Borrower mortgage repayment diligence protecting Australia against ‘unlikely’ house price crash: IMF

A house price crash has been rated as a low to medium risk of occurring in Australia, according to the latest Financial System Stability Assessment report from the International Monetary Fund (IMF).

The report does note that the banking sector is heavily exposed to the housing market, with residential mortgages the banks’ single largest asset, but says the financial system is buffeted from an “unlikely” house price collapse because the household sector is not highly leveraged.

The report says an average loan to value ratio of 50% on mortgages provides the Australian financial system with “a buffer against a large decline in house prices”.

In addition, the IMF notes the differences in the Australian mortgage market compared with other countries and the propensity of borrowers to pre-pay their mortgages.

“[In Australia] there is no tax incentive for owner-occupier debt,  and prepayment on housing loans is prevalent and sizable.

“Mortgages are full recourse loans, giving borrowers an incentive to continue making payment even under stress,” the IMF adds.

Apart from the diligence of borrowers, the IMF says that at a central bank and government level, there are good structures in place to mitigate against structural risk from Australian banks' heavy exposure to the residential mortgage sector.

The IMF says authorities have “considerable policy space to respond to negative shocks given low public debt, a flexible exchange rate, some scope for monetary easing, and a well-capitalized banking system”.

However, it does warn of some risks to financial stability due to about a quarter of mortgages having a loan to value of 80% or more at origination mainly by first-home buyers and low-income households.

“The buffer for this group is much smaller and a large decline in house prices would have an impact on asset quality,” says the IMF.

But a house price crash is unlikely given that there is no oversupply of housing as was the case in the US sub-prime-fuelled mortgage crash.

“No construction boom has accompanied the run-up in house prices, and supply remains quite tight,” says the IMF.

While the report notes that house prices have “declined gradually over the past year” it anticipate a further correction in commercial property prices.

“Commercial real estate prices have seen a large correction since 2008 but still appear high by international comparison,” says the IMF, which calculates that commercial real estate represents about 10% of banks’ exposures and a sharp fall in prices would impair banks’ balance sheets.

The report does highlight how heavily Australia depends on the residential property market, with 90% of Australia’s household debt being housing loans, above the average of advanced economies in the G20.

“Strong house price gains over much of the past two decades have made Australia’s house prices relatively expensive now. This combination exposes banks to negative income shocks generated by a sharp increase in unemployment.

“Moreover, around 30% of new mortgages are interest-only, a potentially riskier type of lending than regular mortgages, and 55% of those mortgages are interest-only investor loans.

“However, the risk is mitigated by a number of factors, including much larger household assets that dwarf household debt, relatively low household leverage and increased household savings over recent years."

The report also notes that loans with an LVR of greater than 80% are “generally covered” by lenders mortgage insurance (LMI).

“The banks’ capital positions seemed capable of withstanding a range of adverse scenarios ranging from slow growth to severe macroeconomic shocks, even after taking into account banks’ cross-border-exposures.

“Under the most severe scenario, aggregate Tier 1 capital (funding sources to which a bank can most freely allocate losses without triggering bankruptcy such as ordinary shares and retained earnings) remains above the minimum threshold, although total capital of some banks falls slightly below the threshold after two years.

“The liquidity stress test, which simulated a bank-run type scenario, indicates that banks would be able to withstand a severe liquidity shock with support from the RBA under a new Basel-approved facility, and withdrawals of funding from banks in the United States, United Kingdom, and Japan would have the largest impact,” says the IMF.