Six years is a long time in the globally enmeshed, modern world of high finance. It was only 2008 when the warning bells alarmed for Aussie lenders; as we watched the US and much of Europe become an example, illustrating why a glut of sub-prime (read dodgy) mortgages can be your country’s economic undoing.
With the help of some fiscal manipulation and government policy, as well as tighter regulations around property loans, you could almost say we dodged a bullet here in the ‘Lucky Country’.
While other overseas real estate markets crashed and burned in an alarming way during the GFC, our residential housing sector took a bit of a breather before once again shifting up a few gears.
Of course it wasn’t all smooth sailing. A lot of people lost a lot of money from their super funds and investment portfolios, but interestingly, most local property investors continued to prosper at best and walked away relatively unscathed at worst.
In turn, more people started looking at bricks and mortar as a viable and importantly more secure, long-term path to financial independence. Now, property is once again fashionable and property investment, particularly within SMSFs, dominates as ‘the new black’ of the investment world.
The problem with all this renewed interest in property is that it drives the lending industry and increases the banks’ bottom lines. It gets everyone excited about profits – investment product spruikers and off the plan developers come out in droves – and of course, lenders vie with one another to attract and retain the blossoming business on offer.
Not too long ago, local banks were tightening their belts and sheltering from the GFC storm by implementing stricter policies around sub-prime lending. No recourse or no-doc, and low-doc loans were all but scrapped and the need to demonstrate affordability as an applicant became a priority.
Short memory…
Fast forward just over five years later and ratings agency Moody’s is raising serious concerns around the amount of so-called ‘risky’ home loans Australian banks are currently handing out.
A review of figures from banking regulator, the Australian Prudential Regulation Authority, revealed that banks are increasingly handing money to clients who represent a higher risk.
June quarter APRA figures showed investor loans increase to constitute a sizeable 37.9% of new lending, compared with an average 32.6% for the previous six years. And on top of this, interest only and non-conforming products have gained significant traction in the market.
Although five per cent might not seem too dramatic in the big scheme of things, that extra 5% worth of investor activity can actually have serious consequences when you consider that investors are more likely to default on a second or third property loan if things go pear shaped, than a home owner.
Remember, they don’t rely on the property for shelter and these borrowers are more likely to have higher leveraged loans. Therefore, if markets become shaky or a change in personal circumstances causes a dramatic income adjustment, they are prepared to sacrifice the investment property.
If all you can afford is the interest now…
Then you might be in for some serious pain when we get to that inevitable tipping point in the market, where interest rates once again start to rise.
Worryingly, says Moody’s, APRA figures confirm that 43.2% of loans committed to in the June quarter were investor preferred, interest only products.
Given how low the current interest rate environment is, if people are entering into these types of arrangements because it makes the debt they commit to more affordable, then that could pose a bit of a problem. Particularly if maturation of the Interest only period happens to coincide with a likely escalation in interest rates down the track.
Add non-conforming loan candidates to the mix…
Where borrowers do not meet the usual standards when assessing capacity to repay the mortgage in a higher interest rate climate, and you have quite a few flies in the financial ointment. While these loans only make up 3.7% of the mortgage market, Moody’s says this is still the highest level recorded over the past six years. Note that six-year timeframe again.
Not all bad for the banks
Downplaying a list of genuine concerns, Moody’s reassures us that the Australian banking system is actually very resilient, suggesting the report should be taken as a ‘wake up call’ rather than a red flag.
Moody’s senior credit officer and vice-president Ilya Serov says “We generally see the Australian banking industry as being quite well capitalised, there are certainly some issues around the consistency of the application of capital rules across different types of institutions, particularly from a competition point of view, and that’s something the [Financial System] Inquiry is looking into.”
He does caution that banks need to remember the more risk they take on when it comes to loan sizes, types and applicants, the more their creditworthiness on the international stage stands to be scrutinized and potentially reduced.
Not a good position to be in when stronger home lending, combined with weaker deposit growth, means banks are being increasingly forced offshore to source additional funds.
In conclusion…
Lenders will invariably step up their game when it comes to increased business in the property finance pool. This current frenzy of renewed investor interest has certainly agitated the waters, encouraging the banks to come out all guns blazing, as we saw recently with their noise about low fixed interest rate loans.
Let’s just hope that the promise of increased profits doesn’t entice lenders into too many high-risk scenarios that ultimately stand to jeopardize the integrity of our financial regulatory environment. After all, it was our stricter home loan criteria that assisted in sheltering us from the serious GFC storms in 2008; a lesson we would do well to remember.
About the Author
Since 2008, David Thomas has built a business aimed at servicing the needs of property investors, owner occupiers and small business owners. David is recognised as one of the top 10 independent mortgage brokerages in the country, David and his team have settled almost billions of dollars worth of residential and investment loans over the last decade.
Known for his straightforward, relatable style, David believes by educating people about property funding; they fare better in the market. By sharing his expertise openly, some of the people he educates will likely become his clients. It's a win-win approach.
David Thomas is a credit representative (Representative Number 506153) of BLSSA Pty Ltd, ACN 117 651 760 (Australian Credit Licence 391237).