Here’s the inside run on the new Variant Perception report by Jonathon Tepper on the mortgagenado unfolding in Western Sydney (excerpts republished with permission):
> The property bubble in Australia is now one of the biggest in history. It has reached proportions last seen in Japan before 1989 and Ireland in 2006. In Japan’s case, real estate prices fell 80% over the next decade and in Ireland they fell 50% over the next six years.
> We expect a very big fall in Australian house prices. In mining towns, prices will fall by 80% in some places and in big cities such as Sydney and Melbourne, we expect prices to fall 50% in many suburbs and areas.
> The Australian economy is highly geared to Finance, Insurance, Real Estate and Mining. The combined size of all of these sectors is 21% of GDP. The multiplier for these sectors is much higher, however.
> Underwriting standards are very poor at the big banks. We spoke to many mortgage brokers and banks, and getting a high loan-to-value ratio mortgage is simple and requires only two payslips. Banks do not generally verify the payslips. The local regulator ASIC confirmed this in a report last year, although the situation is even worse than the regulator believes.
> Australia’s big banks will be illiquid but not insolvent. Australian banks require large scale wholesale funding. In the event of a banking crisis, it will be difficult to roll the wholesale funding without any public sector guarantees. The Reserve Bank of Australia will guarantee the banks and charge a fee, as it did in the 2008 financial crisis. We anticipate most bank shares will cut dividends entirely, raise capital and stock prices will likely decline 80%.
> The Australian dollar should trade towards 0.40 against the USD. In the Irish and Spanish banking crises, the bust was long and painful due to the implacability of the euro. The central banks couldn’t monetize liabilities and improve liquidity, and the euro didn’t devalue to adjust. In the case of Australia, the AUD will be the adjustment mechanism and it will fall hard. A weakening currency is what we have seen in almost all other banking crises.
VP goes on to make many of the points that MB readers will be very familiar with: huge debt; bad mortgage market structure; unbalanced economy, recent over-building, risky Chinese buyers etc, etc but it’s real break through insight is on its recent tour of Western Sydney mortgage brokers:
One of the most popular programs in Australia last year was Struggle Street, a series about the poor Sydney neighbourhood of Mount Druitt. It beat other reality TV shows and was the most-watched show in Sydney. It depicted poverty, alcoholism and drugs. The show was condemned by some as “poverty porn” before the broadcast but received a strong response upon broadcast and trended on Twitter around the country. Prices in Mount Druitt are up over 50% since 2012 and in neighbouring Rooty Hill they are also up 50% since 2012.
In Australia, even the poor and drug-dependent can be property millionaires.
So how do people on modest incomes afford such expensive houses? Poor underwriting is the answer.
The Reserve Bank of Australia and the Australian Prudential Regulatory Authority (APRA) all insist that there are almost no low-doc or no-doc loans. They also insist there are few high loan-to-value ratio loans. The truth is much worse.
Underwriting standards are poor in banks. The regulators trust the big four banks’ statistics, but we’ve seen that underwriting standards are much worse than advertised.
In our due diligence, we told mortgage brokers and bank managers that we required a 95% loan-to-value mortgage at 10x our gross household income to buy our dream house, and we were consistently told it was not a problem at all. All we needed were two payslips and mortgage insurance. We asked if the bank would call our employer, and both reputable and disreputable brokers said banks rarely verified payslips. Also, “most of the people checking documents are in Indian call centres.” Furthermore, we were told that as long as the payslips had the right Australian Business Number (ABN) and the business checked out, that was enough.
This is not how it has to be. In the UK, for instance, after the credit crunch, banks are far more thorough when verifying income. The bank cross-checks payslips with one’s bank account to see the net amount received corresponds to the gross amount paid. A lengthy affordability questionnaire must be filled out to make sure that pay is sufficient to cover mortgage payments, that are also stress-tested for higher rates. Bonuses, once nonchalantly taken as regular income, are much more strictly dealt with. No-deposit and minimal-deposit loans are much rarer and harder to obtain. Similarly, the US has tightened lending standards since the financial crisis.
But in Australia, more alarmingly, we were informed from various sources that disreputable brokers had software to make authentic looking tax returns for clients who needed mortgages. We were encouraged to lie about our incomes by multiple brokers in order to get dodgy loans past bank loan officers.
It should come as no surprise that lending standards have fallen as third-party origination of mortgages has risen. This was typical of standards in the US in 2005-07. Today, almost half of new housing loans are originated by third parties.
But our biggest surprise came when we visited a building society (a thrift). The bank manager told us her lending standards were conservative compared to the big banks. She would check our income more thoroughly. She then encouraged us to take a 95% loan to value ratio at 10x our gross income because, “It isn’t worth saving another 5% when house prices will rise more than 5%. By the time you save the 5%, prices will rise exponentially.” Those were her words, not ours.
Needless to say, John Hempton of Bronte Capital and your dumbfounded analyst from Variant Perception wandered around Sydney in shock and amusement after every meeting.
I’m sure they did! Meanwhile the banks have responded with some pretty weak come back at the AFR:
Westpac said there was a “rigorous” process for validating loan documents. “Whilst in the majority of cases this doesn’t include calling the employer, we have processes to check documents, including payslips,” Westpac said. “The checks on those documents represent a prudent approach.”
ANZ Banking Group said all loan applications from mortgage brokers were verified by the bank, which included double-checking the calculations brokers made on a customer’s ability to service a loan.
“ANZ validates income documents provided by brokers and doesn’t rely on broker verification,” it said.
National Australia Bank said it continually reviewed risk settings. “Home loan applications made through NAB’s branches, digital channels or mortgage broker network are considered on a case by case basis taking account of individual circumstances.”
While banks admitted it was true that not every payslip was verified with employers, they took other steps to check customers’ income, such as looking at bank deposits and making inquiries with employers where an application looked suspicious.
It would be impractical and cause significant delays for customers if every payslip provided by a customer were double checked, banks said.
Australian Bankers’ Association chief executive Steven Munchenberg said customers would have to wait “quite some time” for loans to be approved if banks checked every payslip.
Not much of a denial there!
As a bonus, here’s the recent 60 Minutes segment on property starring Mr Tepper: