Australia’s Mortgage Insurance Time Bomb
Before I get on to today’s subject, a quick note about a cornerstone development in Australia’s liquefied natural gas (LNG) industry.
You may have seen the press reports about China signing a $50 billion deal for a gas supply from the Gorgon field off Western Australia.
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Australia’s Mortgage Insurance Time Bomb
What a relief the Australian banking system is in much better shape than those awful banks in the UK and US.
You remember how bad they were. So bad they collapsed. They collapsed, in part due to dodgy lending practices and over-valued property prices.
Something we are told will never happen here.
I’ll go through the details in a moment.
But first, if you thought the housing market was going to crash, well, just get over it. It’s not going to happen. Who says? David and Libby Koch that’s who.
In their joint column for News Limited, Dave & Lib tell readers:
“It is very unlikely that the Australian residential property market will plunge anywhere near the extent of that in the US, because we haven’t been through a huge construction boom, borrowers haven’t leveraged themselves to quite the same extent and we have strong immigration to underpin demand.”
That’s right, as much as you may think Australia has been through a construction boom, it hasn’t.
And as much as you may think Australian borrowers have leveraged themselves up on real estate, they haven’t.
Not only that, but we have lots of immigrants who are buying the houses the non-construction boom hasn’t built.
Therefore we can thank Dave & Lib for putting everyone straight on the Australian property market. If only we’d known before, we wouldn’t have wasted your time writing about a property crash.
But before we hang up our boots, we’ll make the effort to finish their article.
Let’s see what else they have to say:
“The banks are starting to ration credit that means they’re making it more difficult for people to borrow money. The banks are lifting their standards.”
“We’re starting to see the good old-fashioned request for a 15-25 per cent deposit on a home loan and mortgages where the repayments must be less than 30 per cent of the borrower’s income.”
“Tightening the criteria for home loans means fewer borrowers will be eligible for a loan than before, so there will be fewer potential buyers and less competition in the market.”
“Last week’s housing finance figures saw new housing loans at 17-month highs and loans for new home construction at a seven-year high as first-home buyer grants from the federal and state governments kicked in.”
“The only concern is the property bubble at the first home-owner end of the property market for existing homes could deflate when these incentives finish.”
“Hopefully, investors will come back in to the market at that time and fill any void that first homeowners leave.”
“First-home buyers still account for 27 per cent of all new home loans being written, while investor lending continues to fall.”
“Investors should come back to the market in the not too distant future as interest rates stay low, the share market continues to improve and rents remain high.”
“The key is the rental market. As vacancy rates stay low and rents continue to rise, investors will start to trickle back in to the property market. A problem at the moment is that many investors target the currently inflated first-home buyer unit market and are simply waiting for that to cool off before they move in.”
Boy! It looks like we were about to hang up our boots too soon. Seems like Dave and Lib have got absolutely no idea how markets function.
The more they write about there not being a property crash the more they bolster the argument for a crash.
It looks as though they truly believe the combined efforts of the Government, RBA and the banks are capable of micro-managing a ’soft-landing’ for the housing sector. We can picture it now…
“Tighten the interest rates… no, not that much, that’s it… tighten the lending criteria… nearly… a little bit more… stop construction, no not yet… NOW! Oops! One house too many, right ease interest rates, loosen the lending, and… Who let that immigrant in? Now we’ll have to start again!”
Not only do Dave & Lib believe the policy makers can micro-manage an economy, but those trying to manage it also believe they can pull it off.
But rather than analyse every word of a third-rate property spruik, we’ll simply cover off the single underlying theory to Dave & Lib’s argument…
That the banks are much more conservative because they have tightened their lending standards… which apparently were never slack to begin with.
The banks like to spin the line that they are lending responsibly, and the bank-loving commentators lap it up. “Australian banks are better than anywhere else because they haven’t collapsed” seems to be the gist of the argument.
So, we thought we’d take a look at the facts. Have the banks really tightened their lending standards? Well, they may tell you that, but the reality is far different. Here’s a snippet from the CBA website:
“If you have been a home loan/personal loan/credit card customer of the Commonwealth Bank for the past 6 months, you may be able to borrow up to 95% of value of the property, as long as you are not in arrears or have missed any payments. Your account needs to be currently open.”
“If you have not been a home loan/personal loan/credit card customer of the Commonwealth Bank for the past 6 months, or if you are a new customer to the Commonwealth Bank, you may be able to borrow up to 90% of value of the property, as long as you contribute 5% of the deposit in genuine savings, (excludes the First Home Owners Grant).”
In other words, existing lending customers of the CBA can borrow up to 95% of the value of the property. And that can include the first home owners grant.
Why is the CBA offering 95% mortgages when we’re told it lends responsibly?
Simply because of something called Lenders Mortgage Insurance (LMI). LMI isn’t new, it’s been around for years. I’m sure you’re familiar with the concept. And you may also know that LMI is available in those rotten UK and US markets as well.
But just in case you aren’t familiar with how it works, here’s Lenders Mortgage Insurance 101…
In a nutshell it allows banks to dish out loans to almost anyone and palm off the increased risk to an insurance company. But don’t think they palm off the entire risk, because they don’t.
In effect, with a 95% loan the bank is only getting out of the difference between 80% (the amount at which LMI cuts in) and the 95% level.
In other words if a borrower takes out a loan for $300,000 on a $315,000 house and then fails to keep up repayments, the bank will only suffer a loss on its books if the house fails to sale for at least $252,000.
Of course that would mean property prices would have to fall by 20% for such an event to happen.
That’s not likely. Is it? Well, not if you believe Dave & Lib, Michael Pascoe, Christopher Joye or Rory McGrath. But if you take a look at the table below from Global Property Guide, you’ll notice that prices haven’t had to fall by a huge amount for it to have a massive impact on the banking industry:
US regional banks are still going bust. About 70 have gone out of business so far this year. And more will follow.
But don’t forget one very important thing. A major reason behind the collapse of markets in the US and the UK wasn’t just because of what the banks were carrying on their balance sheets.
US and UK banks, just like Australian banks, were able to lay the risk exposure off elsewhere. In the US it was laid off to Fannie Mae, Freddie Mac, AIG, Lehman Brothers, Citigroup, etc…
That meant the financial institutions accepting the loans were prepared to accept higher risk clients because they knew they could pass the risk on and only face any exposure if the ‘impossible’ happened and the housing markets collapsed.
Only that was the other problem. The banks leveraged themselves up so much to the ‘impossible’ never happening that it took a much smaller rise than expected in delinquencies for it to have an impact.
You know what they say about leverage increasing your returns and your losses. It seems as though the banks and insurance companies made a classic schoolboy error of underestimating the downside risk.
So, what about Australian banks? Well, now might be a good time to take a look at where our banks lay off their risk.
In the case of Commonwealth Bank, it offloads its LMI risk to a company called Genworth Financial Inc. They’re the ones that take on the risk of a defaulted property price falling from $315,000 to $252,000.
This is where we get a real picture of the lending standards in the Australian market. Take a look at this snapshot from the Genworth Financial underwriting policy:
You’ll notice it says “Borrowers who have saved a deposit are generally more likely to be prepared for difficult circumstances.”
Yet despite that, the ‘Homebuyer Plus’ LMI product states the deposit requirement (Genuine Equity Requirement) is “Nil.” That’s right, no genuine savings required.
And who is the ‘Homebuyer Plus’ product aimed at? Again, the Genworth underwriting policy explains all:
“Suited to borrowers, including First Home Buyers, wishing to purchase or construct owner occupied property with limited or no savings… Borrowers do not have to contribute any of their own savings, allowing these funds to be used for stamp duty, renovations or setting up their own home. This also means a borrower does not need to wait to save up their own deposit before entering the property market.”
There you have it, our financially conservative and responsible banks are not financially conservative at all. They are – and have – taken on virtually any risk profile of borrower they like.
Or rather, any borrower that satisfies the non-rigorous standards of Genworth.
And to put it in perspective, Genworth boasts it insures “over 5,000 residential mortgages every week.” That’s a lot. In fact, based on the recent Australian Bureau of Statistics (ABS) numbers for housing finance, that equates to about 32% of all mortgages that require LMI.
In fact, according to Genworth’s 2009 Mortgage Trends Report:
“58% of borrowers who took out a mortgage in 2009 did not have a 20% deposit, compared to 47% of those who took out a mortgage in previous years… Overall, 35% of borrowers in 2009 took out a loan with a 90%-100% loan to value ratio (LVR), compared to 21% in 2008.”
I’ll just leave you with these comparisons from the recent Commonwealth Bank analysts’ presentation. It was another attempt by Ralph Norris to explain that the CBA is so much safer than UK and US banks due to CBAs high exposure to residential property.
As you can see on the top two charts, the UK and US have 17% and 15% exposure to home loans…
… by contrast, CBA has on this following chart a 49% exposure (although elsewhere it claims it is 56%, so we don’t know what to believe!)…
Let’s get one thing clear. Whether CBA has a 49% or 56% exposure to home lending, it is not something for them to crow about.
The facts are clear, Australian banks and the mortgage insurers now find themselves near the precipice. The property ponzi scheme is nearing its final crescendo.
It is the point at which the final burst of activity pushes the market on one last great leap forward before the whole sham falls apart at the seams.
And the best the property spruikers can come up with is some vague and unquantified notion of a chronic housing shortage, and that immigrants will keep our home prices from falling.
They’re gonna have to try better than that.
Other Stuff on the Markets
The S&P/ASX200 fell 0.12% yesterday, while there was marginally better news overnight on Wall Street with the Dow Jones Industrial Average adding 4.76 points. In Europe the FTSE100 gained 0.45% and the CAC40 added 0.54%.
The price of gold in Australian dollars is trading at $1,164.97, while in US Dollars it trading at $914.06.
The Aussie dollar strengthened slightly versus the US dollar and Japanese Yen, trading at USD$0.7846, and JPY72.79.
Further strength for Crude oil overnight, closing at USD$60.74.
For the biggest movers on the market yesterday click here…
