vigilance over, by comparing the periods leading up to the current recession and Australia’s most recent downturn during the GFC.

These three factors, which have been a source of stress for commercial and property developer lenders in the past are:

• The pace of credit growth
• Participation of foreign banks
• Lenders’ portfolio balance.

Our limited review indicates APRA’s increased supervisory intervention over the past decade may have better positioned lenders to weather any prolonged downturn. We caution, however, that lenders may – despite at times drawing criticism from market participants – face unforeseen challenges given the potential for sustained structural weakness in the economy over the near term.

Key insights

Sharp growth in ‘All Commercial’ property exposure

Contractions in aggregate commercial property exposure during June to December 2019 were in stark contrast to the 3.9% exposure growth recorded in March 2020. This quarter’s increase was led by the Office sector which jumped 10%, consolidating its position over Retail as the ADIs’ largest sector exposure, with 31.4% of total commercial property loans. This exposure growth was the highest recorded for the Office sector since March 2008 and coincides with broader favourable leasing conditions, particularly in Sydney and Melbourne.

Robust Land development/Subdivision exposure growth

Interestingly, ADIs’ exposure to the Land development/Subdivision sector increased by a robust 6.7%, the first quarter of growth in twelve months. Exposure growth is likely a flow on effect from APRA removing its supervisory benchmark on interest-only residential mortgage lending by the ADIs’ in late 2018. The temporary lending benchmarks on investor and interest-only loans were put in place in March 2017 to moderate higher risk lending. We will continue to monitor the sector for signs of a contrarian trend to the broader market challenges particularly now surrounding COVID-19.

New residential lending weakness amid house price decline

New residential mortgage lending totalled $95.0 billion in the March 2020 quarter, an increase of 20.1% across the year. However, this represents a 10.9% decrease across the quarter which could be a reflection on the seasonality of the housing market and potential early signs of borrowers’ uncertainty surrounding COVID-19.This coincided with Australian capital city house prices which fell -0.5% in May, according to CoreLogic data, amid the early stages of the COVID-19 pandemic and potential flow on effect from the ‘Black Summer’ bushfires. Although further softening is anticipated, worst-case fears of a c.30% fall in house prices over the next three years (as predicted by CBA economists) is seemingly less likely. On the other hand, the likelihood of increases seen in non-performing loans is expected, as policy responses such as JobKeeper and bank mortgage payment holidays cease in September 2020.
 

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