S&P: Property risks “firmly down”

More amusing stuff from S&P:

A contracting economy in the short term, rising unemployment, and depressed consumer and business sentiment in the wake of the COVID-19 outbreak have increased the downside risks for property prices and consequently the financial system in Australia, S&P Global Ratings said today.

We consider that the closure of real estate auctions as announced by the Australian government should, by itself, have only a short-term impact on the property market transactions. Although it is difficult to be definitive in these rapidly changing operating conditions, we currently foresee a downturn in the property sector to be relatively short lived, consistent with our economic forecast that real GDP growth will rebound toward the end of this calendar year and over the summer. We estimate that the Australian banks should be able to absorb increased credit losses due to COVID-19 within their annual earnings.

We consider that the fiscal and monetary support announced by the Australian authorities in the past two weeks, in combination with hardship relief measures announced by the banks, should cushion the blow from COVID-19 to property prices, and consequently the banking sector. For example, payment holidays on mortgages for borrowers facing hardship should reduce distressed sales. Furthermore, reduction in the proportion of high loan-to-value, interest only, and investor mortgages in the past three years has improved the ability of the Australian banks to absorb a property price and economic downturn, in our view. The absence of auctions would make it difficult to transparently gauge property prices, which is likely to disrupt and suppress private sale volumes in the short term. Nevertheless, we expect that a strong rebound in economic activity, following the substantial downturn, should boost the property market as interest rates are likely to remain low.

At the same time, risks to property prices, and to the banks from their home loans, are firmly on the downside, in our view. Following an orderly correction in recent years, house prices have risen rapidly in the past nine months, particularly in Melbourne and Sydney–the two most populous Australian cities. We expect that despite low interest rates, demand for housing should remain subdued in the short term due to the current travel restrictions, weak consumer sentiment, and the wealth effect that comes with falling asset prices.

In our opinion, the combination of high household debt and house prices exposes the Australian banks to a scenario of a sharp correction in property prices, especially in the economic conditions weakened by COVID-19 outbreak. Although outside our current base case and economic forecasts, a more severe and prolonged economic downturn could precipitate such a scenario, which would trigger credit losses significantly above our current estimates, and consequently weaken the creditworthiness of the Australian banks.

S&P Global Ratings acknowledges a high degree of uncertainty about the rate of spread and peak of the coronavirus outbreak. Some government authorities estimate the pandemic will peak in June or August, and we are using this assumption in assessing the economic and credit implications of the pandemic. We believe measures to contain COVID-19 have pushed the global economy into recession (see “COVID-19 Macroeconomic Update: The Global Recession Is Here And Now” and “COVID-19 Credit Update: The Sudden Economic Stop Will Bring Intense Credit Pressure,” published on March 17), which could also negatively affect employment levels or housing markets. As the situation evolves, we will update our assumptions and estimates accordingly.

I hate to break it to S&P but its upside scenario for banks and property prices is actually one of zombie banks and falling prices. The only way the 11% plus sudden unemplyment rate is not going to gap prices lower by 20% is if the hardship measures are so widespread that they eat up giant wads of loss provision capital. Even though APRA is allowing banks to not characterise virus arrears as arrears, they’ll need to be accounted for somehow. The payment holiday’s can’t go forever.

Less capital will mean less lending to others, very likely those more worthy of the debt.

And it will, therefore, also mean lower house prices.

David Llewellyn-Smith

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