Banks can withstand 40% drop in house prices, preliminary Fitch stress tests reveal

Australian banks can withstand a 40% drop in house prices and mortgage delinquencies reaching as high as 8%, according to preliminary results from a stress test undertaken by Fitch Ratings.

The tests come as speculation continues to grow regarding a property bubble in Australia, with some investors believing prices have risen too far and unaffordability is too high to sustain such high price growth for long.

Fitch Ratings director of financial institutions John Miles says while the tests are still ongoing, preliminary results indicate the four major banks will be able to withstand even the most scenario defaults.

“At this stage, we’ve just done some preliminary analysis. We’ve conducted these through compiling public disclosure statements and accounts, which reveal information on mortgage books. We use these pretty much to establish our ratings.”

“The general finding was that for the most severe scenario, these banks still have good reserves and would be able to adequately sustain the losses in that circumstance.”

Fitch is using three different scenarios to test the banks. The worst would propose a 40% decline in prices, with defaults reaching as high as 8%. Miles says such a situation is unlikely, but would occur if China were to experience a downturn and unemployment would subsequently rise.

The “medium” test will use defaults of 6% along with a 30% fall in prices, while the “mild” test will test banks and securities against mortgage defaults of 2.5% and a 20% drop in prices.

“I think the only caveat we’ve put in there so far is that, if we do see price defaults assumed in the most severe scenario, you will have much broader issues to deal with in the macro economy. This will have larger effects on SMEs and there will be a lot of impaired loans in other areas.”

“But we think the current lending practices are appropriate. What we’ve stressed in this case is certainly nothing near the moderate scenario, and when you look at the predictions for unemployment, it suggests we are doing very well.”

Looking forward, Miles says the only problem he can foresee in the housing market is that “unaffordability will remain high as interest rates rise. But we think overall, the market will remain steady”.

The tests come as more investors believe Australian property prices will drop. A recent report from The Economist predicted Australian housing is 60% overvalued, while local economist such as Morgan Stanley’s chief strategist Gerard Minack says prices could drop as much as 40%.

However, some believe the market is cooling. Recent data released by RP Data and Rismark found that prices decreased during August by a seasonally adjusted 0.2%.