Buried deep in the mass of documents released by the National Australia Bank accompanying its profit and capital raising is a fascinating set of graphs that indicates where NAB fears future bank problems may arise.
And those NAB graphs are also a not too subtle warning as to what may happen in a downturn to some listed property trusts that have short leases.
The NAB has chosen commercial property exposures to undertake a comparison with its three ‘peers’. It doesn’t name the peers but they are clearly ANZ, CBA and Westpac, although, as you can see from the accompanying graphs we can’t identify each ‘peer’ bank.
Commercial property loans are the segment that caused the NAB such heavy losses in the UK, so chief executive Andrew Thorburn is very sensitive to exposure to this sector. That’s why he highlights it.
Back in 2009 the NAB, excluding the UK, had commercial property exposures totalling $64.5 billion, which was substantially above the ANZ, CBA and Westpac. Indeed, one of those banks had a commercial property exposure as low as $38.4bn in 2009.
Going forward five years, and NAB’s Australian commercial property exposure has risen by only 4 per cent while the other banks have increased by between 16 and 44 per cent.
Why is commercial property dangerous in a downturn?
In the dwelling market, the loans tend to be much more diverse and there is an open market for the assets.
In commercial property, where the business owner fails, the value of the commercial property depends on another business being prepared to lease it. If the business bank that has supported it gets into trouble, then commercial property security can be very hard to sell if no new tenant can be found.
That was part of NAB’s UK experience.
In Australia, I think the biggest danger to commercial property values is strip shopping centres. In a downturn, property values of strip shopping centres that are not coping with the new retail environment will be savaged.
Also at risk is land held for apartment development if that market turns down or there are approval problems.
In a downturn, factories and warehouses can lie empty and land can be vacant for years.
Property values have risen as a result of the lowering of interest rates although valuers have not increased the values as far as the sharemarket, where most property trusts usually sell about 30 per cent above their asset backing as determined by valuers.
Part of the reason for this difference is the liquidity that the listed property trust offers. In addition the listed trusts are borrowing at rates that are well below the returns offered the property market. In other words, gearing boosts the returns and creates part of the premium over valuer's property values.
Leaving these factors aside, the sharemarket still values commercial property higher than valuers. Many property investors favour unlisted property trusts where they buy at valuer’s values. Usually they have no or limited liquidity.
All this underlines the risk that exists for listed property trust investors if there is a rise in interest rates. Not only will the properties fall in value but the value of positive gearing will diminish.
NAB’s table is a gentle reminder of that often overlooked risk.