Australia’s top four banks face rising risks in commercial real estate sector: Moody's

Higher office vacancy rates and growing settlement risk from a potential oversupply of newly built residential apartments in Australia's commercial real estate (CRE) sector is posing risks to the country's Big Four banks because of their growing exposure to them, according to Moody's Investors Service.

The big four — Australia and New Zealand Banking Group, Commonwealth Bank of Australia, National Australia Bank Limited and Westpac Banking Corporation — are all rated Aa2/Aa2 negative, a1 by the credit rating agency.

According to the report titled, Banks -- Australia: Risks from Commercial Real Estate Are Rising but Remain Manageable, office vacancy rates have been rising in Perth and Brisbane as tenants from the resource industry and public sectors scale back their office space requirements, and as new supply in both areas grows. While demand in Brisbane is showing signs of recovery as the economy improves, Perth remains weak due to the contraction in resource-related service industries.

Meanwhile, Sydney, Melbourne and Brisbane have a potential oversupply of residential apartments due to expected new supply amid falling migration and tighter lending rules, particularly for foreign buyers who make up a large percentage of residential property investors.

"Australia's major banks have been growing their CRE exposures modestly in recent years, and are thus vulnerable to the risks from higher office vacancy rates in Brisbane and Perth and settlement risks from a potential residential apartment oversupply in Sydney, Melbourne and Brisbane," says Maadhavi Ramanayake, a Moody's Associate Analyst.

"These credit negative developments are somewhat mitigated by the banks' limited direct exposure to the higher risk CRE segments and by their tightened lending criteria.” 

According to the Moody's report, the combination of increased supply and tighter lending raises the risk of non-settlement, and could expose residential property developers to higher risk. Furthermore, it could depress overall market sentiment and put downward pressure on general house prices.

These developments are credit negative for Australian banks, which have increased their lending to the CRE sector by 1 percent to 4 percent each year between 2012 and September 2013, and by around 5 percent or more annually since December 2013 onwards.

Nevertheless, Moody's expects the risks from their CRE exposures will remain manageable for the banks.

First, the major banks' share of CRE loans -- as a percentage of total committed exposures -- was moderate at 6 percent to 8 percent as of 30 March 2016 for ANZ, NAB and WBC and 30 June 2016 for CBA, below the pre-crisis level of around 10%. Also, the current weakness in the office market remains limited to select regions.

Second, Australia's major banks have tightened their lending criteria to the CRE sector after losses in the aftermath of the global financial crisis. As a result, Moody's sees foreign bank branches as more exposed to the current headwinds in the segment, and expects the major banks' CRE impairments to remain at low levels.

Moody's stress tests show that, even in a scenario of isolated severe stress on the commercial property property and related loans, the major banks will only suffer a mild deterioration in their Common Equity Tier 1 ratios.