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Australian Banking Sector Property Exposures and Market Update December Quarter 2020

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Australian Banking Sector Property Exposures and Market Update December Quarter 2020 Australian banking sector property exposures and market update December quarter 2020 The Australian Prudential Regulation Authority (‘APRA’) recently released its quarterly property exposure data for domestic and foreign authorised deposit‑taking institutions (‘ADIs’). KordaMentha Property exposures update 01 Navigating a pandemic Managing commercial property lending risk Managing residential property lending risk An institutional investment view on residential property 2 KordaMentha Property exposures update Navigating a pandemic Resilience-led rebound We release our December quarter Banking on a strong financial system update amid the gathering pace of The Australian economy’s relative resilience during APRA‑led initiatives targeting a Australia’s recovery from its first the pandemic has been due in no small part to the stronger, more resilient banking capacity of banks and other authorised deposit‑taking recession in almost 30 years and institutions, or ‘ADIs’ (such as credit unions or building system have been vindicated, the commencement of the nation’s societies), to absorb $266.0 billion in deferred payments, with ADIs reporting high capital equal to over 10.0% of all lending arrears2. COVID‑19 vaccine program. ratios, strong liquidity and APRA’s enhanced capital and credit control measures implemented in the years prior to the pandemic have funding positions for the December The 3.1% economic growth recorded in the December strengthened ADIs’ financial positions, such that lending quarter, despite the substantial quarter followed the robust 3.4% of the September activity and general liquidity has remained broadly 1 quarter . This marked the first time in the more than 60‑ unaffected. borrower support over the pandemic. year history of the National Accounts that GDP had risen by more than 3.0% in two consecutive quarters. The Highlights economy is now positioned to return to pre‑COVID‑19 7 ADIs demonstrated their resilience in the December Key ADI performance statistics levels during 2021, with the 7.0% collapse in the June quarter, with high capital ratios, strong liquidity and Operating metric* Dec 2019 Dec 2020 Change quarter almost recovered. Importantly, the rebound in funding positions. NPAT 4 (year-end) $33.7 $21.9 ‑35.0% economic activity has helped drive unemployment down to pre‑pandemic levels1,3. Full‑time jobs growth has led Total assets $4,981.5 $5,302.4 +6.4% the rebound, albeit weakness remains in the part‑time Reduced bad or doubtful debts. Total capital base $329.0 $368.9 +12.1% employment category. Total RWA6 $2,089.6 $2,100.6 +0.5% *AUD billion This recovery has, however, been supported by Overall growth in loans and advances 5 elevated levels of fiscal and monetary policy stimulus. (albeit slow). Key ratios Dec 2019 Dec 2020 Change Consequently, the sustainability of the recovery will be Capital adequacy 15.7% 17.6% +1.9 pp Lending standards remain in line with contingent on diligent prudential supervision. Minimum liquidity 16.2% 20.2% +4.0 pp historical averages. holdings Liquidity coverage 131.5% 141.8% +10.3 pp 1 Australian Bureau of Statistics 5 Percentage points (difference between two percentages) 2 APRA Publication: APRA’s loan repayment deferral data: Shining a 6 Risk weighted assets light on credit risk; 2 December 2020 7 Aggregated financial performance, financial position, capital 3 KordaMentha research adequacy, asset quality, liquidity and key financial performance 4 Net profit after tax ratios at 31 December 2020 3 KordaMentha Property exposures update The COVID-19 shock cushioned APRA’s housing loan data provides useful insight into the health of the consumer and corporate sector; key drivers of broader property sector performance. The ongoing and significant reduction in loans subject to repayment deferral provides comfort that banks can remain viable and function normally, despite inevitable losses flowing from severe economic shocks. Deferrals continue to decrease… But vigilance is needed Temporary loan repayment deferrals have been steadily decreasing since the May 2020 We continue to caution that the post‑COVID‑19 economic recovery is likely to be uneven peak of over 10.0%, worth more than $250.0 billion, which housing loans make up over across industries and demographics, especially given imminent changes to key support 85.0%. measures, including loan deferral concessions and the JobKeeper program. In February, only 0.5% ($14.0 billion), of all loans were subject to repayment deferral, Low interest rates are expected to play an important role in ensuring the economic down from 1.4% in January 2021 and 3.3% in October 2020. Victoria has the highest recovery is as broad based as possible. However, noting the potential for inflated house proportion of deferred loans, at 0.7% compared with the rest of the county at 0.4%. prices, the Council of Financial Regulators – the coordinating body for Australia’s main financial regulatory agencies, of which APRA is one ‑ has indicated that it would Key insights from deferrals consider possible responses should lending standards deteriorate and financial risks The strong rebound in economic activity has coincided with a significant and steady increase. decline in loan deferrals. Careful credit management needed for loans still subject to repayment deferral The risk profile of deferred loans is relatively high, with the proportion of loans with LVRs >90.0% and those to investors over‑represented. Loans subject to repayment Housing deferrals, share of Housing loan risk profiles1 Borrowers continuing to deferral housing loans by state make repayments2 $b Total deferrals (LHS) Aug Sep Oct Nov Dec Jan Feb Loan to value ratio >90% Interest only Investor Full repayments Partial repayments 300 Share of total loans (RHS) 12% 12% 40% 40% 250 10% 10% 30% 30% 200 8% 8% 150 6% 6% 20% 20% 100 4% 4% 10% 10% 50 2% 2% 0 0% 0% 0% 0% MarAprMayJun Jul AugSep Oct NovDecJan Feb VIC NSW WA QLD NT SA TAS ACT Deferred housing loands Total housing loands Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Source: APRA’s loan repayment deferral data: Shining a light on credit risk; 2 December 2020 1 Proportion of high risk loans among loans deferred v. proportion of high risk loans within total housing loans 2 Figures based on loans subject to repayment deferral 4 KordaMentha Property exposures update Managing commercial property lending risk Pandemic performance snapshot of two at-risk sectors Retail Office Australian CBD prime yield forecast • Interestingly, the sharp COVID‑19 recession is • Investment activity has improved since Q2 2020, Sydney Melbourne Brisbane Yield still yet to be reflected in the APRA ADI data, with however, transaction volumes are likely to remain Adelaide Perth Canberra December 2020 figures continuing to belie still relatively low over 2021. Nonetheless, Australia’s success (%) 8 constrained aggregate demand (+4.2% Y‑on‑Y and in managing the pandemic has enhanced its appeal +0.7% Q‑on‑Q). among offshore investors, with in‑bound investment 7 during 2020 significantly above the long‑term average 6 • Nonetheless, the tapering of extensive government of 35.0%. While Australia’s major office markets are still 5 stimulus that supported retailers throughout the recovering to pre‑COVID occupancy levels (refer adjacent depths of the pandemic may lead to some volatility 4 chart) and there’s a future expectation of higher employee in retail sector lending activity over 2021, with 3 take up on ‘working from home’ opportunities, Australia’s weakness in valuations across some sub‑sectors 2017 2018 2019 2020 2021 2022 2023 office markets are expected to remain a compelling (among other indicators) falling amid income investment opportunity relative to global peers. uncertainty. Further, a significantly lower number of retail transactions throughout 2020 has likely • The tapering of government stimulus, including the Office attendance rate masked wider market impacts. We continue to conclusion of the JobKeeper program in March 2021, will Dec‑20 Jan‑21 Feb‑21 monitor this sector amid the COVID‑19 vaccination plausibly see vacancy rise, with sub‑lease space peaking % rollout that is so critical to the sector’s short and in 2021 that, in‑turn, may draw more generous incentives 90 medium term trading conditions. and impart downward pressure on income. Experience 80 from past cycles suggests secondary grade assets are 70 60 Total retail property transaction volumes most exposed to excess space supply, which allows 50 tenants to ‘trade up’ to prime grade accommodation 40 AUD ($b) Australia New Zealand 30 12 commonly managed by institutional investors. 20 Consequently, prime grade assets may continue to be 10 10 0 priced on low yields, supporting valuation resilience. MEL1 SYD1 BRI CAN ADE HOB PER DAR 8 A‑REITs have already provided evidence of this scenario in practice, with small increases in valuations reported 6 Source: (Above) PCA, Q4 2020 CBRE Office report, over the six months to 31 December 2020. End of Year Review: Jan‑ Nov 2020 Office Middle Market Colliers. 4 • Accessible and historically cheap debt remains a tailwind 1 Data is reflective of snap lockdowns in these cities 2 for the sector, with several A‑REITs reporting reduced Source: (Left) JLL Research interest costs, with rates generally falling between 3.0% 0 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 to 4.0% across the sector. 5 KordaMentha Property exposures update Managing residential property lending risk Stimulus-led residential rebound The performance of Australia’s residential markets has Detached-housing1 increase in Melbourne. Reflecting the asymmetric been closely linked to health outcomes and the severity impact of COVID‑19 around Australia, Darwin, Canberra of lockdowns. More specifically, the varying speeds of The detached housing sector is emerging from COVID‑19 and Hobart recorded substantial increases of 16.3%, recovery across geographies, along with the detached in a stronger position across most capital cities amid low 13.9% and 12.8% respectively.
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