‘A fragile sector’: Bank bosses warn on construction risks

The chief executives of two of Australia’s biggest banks have underlined the mounting financial risks in the construction sector, as builders face a hit from surging costs of materials and rising wages bills.

Amid concerns about growing financial stress in parts of the building industry, National Australia Bank chief executive Ross McEwan and ANZ Bank chief Shayne Elliott both highlighted the difficulties facing builders who had signed fixed-price contracts but now faced a jump in their expenses.

NAB chief executive Ross McEwan Credit:Louie Douvis

Elliott said these construction firms could not cope with the “massive” shifts in the price of commodities and labour because they struggled to pass on higher costs, adding that construction and commercial property businesses were two sectors with companies at higher risk of failure in a downturn.

“The business model has moved towards a fixed price contract model. The problem with that is that when you end up with cost shocks or labour shortages, the business can’t pass it on,” Elliott told an Australia-Israel Chamber of Commerce luncheon in Melbourne on Tuesday.

“So you are in this weird situation, which is sort of counterintuitive: construction is booming, and construction companies are falling over.

McEwan told The Australian Financial Review Banking Summit in Sydney that the prices of key building materials such as steel and timber had surged “dramatically,” with labour costs also jumping amid severe shortages in skilled workers. This was squeezing builders that committed to fixed-price contracts with clients, though he said the bank’s broader loan book remained in good shape.

“That [construction] is probably the sector that is most worrying, but our book when we look across it, we are yet to see any signs that the economy is having difficulty.”

Speaking more generally about the outlook, McEwan said the economy had rebounded strongly, but supply chain pressures and mounting costs were biting for NAB’s clients, alongside the risk of rising interest rates.

Commonwealth Bank chief executive Matt Comyn, appearing at the same event as McEwan after a recent trip to the US, said the economy was in far better shape than the US, but he also indicated CBA was cautious towards the housing market.

“As rates go up there’s going to be downward pressure on prices. I don’t think it’s going to be a problem, I think clearly the labour market is still extremely strong, but I think consistent with probably a number of indicators we are seeing, it’s probably a time to be slightly more cautious,” Comyn said.

Loans for commercial property and construction are among the higher-risk types of lending for banks, and Elliott said there was no easy answer to the problems faced by construction companies.

ANZ Bank chief executive Shayne Elliott.Credit:Louise Kennerley

“It is a fragile sector,” he said. “And we shouldn’t be terribly surprised, history shows us that in any sort of crisis or downturn, sadly construction and commercial property are two of the most prone to failure because of that structure of the way they run their businesses. So I don’t know the answer to that, clearly there’s a lot of complexity,” Elliott said.

Credit Suisse analyst Jarrod Marin recently reported construction exposure had been dropping across most of the big four banks in recent quarters, and such loans were generally under 1 per cent of the big four’s total lending.

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