Dark cloud risk for big four banks after GFC mortgage crisis escape: Credit Suisse

The GFC forced Australia’s major banks – among the most heavily exposed in the world to the local residential property market – to raise their mortgage underwriting standards and helped avoid a mortgage arrears crisis, according to a new report by investment bank Credit Suisse.

However, in the current slow housing credit market (the value of owner-occupier loans fell 0.3% in March) Credit Suisse warns there could be the “commencement of the next cycle of degradation of mortgage credit underwriting standards”.

“Our industry liaison suggests that this process is starting to occur (albeit has not slackened to the extent seen in the pre-crisis era), with banks more selectively retaining mortgage credit risk that previously would have been transferred to the lenders mortgage insurance (LMI) industry,” says Credit Suisse.

The report also notes that lenders resumed offering 95% LVR mortgages in 2011, with loans with LVRs of more than 90% rising from a trough of 11.5% in the June 2010 quarter to 17% in the December 2011 quarter.

The present decline in mortgage standards, Credit Suisse analysts say, is being driven by “challenges of achieving mortgage balance growth and revenue growth in a subdued macro environment”.

The Credit Suisse report shows that Australian lending institutions are among the most heavily exposed to the residential property market, with 59% of their loans offered to this sector, compared with 38% in the US, 33% in Canada and 13% in the UK.

Within Australia, the Westpac group has the most exposure to the residential property market, with 67% of its lending in the form of home loans.

The Commonwealth Bank has a 65% home loans exposure, followed by ANZ (53%) and NAB (52%).

Released at a time when APRA figures show the stock of bank-problem mortgage assets is now declining, the report says the GFC “reset the clock” in 2008 and 2009 and was a key reason why the 2009 mortgage vintage proved so resilient despite it having many unfavourable credit characteristics, such as “first-home owners that had received the first-home owner grant boost, written at or near-peak house price levels in many markets, and written at or near trough mortgage interest rates”.

Report authors and Credit Suisse analysts Jarrod Martin and James Ellis contend that “a potential mortgage arrears crisis was probably averted in Australia by the onset of the global financial crisis from mid-2007”.

They argue that a mortgage arrears crisis is founded upon “substantial, enduring and widespread degradation of origination underwriting standards, “not merely upon (say) overpriced housing or highly indebted households”.

“Conversely, had the global financial crisis not occurred, the alternative future might have been that ongoing growth and development of higher-risk mortgage products such as low-doc mortgages might have degraded Australian mortgage underwriting standards to a sufficient degree, across a wide enough range of mortgage originators and for a long enough period of time — that a material portion of the system’s mortgage stock would have become tainted with low credit-quality mortgages that had high probability of loss given default characteristics,” the report says.

Putting it another way, Credit Suisse argues that the “silver lining of the GFC for Australian banks” was that it brought to a halt lending by “highest risk mortgage providers (many non-banks and some regional banks)” and prevented the “meaningful spill-over of lax mortgage underwriting standards over to the major banks”.

“In this regard, we note that, even Westpac’s mid-2000s staunch resistance to offering low-doc mortgages saw a capitulation when Westpac’s on-going mortgage market share losses coincided in a de-rating of Westpac’s stock multiple.”

Westpac ramped up its play in the riskier low-doc loan market in 2005 in an effort to capture market share as lending slowed, prompting the RBA to warn that an increase in these riskier loans was a potential threat to the banking system.