Australia’s COVID-19 lockdown legacy continues Property market update and local banking sector exposures – a year on from the pandemic
March quarter 2021
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 Retail – convenience the winner Commercial office – culture and conditions guiding new working styles
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Navigating a pandemic
Forward-looking regulation 12 months ago we drew attention Australian financial system resilience to how APRA’s forward-looking Authorised deposit-taking institutions (‘ADIs’) have The Australian economy is approach to regulation had absorbed $266 billion in deferred payments over the now Pandemic, equal to over 10% of all lending2. larger than it was positioned the Australian financial pre-pandemic (+0.8% system to function and support the Despite the scale of this support, March quarter statistics reveal ADIs remain highly profitable financial above) as Australia’s economy in a crisis as deep as that institutions, anchored by a sound capital base and caused by the COVID-19 pandemic strong liquidity that remain able to support customers COVID-19 vaccine amid state lockdowns. (‘the Pandemic’). program gathers The results are in: March 2021 ADI statistics momentum. Remarkably, the Australian economy is now larger The suite of measures adopted by ADIs, including (+0.8% above) than it was pre-pandemic as Australia’s prudent capital management – such as lowered dividend COVID-19 vaccine program gathers momentum. The payout ratios - and implementation of APRA’s capital 1.8%1 economic growth recorded in the March quarter treatment concessions, have ensured Australia’s was above market expectations (1.5%) and more banking sector remains unquestionably strong. than half the Reserve Bank’s 2.8% growth forecast Operating metric* Mar 2020 Dec 2020 Mar 2021 Q-o-Q Y-o-Y for the entire first half of 2021. Business investment NPAT 3 (year-end) $28.3 $21.9 $29.4 34% 3.8% rose the most since 2009, while dwelling investment Total assets $5,599.2 $5,302.3 $5,206.8 -1.8% -7.0% continues to boom as federal stimulus measures – led by HomeBuilder – bring forward demand. Total capital base $340.2 $369.0 $378.1 2.5% 11.1% Total RWA4 $2,161.9 $2,100.6 $2,073.6 -1.3% -4.1% Sharp risks do remain, including the low vaccination rate (~20% of adult population) relative to global standards Key ratios Mar 2020 Dec 2020 Mar 2021 Q-o-Q (ppts5) Y-o-Y (ppts5) (51% in the US and 59% in the UK) that poses ongoing Capital adequacy 16% 18% 18% +0.7 +2.5 lockdown risk - as evidenced by VIC, NSW, QLD, WA and Minimum liquidity holdings 18% 20% 20% -0.5 1.6 NT; uneven growth; and geopolitical tension. Liquidity coverage 150% 142% 131% -10.6 -19.0 Consequently, diligent prudential supervision – especially amid the housing boom – remains as important as ever. 1 Australian Bureau of Statistics 3 Net profit after tax 2 APRA Publication: APRA’s loan repayment deferral data: 4 Risk-weighted assets Shining a light on credit risk; 2 December 2020 5 Percentage points
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Caution-led strength
APRA’s quarterly ADI statistics provides useful insight into the health of the consumer and corporate sector; key drivers of property performance. The strength in credit quality continued in the lead up to the March 2021 end to repayment deferral concessions, indicating that banks’ ability to remain viable and function normally amid severe economic shocks has significantly improved post-GFC.
Credit quality remains good, especially relative to the GFC But vigilance is needed
APRA noted measures of asset quality, such as non-performing loan ratios, were stable We continue to caution that the post-COVID-19 economic recovery is likely to be at 31 March 2021, and the share of new higher-risk residential mortgage lending across uneven across industries and demographics. Ongoing state government-directed ‘snap’ most key metrics (for example, lending at high loan-to-valuation ratios) declined over the lockdowns are an ever-present threat to confidence, especially given the conclusion of quarter. This is despite the largest shock to the Australian economy in a century, which the key loan deferral concessions and the JobKeeper support measures. dwarfed that of the GFC. Low interest rates will play an important role ensuring the economic recovery is as broad based as possible. However, noting the potential for inflated house prices, the Council of Financial Regulators – the coordinating body for Australia’s main financial Impairment as a proportion of loan portfolio by lender regulatory agencies, of which APRA is one - has indicated that it would consider possible
Major banks Other domestic banks Foreign subsidiary banks Foreign branch banks responses should lending standards deteriorate and financial risks increase. APRA’s March 2021 data release revealed a notable increase in new lending at high 25% GFC period COVID-19 debt-to-income ratios as interest rates are set at very low levels. 20% New residential mortgage loans funded during the quarter 15% Mar 2020 Dec 2020 Mar 2021 Q-o-Q Y-o-Y Share of total Change (ppts) 10% Owner-occupied 68.5% 69.8% 69.9% +0.1 +1.5 5% Investment 29.7% 28.6% 28.6% Unchanged -1.1 Interest-only 18.1% 19.4% 19.5% +0.1 +1.3 0 Jun Jun Jun Jun Jun Jun Jun Jun Jun LVR ≥ 90 per cent 9.9% 11.3% 10.4% -0.9 +0.5 2005 2007 2009 2011 2013 2015 2017 2019 2021 Third-party originated 51.1% 54.6% 54.0% -0.7 +2.9 Debt-to-income ≥ 6x 16.3% 17.3% 19.1% +1.8 +2.7 Source: APRA, Commercial Property Exposures Update, March quarter 2021 Source: APRA quarterly authorised deposit-taking institution statistics for March 2021
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Retail
The Pandemic-led extensive change in the structure of retailing over the past 18 months has highlighted the sector’s dynamism and ability to respond to rapidly changing point of sale and logistics settings.
Government stimulus – at both household and company levels – has been extremely successful in averting a sustained and crippling retail trade recession. This trade performance has been broadly reflected in retail property investment Online sales (% of total retail sales) activity, with the strong demand for grocery and ‘daily needs’ anchored centres over the last 12 months mirroring the Online non-food retailing Online food retailing success of non-discretionary retailers over the Pandemic. AUD ($m) % of total Australian retail turnover 3,500 12%
Pandemic online penetration permanent 3,000 10% 2,500 The sheer size of online sales and growth recorded since the beginning of the Pandemic – notwithstanding the 8% substantial stimulus programs in place – has expedited a structural change in retail property, evidenced by a growing 2,000 6% trend of ‘dark stores’ and ‘click and collect’ facilities, as well as greater prevalence of online only retailers. 1,500 4% While these growth rates are anticipated to stabilise as vaccination rates rise, the experience has consolidated 1,000 localised convenience and industrial warehousing as part of a ‘new core retail’ sector, drawing capital away from assets 500 2%
traditionally favoured by investors seeking retail exposure. 0 0% Mar Sep Mar Sep Mar Sep Mar Sep Mar Sep Mar Sep Mar Sep Mar Major mall and CBD retail hit hardest 14 14 15 15 16 16 17 17 18 18 19 19 20 20 21 Investor demand for large ‘Regional’ and ‘Super Regional’ centres1, in addition to CBD located stores has been, and will likely remain, most at risk of under-performance as a result of new core retail. Whilst there has been a slow return to Australian CBD prime yield forecast Sydney Melbourne Brisbane both assets (given both have heavy reliance on foot traffic), leasing and valuation evidence, points to the emergence Yield of a more discerning shopper, for whom lockdown risk and state mandated travel restrictions provide major deterrents (%) from shopping in these traditional settings. 12 10 8 6 4 2
0 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
Source: ABS and CBRE Research, Q1 2021 1. http://www.shoppingcentresonline.com.au/OnlineInfo.aspx
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Retail
Convenience is king In stark contrast to CBD and larger discretionary- spend anchored centres, the data and anecdotal evidence suggests COVID-19 has acted as a tailwind for neighbourhood convenience and large format daily needs focused centres, across both metro and regional markets. The close proximity to their primary market and non-discretionary offer, led by supermarkets, chemists, fast food, core health and other services – has deeply resonated with shoppers and investors as living and working patterns have changed. We think the strong investment performance of the categories will likely continue beyond the Pandemic, given its resilience is now irrefutably proven.
Key markets – average yield by centre type
Regional Sub-regional Neighbourhood Yield (%) Average blended yield Large format
11 10 9 8 7 6 5 4 Mar Mar Mar Mar Mar Mar Mar Mar Mar Mar Mar 11 12 13 14 15 16 17 18 19 20 21
Note: Average retail yield includes NSW, Vic, Qld, WA and SA Regional, Sub-Regional and Neighbourhood centres. Source: Savills Research/RBA
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Commercial office
Transactions – overseas investors still active Australian CBD prime yield forecast Transaction volumes were more than $2.5 billion across almost 30 sales for Q12021 increasing by 34% over Q12020. Expected to remain stable Overseas investors accounted for almost half of total transaction volumes over the quarter, highlighting the strong Sydney Melbourne Brisbane Yield demand for quality Australian office assets. The sector continues to be supported by accessible and historically cheap (%) Adelaide Perth Canberra
debt, and the relatively strong Australian economic fundamentals generating deep competition among financiers – 8 overseas, non-bank lenders and ADIs alike. 7 Valuation performance – all is not what it seems 6 5 Prime yields across the major commercial office markets have remained fairly stable at approximately 5.25% during Q12021; significantly below the five-year quarterly average of 5.70%. With vacancy rates rising and expected to 4 increase further, history suggests a ‘flight to quality’ will likely see a further divergence of yields between prime 3 and secondary office assets, in the short term. This will favour better capitalised investors over private owners who 2017 2018 2019 2020 2021 2022 2023 generally have less capacity to meet ongoing capital expenditure requirements of their assets to maintain market competitiveness against institutional owners. Source: CBRE Research, Q1 2021
Global comparison – CBD offices underperforming in the US From a global perspective, CBD offices in the United States have underperformed in terms of total returns when US downtown versus suburban vacancy compared to offices in CBD fringe and suburban locations since the beginning of the Pandemic and throughout the Vacancy Downtown Suburban 2020 calendar year. The US, in the past, has been a leading indicator of trends later experienced in all property sectors Rate across Australia and other parts of the world, so it is possible that we will see a similar pattern occur locally. (%) 20 Previous peak 18 16 Previous peak 14 12 10 8
2007 2009 2011 2013 2015 2017 2019 2021
Source: CBRE Economic Advisors, Q1 2021
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Commercial office
Lockdown legacy Office occupancy, as a percentage of pre-COVID levels While most of Australia’s major office markets are slowly recovering to pre-COVID-19 occupancy levels, there appears to be some resistance from Melbourne CBD office workers to return, who continue to seek greater flexibility under State Jan-21 Feb-21 Mar-21 Apr-21 May-21 ‘hybrid working’ arrangements, with Melbourne remaining at 45% of pre-COVID-19 occupancy levels1 . The largely ‘lockdown free’ Sydney CBD was back to 68% of pre-COVID-19 levels at May 2021. We expect the spectre of lockdowns Melbourne 34% 27% 39% 45% 45% to loom large over office attendance rates, leading to slow and varied recoveries around major CBDs, especially amid Sydney 50% 54% 56% 65% 68% the recent incidents of new COVID-19 outbreaks around the country. Brisbane 70% 72% 69% 70% 71% Canberra 76% 72% 72% 70% 71% A fun fightback Perth 74% 72% 79% 78% 77% Property Council of Australia (‘PCA’) led initiatives, developed and implemented in partnership with state governments, Adelaide 77% 77% 79% 78% 78% city councils and key stakeholders, are seeking to reactivate CBDs one Friday at a time. In Victoria, the City of Hobart 89% 84% 89% 91% 93% Melbourne has introduced ‘FOMO Fridays’ offers (with a similar initiative recently being introduced by the Government Darwin 89% 89% 93% 93% 93% of South Australia), whilst Brisbane’s ‘Fridays in The City’ come with discounted parking, free fitness classes and a range of food, beverage and other giveaways. Many of Australia’s largest office landlords including Charter Hall, Dexus, ISPT, Lendlease and Mirvac, are also supporting the initiatives, with the activation of office lobbies on Fridays offering free coffees, live music and even allowing office workers to bring their pets into the office! Office attendance rate
Culture and conditions guiding new working styles Mar-21 Apr-21 May-21 How we interact with our workplaces continues to rapidly evolve as we emerge from the depths of the Pandemic. A % normalisation of remote working has revealed the importance of workplace culture in an office setting and ultimately, 100 space needs for organisations. We suspect these new working styles have resulted in inefficiencies across some 75 organisations, as those with a history of poor office culture being the most exposed. 50
25
0 MEL SYD BRI CAN PER ADE HOB DAR
Source: PCA
1. PCA May 2021 Office Occupancy Survey
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02 ADIs’ overall property exposure Commercial sector Residential sector Lender composition
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ADIs’ overall property exposure
Commercial lending snapshot Commercial property exposure by sector • ADIs grew their exposures to commercial property by 1.3% over the 12 months to March 2021; a considerably lower growth rate compared with previous years. Office Retail Industrial Land Other residential Tourism and Leisure Other Exposure growth, albeit subdued, was once again supported by the increase in Millions lending to the Industrial property sector (9.6% year on year). Current $350,000 $305.44 billion Peak (Mar 2021) • March quarter data once again demonstrated the resilience of the Australian $300,000 $248.98 billion 10% financial system, with ADIs increasing their exposures to sectors most sensitive to (Mar 2009) 4% $250,000 11% lockdown measures. Exposures to the Tourism and Leisure and Office sectors rose 4% $200,000 11.8% and 3.1% respectively over the year to March 2021. 9% 13% $150,000 12% • However, despite previous resilience in the Retail sector, exposure decreased 0.8% 26% $100,000 18% across the year. We expect this may be a reflection of COVID-19’s full impact across the year and we will continue to monitor the sector over the following quarters. $50,000 27% 32% 0 Mar Mar Mar Mar Mar Mar Mar 2009 2011 2013 2015 2017 2019 2021
Commercial property exposure growth
% 8.0 7.6
7.0
6.0 5.4 5.0 4.1 4.0 3.7
3.0 2.0 1.3 1.0
0 Mar Mar Mar Mar Mar 2017 2018 2019 2020 2021
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ADIs’ overall property exposure
Residential overview New residential loans approved per quarter by LVR • Interest-only exposures fell a further 17% during the March quarter, in line the previous quarters. This is a continued reflection of APRA’s tightening of restrictions in 2017, which targeted interest-only loan lending – interest only loans typically ≤60% LVR 60%
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Commercial sector
Aggregate exposure limits Commercial sector exposure • Aggregate commercial property exposure continues to grow substantially above the previous peak of March 2009 (now 22.7% above). Exposures rose 0.9% over the Q-o-Q (Mar21) Q-o-Q (Dec20) Y-o-Y (Mar21) March quarter, higher than growth recorded across the previous three quarters. All commercial 0.9% 0.1% 1.3% Retail exposure down, ongoing robustness in Industrial and Tourism exposure: Office 0.9% 1.6% 3.1% • Unsurprisingly ADIs decreased their exposure to the Retail sector over the March Retail (0.5%) 0.7% (0.8)% quarter (-0.5%). As highlighted in our previous publication, despite the slight improvement during the December quarter, we do not anticipate a return of Industrial 4.3% (0.9%) 9.6% sustained robust exposure growth in the short to medium term. Land 0.5% (1.8%) (2.1)% • A sharp increase was recorded in Industrial exposure (+4.3%) following a marginal Other residential (0.8%) (0.9%) (7.1)% decrease in the previous quarter. The return of positive growth in this sector reflects Tourism and leisure 1.7% (0.4%) 11.8% our views on the strengths of the sector’s fundamentals. Other 1.8% (2.6%) (2.5)% • Tourism and Leisure exposure increased 1.7% over the March quarter, also following a marginal decrease in the previous quarter. We will continue to monitor how ADIs’ exposure to this sector changes as sentiment toward domestic and in-bound tourism Commercial sector peak exposure improves over time with the global vaccine rollout. Change since 2009 peak Other Residential and Land Developments remain substantially below peak: Office 49.9% • Lenders continue to decrease their exposure to Other Residential (apartments and Retail 77.7% high-density accommodation) with a further 0.8% drop, in line with the previous quarter, contributing to the largest year-on-year fall of all sectors (-7.1%). We Industrial 45.7% consider this to reflect the restricted investor market and heightened settlement risk Land developments/subdivisions (42.0%) onset by COVID-19. Other residential (18.2%) • Land Developments/Subdivision exposure continues to represent the second Tourism and leisure 15.9% smallest exposure by sector following Tourism and Leisure. The sector experienced a slight increase in the March quarter (0.5%). Other (24.7%)
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Residential sector
Aggregate exposure limits Key insights Q-o-Q (Mar21) Y-o-Y (Mar21) Y-o-Y (Mar20) • New residential mortgage lending increased 1.3%, in line with the previous quarter. Residential term loans growth +1.3% +4.2% +3.7% We expect the recent increases may be a continued indication of borrowers’ general confidence despite some limited supply during the months hardest hit by COVID-19. Mar21 Dec20 Mar20 Peak Sep15 Spike in new interest-only loans across the year: Investor share of lending 33.7% 34.1% 35.5% 38.0%
• New interest-only growth dropped 0.1% following a considerable increase across the Y-o-Y (Mar21) Y-o-Y (Dec20) Y-o-Y (Mar20) December quarter (+17.1%). Notwithstanding the March results, new interest-only New interest-only loans as a proportion of total +44.6% +31.6% +11.8% growth increased 44.6% across the year. residential exposures
• Interest-only loans as a proportion of lenders’ overall residential exposures continued Mar21 Dec20 Mar20 Sep15 to drop, albeit at a slower rate, despite another sizeable increase in new interest- Lenders’ proportionate exposure 19.5% 19.3% 18.1% 41% only lending year-on-year. Interest-only term loan exposure decreased a further to interest-only loans
17% across the year to March 2021, an on-going reflection of lenders’ preference for Mar21 Dec20 Mar20 principal and interest loans following APRA’s policy changes in 2017. Proportion of highly leveraged new housing loans 41.2% 42% 38.4% Offset balances follow lockdowns: • Balances held in offset accounts grew at a much slower pace compared with previous quarters (+1.5%). We expect this reflects less lockdowns and an ease in Aggregate residential property exposure by type travel restrictions at the beginning of 2021 which likely contributed an increase in Owner-occupied Investment consumer spending. However, balances in offset accounts remain up 17.9% across Millions ($) Y-to-Y Y-to-Y +3.8% +4.5% the year, thought to be a continued reflection of low interest rates and Government 1,800,000 stimulus measures. 1,500,000 1,500,000 33% 36% 34% 1,200,000 900,000 900,000 900,000 600,000 300,000 67% 64% 66% 0 Mar Jun Sep Dec Mar Jun Sep Dec Mar 2019 2019 2019 2019 2020 2020 2020 2020 2021
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Lender composition Commercial property exposures by lender group
Major banks Other domestic banks Foreign subsidiary banks Foreign branch banks • Major Australian banks still dominate the lending market, making up almost 80.0% Millions of commercial and residential loans. $350,000
• Foreign banks’ share of Australian commercial property loans continues to grow at $300,000
a robust annualised rate of 20.4%, with actual exposures now 4.2 times higher than $250,000 the post GFC low in March 2013. $200,000
• Despite increases in impairments year-on-year, numbers in absolute terms remain $150,000 low and provisioning appears appropriate for the level of impairments, unlike in the $100,000 lead up to and during the GFC. Nonetheless, there will be heightened vigilance over COVID-19 legacy risks and the unwinding of substantial stimulus programs over the $50,000 0 next 12 months. Mar Mar Mar Mar Mar Mar Mar Mar Mar 2005 2007 2009 2011 2013 2015 2017 2019 2021
Foreign branch banks’ share of commercial lending
Office Retail Industrial Land Other residential Tourism and Leisure Other Millions Current $60,000 $61.65 billion (Mar 2021) $50,000
$40,000 Peak $30,000 $20.40 billion (Mar 2009) $20,000
$10,000
0 Mar Mar Mar Mar Mar Mar Mar 2009 2011 2013 2015 2017 2019 2021
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Notes
APRA Revisions Further information KordaMentha Real Estate key contacts March Quarter 2021 APRA’s ‘Quarterly ADI Property Exposures’ contains Tom Davis information on ADIs’ commercial property exposures, Partner | Melbourne No institutions resubmitted data to APRA. residential property exposures and new housing loan [email protected] The March edition of the Quarterly ADI Property approvals. +61 3 8623 3449 Exposures publication includes revisions to previously Further information including explanatory notes and an published statistics, due to better source data extended glossary can be found at: apra.gov.au Berrick Wilson becoming available. Partner | Melbourne In 2017, APRA announced that Reporting Form ARF Notes [email protected] 320.8 Housing Finance Reconciliation, (ARF 320.8) +61 3 8623 3322 Commercial property sectors: would cease after the September 2019 reporting period as part of the implementation of the Economic and • Development: Land development/subdivisions. Paul Mirams Financial Statistics data collection. APRA now source Partner | Sydney • Other residential: Excludes loans to individuals or its residential property exposures and new housing loan families, loans to private family companies or trusts [email protected] approvals from Reporting Form ARF 223.0 Residential for owner-occupation. +61 2 8257 3067 Mortgage Lending (ARF 223.0). As a result QPEX will contain more detailed aggregated data on residential • Other: All other loans for the acquisition of Brad Bennett property exposures and new housing loan approvals than commercial property not included in remaining Partner | Brisbane were previously published. categories. [email protected] +61 7 3338 0242 Commercial property exposure limits: • The aggregate of all claims, commitments and Sam Woods contingent liabilities arising from on and off balance Executive Director | Perth sheet transactions with the lender counterparty, [email protected] i.e. includes outstanding balances and undrawn +61 8 9220 9306 commitments. • Commercial property exposures include offshore interests, which represent ~15% (i.e. 85% of loans against Australian assets).
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Contacts
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