Treasure Chest | May 31 2018
Credit conditions for Australian housing are set to tighten further as a result of the Royal Commission than they already had, suggesting what most assumed would be a market cooling may now become a more disorderly affair, UBS warns.
-Australian housing market already cooling
-Royal Commission to lead to further tightening
-Risks of a credit crunch growing
By Greg Peel
Australia’s housing market was raging out of control through to the middle of this decade on a combination of strong investor and foreign demand. Investors were spurred on by historical low interest rates while foreigners were spurred on by their own growing wealth and the desirability of an Australian address.
While politicians grappled with the issue of plummeting housing affordability and a complete crowding out of first home buyers in a surging market, the RBA began to become concerned over growing household debt levels, growing mortgage repayment to income ratios, and the possibility of the housing bubble bursting with dire results.
The RBA thus sent in its attack dog, financial regulator APRA, which slowly began to tighten the screws on bank mortgage lending practices, flowing through to tougher borrowing conditions for investors. At the same time, FIRB tightened the screws on foreign buyers when evidence suggested many were finding their way around the regulations.
Initially APRA attacked investor loans, and immediately demand from investors dropped off. But this only lasted about six months. Sydney and Melbourne house prices continued to rise.
APRA was then forced to up the ante, moving to attack interest-only loans. The net result of combined APRA tightening was a move by the banks to reprice their mortgage rates in order to comply with the new rules by discouraging demand.
The Australian housing market did begin to then show signs of easing, but not in any significant way. Then along came the Royal Commission.
The revelations of the Commission became a shock to all and sundry from day one. Prior to commencement, bank analysts had suggested the bad news was likely already in the market and bank share prices had already de-rated, meaning there was probably limited further downside.
They have since conceded they never saw anything like it coming.
Prior to the Commission, the general assumption is that APRA tightening would cool the housing market, but not crash it. There remained too much latent demand from a rising population enjoying still-low mortgage rates.
But in light of what has since transpired, UBS analysts have asked the question: Will the Australian housing market correction become disorderly? UBS is not suggesting it will, but expects credit growth to slow sharply and believes the risk of a Credit Crunch is rising. The analysts have cited seven factors now weighing, or set to weigh, on housing lending.
Seven Deadly Signs
The Royal Commission appears to have arrived at a much more rigorous interpretation of “responsible” lending when it comes to banks making “reasonable enquiries” and taking “reasonable steps” to verify a borrower’s financial situation. The banks are now moving to make a more thorough assessment of stated income and living expenses.
Bank boards are likely to become a lot more risk averse following the Treasurer’s threat of gaol time.
Were mortgage brokers to be forced to shift to a flat fee rather than a commission-based charge, mortgage broker penetration may reduce and this would flow to reduced access to credit for some borrowers.
The adoption of mandatory Comprehensive Credit Reporting from July 1 enables lenders to have a more complete view of borrowers’ financial positions. APRA is yet to specifically set a limit on borrower debt to income ratios, but the regulator, bank boards and bank shareholders would not be comfortable with any concentration of “very high debt to income” (in excess of six times) on banks’ books.
Labor’s policy to limit negative gearing will likely weigh on investor sentiment as the election approaches (April/May).
FIRB approval of foreign investment in Australian housing plunged -65% from FY16 to FY17, to a four-year low.
Some $120bn of interest only loans will revert to principal & interest loans each year until 2021. With mortgage repayments subsequently jumping 30-50% on reversion, and rising house prices no longer a given, many an investor may be tempted to sell.
UBS is not suggesting all of the above seven factors will eventuate, but believes it’s likely some combination of risks plays out, weighing on credit availability and the housing market. The risk of a Credit Crunch is rising, the analysts believe.
During the recent bank reporting season the analysts downgraded their housing credit growth assumptions to 4-5% for FY18 and 0% for FY19-20. For FY20, UBS’ forecast currently sits some -9% below consensus.
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