Australian exceptionalism is as much a myth as Ireland’s was in the face of an excessive debt bubble from a prolonged housing boom, suggests Eddie Hobbs.
A technical paper just released to professional clients by Australian bank equity analyst Douglas Orr of Sydney-based Endeavour Equity undertakes a deep dive into the riskiness of the Australian mortgage book.
It’s hard to read the research without being reminded of Morgan Kelly’s analysis at a time when Taoiseach Ahern and Anglo Chairman Fitzpatrick led attacks on critics of Irish exceptionalism.
Housing values are already down 10% to 15% on average and by over 25% in spots like Ellenbrook in Western Australia, credit growth is cooling rapidly and early warnings like falling recruitment advertising, white goods and car sales are flashing red as employers and consumers rein in spending as the negative wealth effect takes a grip.
Hard to believe Australian banks still categorise all mortgages as prime, but Orr baldly states that at least 40% of Australian mortgages are non-prime or sub-prime. These higher risk loans suffer from arrears and default two to five times higher than prime loans during a downturn. This is because the mortgages are held by borrowers where 45% of income is eaten by monthly mortgage costs and where debt was set at more than five times annual earnings.
Systemic crises aren’t linear. Arrears begin low and steady until they cascade when cash buffers run dry. There is no crisis, until it arrives. Irish mortgage arrears hovered between zero and very low single digits before the teeth of the crisis, just like in Australia today.
Evidence from Ireland and elsewhere shows that arrears and defaults are in the first instance led by an inability to meet monthly bank direct debits because the cash isn’t there as work and savings runs out. This takes time. But as house values fall further, leading to greater negative equity, this shifts to ‘won’t pay’ strategic default especially among investors, when they determine that the pain of continuing outweighs the pain of defaulting.
Based on a Central Bank study a quarter of the Irish mortgage book was in some kind of trouble by 2012 and 11% were already 90 days in arrears. Three years later some 40,000 mortgages were in arrears over 720 days and 40% were deemed to be held by ‘non-engagers’.
Ireland and Australia have different economies that’s for sure, but not different people. Why Irish data matters is because the Australian mortgage book looks to have much higher risk than Ireland before its crisis.
Forty percent is a number that keeps coming up, 40% of all Australian mortgages are on capital repayment holidays, serviced on interest-only terms. This is a huge number.
The total loan book is also heavily skewed towards buy-to-lets at 34% of which 80% are interest only. These nose bleeding numbers compare to Ireland where 15% of mortgages were buy-to-lets, half of them, interest only. The great bulk of Irish housing mortgages, 85% were owner occupiers spilt even between first-timers and those switching home or mortgage.
So, have Australian Banks been more carefully lending than Irish Banks? No.
Australian mortgages have been underwritten using a discredited method of calculating household expenses which overstates the capacity to borrow. Called HEM or Household Expense Measure, this does not examine individual living expenses but relies on rules of thumb that overstates borrower buffers by up to 20% and underestimates the risk to the bank.
When banks miscategorise all the mortgage book as prime and write loans using a process designed to diminish risk, they end with having to set less capital aside as shock absorbers for the banks.
After a recent review of banking practices, new loan underwriting has tightened to include customised examination of capacity to repay and a crackdown on interest only deals. This is leading to a credit crunch and will thwart escape routes for refinancing impaired loans. Orr reckons this is the equivalent of adding 2% to 3% to the base rate, meanwhile banks await the outcome of a pivotal legal case being taken against Westpac, one of the top four banks, it is a case about irresponsible lending that relied on HEM. Results should be known within weeks. If Westpac wins, HEM will be deemed responsible lending, if not group legal actions will commence against banks that will escalate as the soft landing gives way to crisis.
Despite its AAA status, high per capita wealth and low joblessness, Australia is in a trap. Heaven help them because it is hard to see a way out that doesn’t involve taking a lot of pain. The economy is sitting on a huge speculative bubble. If Orr and others, like Banking analyst Martin North and Economist John Adams are right, Australia is staring into a full-blown systemic crisis for banks, for mortgage insurers and for sovereign debt as loses get socialised. It may also play into deposit haircuts.
Cutting rates, loosening credit rules to reignite credit growth or adopting emergency fiscal policies to provide market supports, could delay and temporarily inflate the bubble further but it cannot be magicked away. When the public is fed reckless Government, regulatory and banking policies for long enough, the results are always the same.
Australia, where private debt has reached 205% of GDP, is no different and a crisis here for a Aus$1.7 trillion economy ranked in the top 20 worldwide, would not be an isolated event, more likely it would expose bubbles elsewhere built my prolonged access to artificially cheap credit.
Last weekend Australians voted not to switch horses midstream and returned its sitting Government, an organism politically incapable of accepting the unholy mess it faces. If that also sounds familiar, it should.
Eddie Hobbs is a writer and Financial Advisor with www.hobbsfinancial.ie