Banks face profit risks from household debt and global economic recovery: Fitch


Date: 03.03.2018

A leading credit ratings agency has maintained its negative scorecard for Australia's banks, as their profitability is expected to slow down this year.

That was the downbeat outlook given by Fitch since the nation's banks are "significantly exposed" to residential mortgages, which made up 40-60 per cent of their credit exposure in mid-2017.

But when one considers that home loans account for nearly 70 per cent of household debt — which in turn reached nearly 200 per cent of disposable income — this is a potentially dangerous cocktail.

"Combined with low wage growth and high underemployment, this leaves households susceptible to higher interest rates and deteriorating labour market conditions," said Tom Roche, the analyst and lead author of the Fitch report.

Fitch is betting that loan impairments for the banks will be on the rise this year.

Given Australia's official interest rate is at the historically-low 1.5 per cent, there is potential for Australians to borrow further, which would take the nation's record household debts even higher.

Property risks and and the royal commission

Another risk for bank profits is the large number of newly-built apartments in Sydney, Melbourne and Brisbane, which are expected to come on to the market this year.

Fitch warned that if there is a slowdown in investor demand and these off-the plan apartments don't settle, developers would have to re-list these apartments — potentially at lower prices.

"Overall, property prices should remain largely stable over the next year," Mr Roche said.

He expects house prices will rise "modestly" this year, but also said Sydney and Melbourne are the markets which are most at risk of a "correction" since they have enjoyed the biggest price surges in recent years.

In addition, there are also risks posed by the banking royal commission.

"Even if it does not identify broad or significant failings, it could exert further pressure on profitability if the reputation of the system or individual entities is further weakened in the process," Mr Roche said.

"The reputation of the system is particularly important as the Australian banking sector is heavily reliant on foreign investors for funding.

"Any loss of trust may lead to higher wholesale funding costs, which in turn could intensify competition for deposits and push up funding costs for the entire system."

Global recovery and China trade

Australian banks' "continued reliance" on wholesale funding from overseas institutions is another reason why their profit growth may slow down in 2018.

One reason is "global monetary tightening", especially given the European Central Bank (ECB) is starting to wind back the massive monetary stimulus which it pumped into the European economy since the global financial crisis.

In addition, Fitch expects the US Federal Reserve to lift interest rates four times this year.

America's official rate is currently sitting in the 1.25-1.5 per cent range, so even one rate hike would mean US rates would be more competitive than Australia's (currently at 1.5pc).

"Stable customer deposits are the preferred funding source," Mr Roche said.

"This is due to the lack of deposits in the Australian banking system and a reduction in the savings rates combined with a high proportion of loans on Australian bank balance sheets."

Amid the global economic recovery being a drag on Australian bank profits, a "significant unexpected slowdown" in China remains a risk.

The ratings agency predicts that China's economic growth will fall by 0.4 per cent this year to 6.4 per cent.

But if China's economy slows down by more than that, it would have a significant impact on Australia given that China is its largest trading partner.

This is particularly in regards to the mining, education, agriculture and tourism sectors, where one-fifth of the Australian labour force is employed.

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