Outstanding housing debt has been compounding: Pete Wargent

Outstanding housing debt has been compounding: Pete Wargent
Outstanding housing debt has been compounding: Pete Wargent

Through 2008, outstanding loans to households by Australia's banks totalled less than $700 billion.  The final 2016 numbers are not yet plugged into the chart below, but the monthly banking statistics suggest that the total by the end of the year will exceed $1.5 trillion. 

Australia has experienced strong population growth during this period, but nevertheless outstanding housing debt has been compounding at around 9 percent per annum. 

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Outstanding housing debt has been compounding: Pete Wargent

Such a strong pace of increase in household debt is bound to be reflected in housing market conditions one way or another, and in Australia's case the result has been price increases in Sydney and Melbourne. 

This dynamic since the financial crisis has been arousing the interest of short sellers, including from overseas. 

Although house prices have declined in Perth, Darwin, and parts of regional Queensland in particular, to date the most heavily populated markets have held up well. 

If anything, housing market sentiment seems to be improved in Sydney and Melbourne again at the beginning of 2017. 

Changes to the lending environment

Regulators have encouraged several tweaks to lending criteria over the years since the financial crisis first erupted. 

"Low-doc" loans, once fairly commonplace, today only comprise a small share of the mortgage market, while 100 per cent mortgages have thankfully gone the same way.

In fact, new mortgages today overwhelmingly have a loan to value ratio (LVR) of 90 per cent or lower, although in reality many borrowers have used equity from existing properties to fund their deposits. 

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Outstanding housing debt has been compounding: Pete Wargent

Lending standards in Australia are higher than they were, but on some measures remain concerning.

For example, the share of interest only loans remains high by international standards, despite having declined from somewhat alarming levels in 2015. 

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Outstanding housing debt has been compounding: Pete Wargent

ASIC had previously reported that about two in three investor loans in Australia were interest only mortgages, and around a quarter of owner occupier loans - with the repayment typically increasing when the interest only period ends. 

Shorting: what and when

Short sellers rarely bet on house prices directly, rather they tend to be interested in the outcomes of a market downturn (and housing markets are necessarily always cyclical). 

Some will sell the stock of banks, others will look at developers or home building companies, materials companies, retailers of household goods, financiers, or the institutions that insure mortgages. 

Alternatively some may look at buying Australian government bonds, while one of the cleanest and potentially profitable ways to bet against the housing market might be to short the Australian dollar, which at 76.7 US cents arguably still has plenty of downside. 

Timing short bets is important

Maintaining short positions can be costly in terms of interest or dividend obligations, while opportunity cost of suboptimal market timing is another factor to be considered. 

There has been plenty of discussion of the potential impact of an apartment glut in Australia, but in the case of both Melbourne and Sydney accelerating population growth appears to be absorbed much of the new supply to date, although tens of thousands of apartments remain under construction.

The potential for non-resident buyers defaulting on apartment settlements has been another salient risk closely watched by sceptics, though to date news of any fallout appears to have been relatively contained.  

One market risk which cannot so easily be quantified is the potential for defaults in the scenario whereby mortgage rates increase, prices in secondary and lower socio-demographic areas decline, and a swathe of interest only loans reach the end of their interest only period. 

Maths can get ugly

Anyone who had a standard variable rate mortgage in 2009 at above 8 percent will recall that principle and interest repayments could be excruciatingly difficult.

Consider that a homeowner with a $600,000 interest only mortgage at 4.5 percent today might be paying only ~$2,250 per month, whereas as and when the mortgage flips to principal and interest, were the mortgage rate to have increased to 6 percent the repayments could be more than 50 percent higher, even on a 30 year product.

Mortgage repayment calculators don't always give the option to calculate what would happen in a 7 percent scenario, but the answer on a 30 year product might be a potentially punishing ~$4,000 per month. 

With the amount of outstanding interest only debt having increased at an unprecedented pace through this cycle it's not too hard to analyse when this market risk will arise, and in turn which areas might see defaults increase. 

The most successful shorters will be those that can combine market timing with bets lined up against those companies with the most vulnerable financials. 

The big players

Market participants will be well aware of the attractive mortgage rates that the Commonwealth Bank of Australia (CBA) has been offering lately, and in turn the growth in the CBA investor mortgage book looks likely to bump up against the notional 10 percent per annum cap set by the regulator APRA.

Unfortunately for analysts the market data reported for investor loans has been muddied by reclassifications from investor to owner-occupier loans.

For example, the Westpac Banking Corporation (WBC) switched more than $21 billion of loans between July and October 2015 taking outstanding investor credit down from $156 billion to $135 billion and in turn causing its year-on-year growth in outstanding investor credit to appear negative for some time. 

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Outstanding housing debt has been compounding: Pete Wargent

Despite the reclassification Westpac retains the greatest balance of outstanding investor loans, while Commonwealth has the largest total of outstanding household mortgage debt, although the quality of loans rather than the volume is what should be of interest to analysts. 

Investors today typically pay higher mortgage rates than owner-occupiers, with further tweaks a possibility in 2017. 

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Outstanding housing debt has been compounding: Pete Wargent

What shorters should really be paying attention to is which financiers, insurers and developers have been active in the highest risk markets, areas which have been discussed here on this blog previously. 

Prospective borrowers should take into account the likelihood that mortgage rates may move higher over the years ahead. 

PETE WARGENT is the co-founder of AllenWargent property buyers (London, Sydney) and a best-selling author and blogger.

His latest book is Four Green Houses and a Red Hotel.



Pete Wargent

Pete Wargent

Pete Wargent is the co-founder of BuyersBuyers.com.au, offering affordable homebuying assistance to all Australians, and a best-selling author and blogger.

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