S&P warns on property bubble

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From S&P:

Increasing Property Prices — A Key Risk Factor For Malaysia, Australia, and New Zealand Similar to Hong Kong, we consider a risk that ultimately could have a bigger adverse impact on bank ratings is the one associated with a continuing surge of residential property prices rather than short-term property price deflation. As well as for Hong Kong, continuing short-term residential property price appreciation is an identified key risk to bank ratings in Malaysia, Australia, and New Zealand. Hence a retreat of property prices in these markets may–depending on the prevailing economic circumstances–have a solidifying effect on ratings at current rating levels, lessening the possibility of future bank downgrades associated with continuing rampant price appreciation. For Malaysia, Australia, and New Zealand, we believe that a 10% or even 20% property price shock potentially may not impact bank ratings. Property sensitivities as they affect banking sector credit strength are hardly a flash in the pan for these markets. In Malaysia, we placed our economic trend as it affects the banking sector on negative in November 2013, due mainly to the potential economic imbalances that could build up from rising property prices. For Australia, we negatively revised the economic risk assessment in October 2014 to mainly reflect our view concerning recent and anticipated future house price appreciation adding to other economic imbalances, in particular those associated with the current account and external debt position. In New Zealand, we believe that robust house-price growth–particularly in Auckland–is elevating risks in the financial system; hence, on Aug. 14, 2015, we negatively revised our Bank Industry Country Risk Assessment (BICRA) on New Zealand and at the same time took various negative rating actions on financial institutions. This negative BICRA change followed an extended period whereby New Zealand’s previous economic trend was negative primarily because of property concerns.

And their risk scenario:

Property price -30%, household disposable income -5% (high-impact scenario):We expect that bank ICRs at current rating levels potentially would be able to withstand a drop in residential property prices and disposable income of up to 20% and 2.5%, respectively. Nevertheless, we believe that these scenarios would make bank credit profiles vulnerable to any further weakening in the operating environment or bank-specific credit factors. By contrast, we expect that a 30% drop in property prices and a 5% decline in disposable income could have a significant negative impact on the Australian banking system. In our view this scenario would likely coincide with a significant rise in the unemployment rate and a drop in GDP growth. We expect this sharp unwinding of economic imbalances to cause a material rise in credit losses across all asset classes. Consequently, we potentially could expect to lower our SACP and issuer credit ratings on most rated financial institutions.

And the result:

Capture

That’s a four notch dump in the BICRA score to the lowest level in “investment grade” and bordering on junk.

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My own view is that in the current environment this anlaysis is far too sanguine. With nothing but house prices growing in the economy, a 10% reversal in prices would almost certainly guarantee a 20% plunge and that would be enough to trigger everything else above.

About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.