Fitch Ratings to stress test banks over housing bubble concerns, but says downturn still unlikely

Fitch Ratings will conduct a stress test on the Australian mortgage market in response to concerns the industry will suffer a collapse, with analysts both home and abroad suggesting the market will suffer as interest rates increase.

But Fitch senior director Natasha Vojvodic says although the agency will conduct stress tests on banks and residential mortgage-backed securities, the actually likelihood of a downturn occurring is relatively low.

“We’re not taking a view as to any one of our situations will actually occur. We’re not saying that scenario A is more likely than scenario B in that regard,” she says.

“Instead, we’re responding to what we see as regular reports and interest for investors about the strength of the market, and we are interested in seeing what will happen if any one of these situations actually occurred.”

The tests will examine three different scenarios on property price pressure. The first “mild test” will test banks and securities against mortgage defaults of 2.5%, and a 20% drop in prices, the “medium” test will use 6% mortgage defaults and a 30% fall in prices, while the “severe” test will use defaults of 8% and a 40% decline.

“We’re going to look at all the portfolios and run these different scenarios. We’re going to compare their situations before and after these scenarios could occur, and then see what happens to each of those ratings if those scenarios were to occur overnight.”

“There are plenty of articles and commentary in the media almost daily about property prices and whether there is a bubble or not, and whether they’re going to decrease. All we’re doing is just running the portfolios against such a scenario, and asking, ‘what would actually happen?'”

The interest in Australian properties has grown over the past year, along with prices. While some economists and analysts such as Christopher Joye from Rismark believe prices are well in-line with incomes, some publications including the Economist believe prices are overheated.

Nevertheless, the property market is coming down from its 2009 highs relatively well, Vojvodic says. Prices have begun to decrease and most analysts believe prices will only grow this year by about 8-10%.

RP Data and Rismark released new figures today showing prices decreased during August by a seasonally adjusted 0.2%. CommSec economist Craig James says the result indicates a “cooling” market, but not necessarily a collapsing one with prices still up by 8% from this time last year.

And while interest rates are set to increase, (starting from next week, many economists believe), Vojvodic says the market is still holding up relatively well.

“We know that the market is performing well and that delinquencies are not increasing. Interest rates have increased, and arrears did as well, but in quarter one that was mostly a cyclical issue and quarter two say arrears fall again.”

“I think in the absence of an increase in unemployment, then arrears will increase as interest rates increase, but more likely for those households where the affordability issue is more apparent.”

Fitch says the initial report from RMBS will be released by the end of November, while stress tests for banks and mortgage insurers will be released either by the end of the year, or in the first quarter of 2011.

However, Vojvodic also says in an initial statement that the banks should fare relatively well due to their existing capital reserves.

“While all three of the stresses presented are significantly more severe than anything seen previously in the Australian residential property market, our preliminary analysis indicates the impact would be more than adequately covered by the major banks’ loan loss reserves and pre-provision profits, assuming the impact of a downturn is isolated to the mortgage sector.”