On the whole, Australian banks seem in better shape than those in the EU27 and U.S. Though Australian banks will not be immune to asset quality deterioration and funding difficulties during the global credit crisis and recession, Australia’s recession will likely be milder than in its North Atlantic counterparts. With less exposure to on- and off-balance derivatives, Australian bank health is tied primarily to the strength of loans – 55% of which are housing-related, the highest share among the 3 regions. Fortunately, Australia’s housing market has swung around an inflection point into an uptrend driven by lower interest rates and the government’s First Home Owner Grant. As of end-2008, Australia scored best on most of the alphabet soup of bank performance indicators (see table below):
Profitability: ROE, ROA, NIM
Australian banks are more profitable than those in the U.S. and EU27. Return on Equity (ROE) is 10 times that of the U.S. and EU27. Return on Assets (ROA) in Australia is only half that of the EU27 but is 5 times that of the U.S. Australian banks’ net interest margin (NIM) – the difference between lending rates and deposit rates – has remained wide at 6.47%, slightly higher than the 6.1% at end-2007. Banks have sought to widen spreads between borrowing and lending rates to help recuperate bank profitability. NIM in the U.S. and EU27 is only half that of Australia’s, which implies a lower net interest income. Operating expense as a share of assets in Australian banks is 5 times higher than in the U.S. though.
Balance Sheet Risks: NPLs
The 2008 share of non-performing loans (NPLs) – or, loans in arrears for 90 or more days – in the total loan portfolio is lower in Australia (0.74%) than in the U.S. (1.03%) and is down from 1.61% in 2007. No data was found for the EU27. The ratio of impaired assets to total assets in Australian banks fell from 0.19% in 2007 to 0.04% in 2008. The Reserve Bank of Australia’s Financial Stability Review as of March 2009 highlighted 4 factors supporting asset quality in Australia: 1) Lending standards were not eased to the same extent as in the U.S. and EU; 2) The level of interest rates in Australia did not reach the very low levels experienced in the U.S. and elsewhere; 3) All Australian mortgages are ‘full recourse’; 4) The legal environment in Australia places a stronger obligation on lenders to make responsible lending decisions than is the case in the U.S.
Balance Sheet Risks: LDR, LLR
Though asset quality has not deteriorated as much as in the U.S., the size of Australia’s loan book poses a risk if asset quality does take a sharp downturn: Australia’s loan-to-deposit ratio (LDR) of 115% is nearly as high as the EU27’s 118% and higher than the U.S.’s 83%. Moreover, Australia’s loan loss reserves (LLR) cover only 80% of non-current loans (loans on which payments are past due) – not much better than the 79% coverage ratio in the U.S.. As assets exceed liabilities, Citigroup believes Australia’s high LDR will constrain asset growth in the long-term.
Balance Sheet Risks: CAR
Thankfully, Australian banks are better capitalized than those in the U.S. and have been more aggressive with write-downs than the EU27. The ratio of Tier 1 (core) capital ratios to risk-weighted assets is higher in Australia than in the U.S.. The core capital adequacy ratio (CAR) in Australia and EU27 is 8.3% – above the Basel II required 8% – while it sits lower at 7% in the U.S. The write-down rate has been lower in Australia than in the U.S. but noncurrent loans are also a smaller share of all bank loans in Australia compared to the U.S.
Off-Balance Sheet Risks and Other Weak Spots
Derivatives are a bigger threat to the U.S. than Australia. Derivatives are 16 times bank assets and 14 times 2008 GDP in the U.S., whereas in Australia derivatives are only 3.95% of bank assets and 33% of GDP. However, off-balance sheet derivatives are 5 times bank assets and 12 times 2008 GDP in Australia.
Aside from off-balance sheet risk, Australian banks are also relatively more vulnerable than the U.S. and EU27 in terms of liquidity and external liabilities. Cash and liquid assets are only about 4% of total assets in Australia, compared with 8% in the U.S. Banks’ external liabilities as a share of GDP in Australia are double that of the U.S..
Looking ahead, the scourge of external liabilities may subside in the medium-term. Many forecasters believe the Australian Dollar will not go much lower than its nadir of 61.9 cents per U.S. Dollar in October 2008. Since the Federal Reserve announced quantitative easing, the Australian Dollar has enjoyed a run on inflation concerns – against which Australia is better protected with its higher interest rates. An upturn in commodity prices has also pumped up Australian Dollar demand. And, of course, the milder recession in Australia in contrast to the rest of the developed world makes the Australian Dollar seem a safer bet than the traditional safe havens, such as the Japanese Yen and the U.S. Dollar.
Exchange rate concerns aside, wholesale funding costs may remain elevated compared with pre-crisis levels as banks around the world tighten credit and seek liquidity. Moreover, bank debt costs may rise in Australia as banks face an increased risk of rating downgrades. In March 2009, Moody’s warned that Australia’s bank ratings could survive a severe economic downturn but the damage to lending books could last for years. Bank shares meanwhile are stuck in a bear market but, unlike the U.S., have not come under government ownership.
Asset Quality Outlook
Key to the asset quality outlook for Australia is the housing market. Housing loans are 55% of Australia’s bank loan portfolio – higher than in the U.S. (26%) and EU27 (30%). An increasing majority of housing loans are owner-occupier loans and the rest is a stagnating share of investor loans. As 90% of home loans are variable-rate loans, the number and value of loans for housing investments contracted in 2007-2008 as rates shot up.
Fortunately, the Australian housing market downturn is likely to be milder than in the U.S. and EU27 in 2009. Australia’s house price correction had a head start going back to 2003. Furthermore, housing demand from migrants to the commodities-rich West and the chronic housing shortage in eastern Australia will keep prices from stabilizing back at pre-boom levels unless Australia fails to avoid a deep recession. Indeed, housing loans to owner-occupiers began to recover since October 2008 after the government provided grants for first-time purchases of homes. The 2009/10 Budget extended the grant program to December 2009, which should boost the affordability of houses. A Pauletich survey determined Australia had the 2nd least affordable housing in the world, behind New Zealand.
The New Zealand Zinger
Though the local housing market looks unlikely to pose an existential threat to Australian banks, New Zealand’s housing market may give some banks a run for their money. Australian banks own most of the banks in New Zealand, where the housing market is undergoing a deeper correction as immigration to New Zealand slumps. With housing assets 5.7x household disposable income, New Zealand property markets are even more leveraged than their U.S. counterparts. As the Australian Financial Stability Review states: “As at December 2008, the Australian banks’ overseas exposures accounted for around 30 per
cent of their total assets, with New Zealand and the United Kingdom together accounting for about two thirds of these foreign exposures.” Considering the relative outlooks for housing markets in Australia and New Zealand, external assets are a more significant danger to Australian banks than domestic assets. This could be the hidden dragon that swallows up Australian banks in the years ahead despite its ostensibly more comfortable position versus European and American banks.
Data Sources: APRA, RBA, ECB, Committee of European Banking Supervisors, FDIC, U.S. Federal Reserve
1 – weighted average for EU27 countries
2 – weighted average for EU27 countries
3 – median EU27 CAR for risk-weighted assets
4 – as of September 30 for Australia
5 – as of H1 2008 for EU27
6 – as of H1 2008 for EU27
7 – as of September 30 for Australia
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