Gold Coast, western Sydney offer clue to banking outlook

Investor confidence in Australian retail banks stands at a record high. The market capitalisations of Commonwealth Bank and Westpac have charged past $100 billion and the big four are ranked among the world's top 11 by market capitalisation.

Funding costs continue to fall as do the number of non-performing home loans. The local majors fight with the Canadian banks for the honour of generating the highest return on shareholders' funds.

Of the foreign banks, only the Chinese have shown any increased appetite for the Australian market and then only in syndicated loans where they have nearly doubled market share in the past five years.

Ordinary investors have soaked up billions in local bank hybrid issues even though corporate regulator ASIC noted that some rank before equity when it comes to absorbing loan losses.

Australia doesn't do recession, right? We have enjoyed unprecedented economic expansion since 1991. National house prices are up at least 4 per cent since a trough in May last year, adding to the more than tripling in prices over the past 20 years. By global standards Australia's last banking crisis - between 1991 and 1993 - was nothing out of the ordinary.

Sure two of the biggest banks, ANZ and Westpac, needed to take big write-downs and required substantial capital injections to remain solvent. That's the nature of banks when their balance sheet is geared 25 times more than the companies they lend to. In the US, 465 banks have failed since the start of the subprime crisis five years ago.

Many banking crises decades have had a similar ingredient: strong rises in property prices - something that Australians know something about. In the US, property values more than doubled between 2000 and 2007. Mortgage-related debt more than doubled as a result.

House prices in Tokyo rose fivefold in six years to 1990. The Irish property boom was like few others. The Irish economy generated double-digit credit growth between 2001 and 2008, and then between 2004 and 2006 really hit its straps by producing credit growth of about 30 per cent a year. An official report later declared that there had been a "tidal wave of uncritical enthusiasm" to take part in the property boom. A quarter of first home buyers were offered 100 per cent mortgages.

In 2005, perhaps as part of some sort of Irish joke, the government extended tax relief for property developers. Irish bank shares peaked towards the end of 2007 around the time house prices fell for the first time since 2002.

Ten days after the Lehman bankruptcy in September 2008, Ireland became the first European country to enter what was to be one of the most severe recessions in the history of the modern developed world. The peak-to-trough fall in GDP from March 2007 to December 2010 was 23 per cent.

House prices in Ireland fell about 50 per cent from peak to trough. From their highs in late 2007 Irish bank shares fell about 70 per cent.

A quarter of the €400 billion of loans on Irish bank balance sheets at 2008 have since been written off.

Back in Australia, despite our improved savings rate, household indebtedness and gearing are still at historically high levels. The bankruptcy rate among unincorporated businesses has drifted up over the past three years. Sydney's western suburbs and the Gold Coast are the housing markets we need to watch most closely.

Stress-testing by the Australian Prudential Regulation Authority and the International Monetary Fund has found that Australian banks' capital positions would be sufficient to continue meeting minimum requirements in a "severe" recession. The market is backing that assessment.

soldfield@wilsonhtm.com.au