New threat to banks

A fall in house prices and values could be devastating for our banks – but not for the usual reasons you might expect.

Australians have embraced self -managed super funds (SMSFs) in droves. After years of prolonged under-performance by managed funds, mostly caused by falling markets, many have taken matters into their own hands and setup their own super fund.

According to the Australian Tax Office (ATO), more than 35,000 self-managed super funds were established in the 2012 financial year, compared to 28,000 the previous year. A new trend emerging is that the number of funds setup by members between the ages of 35 and 44, have increased significantly.

The ATO says there are now 478,000 SMSFs, holding around $439 billion in assets. That’s just under a third of the estimated $1.4 trillion in the superannuation system.

As more and more people enter the SMSF sector, demand for property related assets is likely to grow. Residential real estate represents less than 5% of SMSF assets, but the Australian Securities and Investments Commission (ASIC) is concerned that real estate promoters may push investors to take on additional borrowing and invest in property through the SMSF.

The issue for the banks, including Australia and New Zealand Banking Group (ASX: ANZ), Commonwealth Bank (ASX: CBA), National Australia Bank (ASX: NAB) and Westpac (ASX: WBC), is that under current laws, they have no recourse against the SMSF’s other assets, if there is a problem with the loan being repaid.

Instead, borrowers have to give personal guarantees, which may or may not allow banks to claim against their other assets. Charles Littrell, from the Australian Prudential Regulation Authority (APRA) says there is not enough evidence on the relative strength of those guarantees, compared to traditional loans, according to a report in The Australian.

APRA has warned the banks that they need to treat loans to SMSFs differently to conventional mortgages, because they are more complex, and APRA requires banks to put aside more capital to fund the loan – the same 100% level required as industrial property.

Foolish takeaway

A significant drop in house prices and values could see many SMSFs make the decision to default on their loan, and test the strength of those personal guarantees. Should they prove hard to enforce, banks could be faced with a nightmare scenario – such as that faced by their US counterparts during the GFC, with owners handing the house keys back to the bank, and walking away. That would leave the banks with large numbers of property on their books – below the value of the defaulted loans.

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Motley Fool writer/analyst Mike King doesn’t own shares in any companies mentioned. The Motley Fool’s purpose is to help the world invest, better. Take Stock is The Motley Fool’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. Click here now to request your free subscription, whilst it’s still available. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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