Commercial property credit losses at Australian banks: RBA research discussion paper chart

Credit Losses at Australian Banks: 1980–2013 is the latest Reserve Bank of Australia research discussion paper, written by David Rodgers.

The paper explores the historical credit loss experience of the Australian banking system.

The paper provides the narrative of banking system credit losses in Australia that includes both the early 1990s and global financial crisis episodes.

During both episodes, banks’ credit losses appear to have had a close relationship with changes in business sector conditions (such as commercial property prices and the business sector’s interest burden).

Losses during the earlier period totalled around 8.5% of lending; losses during and after the global financial crisis were around 2.5% of lending.

The earlier episode was a more severe downturn – business sector conditions declined to a greater extent – but anecdotal evidence indicates that differences in lending standards also played a role in the different levels of credit losses across these two episodes.

As well as macroeconomic conditions and lending standards, portfolio composition turns out to be important for credit losses. The very limited portfolio-level data available for the early 1990s indicate losses during this episode were incurred mainly on business lending.

The better data available for the global financial crisis episode make it clear that the elevated losses during this episode were almost entirely incurred on business lending.

Credit losses on housing loans during the global financial crisis episode were minimal.

It noted the Australian bank credit loss experience since 1980 is dominated by the very high rate of losses before, during, and after the early 1990s recession, as well as the smaller losses during and after the global financial crisis.

Losses around the early 1980s recession were much lower. Relative to lending, credit losses during the early 1990s far exceeded those incurred by banks during and after the global financial crisis.

Current losses between September 1989 and September 1994 totalled around 8.5% of the average value of banks’ lending during this period. In comparison, current losses during September 2007 to September 2012 were equivalent to around 2.5% of average lending over this period.

The partial portfolio-level data that are available for the early 1990s episode indicate that the bulk of credit losses were incurred on lending to businesses rather than households.

Two major banks published usable portfolio breakdowns of their net write-offs in their annual reports for some or all of the early 1990s, but the categories used in this data were not well defined (Figure 5).

They show losses on non-construction housing loans were minimal (these fall within the ‘Real estate – mortgage’ category).

Loans to individuals for construction of housing probably fell within the ‘Real estate – construction’ category, but this category also contains lending for commercial property. Losses on this category were significant, but only make up around 13% of reported losses for these two banks.

The key point is that most of the losses reported by these two banks fall in the ‘Other business’ category.

Losses on personal lending, such as credit cards and non-housing term loans, were non-negligible, but appear to be less cyclical than losses on business lending.

These two banks, CBA and NAB, accounted for 33% of bank lending at September 1991.

CBA’s write-offs include those made within the State Bank of Victoria’s loan book after its acquisition in November 1990.

Portfolio-level data are available on all banks’ non-performing assets from mid 1990 to mid 1994, and these support the conclusion that losses were incurred mainly on business lending.

It shows that the share of banks’ lending to businesses that was non-performing far exceeded the share of their lending to households (including non-mortgage personal lending) that was non-performing.

It noted contemporary accounts of the period also indicate that credit losses were primarily on lending to businesses.

Trevor Sykes’ (1994) classic account of corporate and banking collapses during this period, The Bold Riders, is one example.

Edna Carew’s (1997) account of Westpac’s experience during the period indicates its losses were concentrated in business lending, and more specifically, in property development lending. The dominant role of business lending is also suggested by contemporary accounts from industry participants (Phelps 1989; Lee 1991).

Various authors have set out potential reasons why credit losses were so large in the early 1990s (Battellino and McMillan 1989; Fraser 1994; Sykes 1994; Carew 1997; Conroy 1997; Ullmer 1997; Gizycki and Lowe 2000).

There was a recession during 1990–91, and downturns in financial and property markets, but losses were many times greater than those seen in earlier (and later) downturns, suggesting other factors at play.

A short version is that deregulation of the banking sector in the 1980s was accompanied by very fast business lending growth and declining lending standards, all during a period of strong economic and financial conditions.

Macroeconomic and financial conditions facilitated these developments.

Real GDP grew at an average rate of about 41⁄4 per cent over the five years to September 1989.

Equity prices rose by almost 50 per cent per annum from late 1984 until the crash in October 1987.

Commercial property price growth rose above 10 per cent per annum at the start of 1986, and accelerated in subsequent years.

This price growth was accompanied by an exceptional amount of non- residential construction, particularly of offices (Figure 8; Kent and Scott 1991).

Commercial property was a key form of collateral for the business loans that were secured.

By early 1990, large highly geared companies across a range of industries were unable to meet their increased loan repayments and defaulted on their debts (Sykes 1994).

This, together with a weakening in the commercial property market, exposed banks to a first round of credit losses (Gizycki and Lowe 2000).

These losses broadened as business profits began to fall and Australia entered a recession around the end of the year.

By September 1991, large additions to the supply of office property had combined with flat or falling demand to sharply raise vacancy rates and drive prices down by over 20% on an Australia-wide basis; some banks were forced to recognize significant credit losses on commercial property lending (Carew 1997).

Even during a period in which system-wide lending standards loosened, there are indications lending standards at state government-owned banks, particularly SBSA and SBV, were below average.

These banks grew their lending very quickly over the late 1980s. SBSA and SBV grew their lending at rates of 43 and 27% per year between 1985 and 1990, versus growth in total credit of around 18% per year over this period.

This fast growth was driven by business lending – the share of these banks’ portfolios made up by business lending increased by over 20 percentage points over the same period. State government owners encouraged fast lending growth, both to support state economies and to provide a new source of revenue for state coffers, and installed aggressive managers (Sykes 1994).

The historical experience of credit losses at Australian banks the paper describes should help to guide overall understanding of the credit risk they currently face.

It supports a continued focus on the analysis of the financial health of the business sector as part the Reserve Bank’s semiannual Financial Stability Review, David Rodgers.