From JCP Investment Partners , one of three equity managers that invests for the Future Fund:
In a proprietary study of the nation’s record high-and-growing household debt mountain, the Melbourne-based fund said Irish-style housing losses for the bigger-than-recognised pool of riskier borrowers could wipe out half of the banks’ equity capital.
Interest-only loans, said JCP – which is one of three Australian equities managers appointed by the Future Fund – could be “Australia’s sub-prime”.
As regulators crack down on interest-only lending and the Turnbull government’s decision to introduce a bank levy drives up the cost of loans, “only time will tell if such households can afford the mortgages they have”.
…”The long virtuous housing wealth cycle could easily transition to a viscous cycle,” said JCP. “Smaller mortgages to deleveraging, flat to decreasing house prices and exuberant to melancholic animal spirits will likely expose much bad lending behaviour.”
The fund’s senior researchers Matthew Wilson and Craig Shephard found that about half of all the nation’s mortgage debt was in the hands of borrowers whose debt was more than four times larger than their gross income.
The same borrowers had paid off less than half of their loans, the team found, based on data from several official and private sector sources that adjusted for changes in incomes and the collateral values of their homes.
The average loan-to-income ratio of these heavily indebted households was 6.4, or more than double the old banking “rule of thumb” that mortgage managers didn’t lend more than three times a household’s income “unless they were doctors”.
…Almost a third of the most highly geared borrowers were professionals with pre-tax incomes of more than $250,000. While they accounted for just 2 per cent of total households, they held 17 per cent of mortgage debt, and an average mortgage worth $1.6 million. Half of these borrowers had an investment property loan.
Other young households – dubbed “pretenders” because they had taken on large debts relative to their incomes – were also at risk. This group tended to have average incomes of $110,000 but an average mortgage that was an “eye-watering” 7.4 times larger at $840,000.
The last group, young families, were slightly better placed with average incomes of $80,000 and average mortgages of $420,000.
While they are a small part of the loan book, their household stress could be high because there were “question marks surrounding treatment of expenses in home loan applications, and generally high costs of living.”
JCP, which says it is “underweight” in its holdings of bank stocks relative to the benchmark ASX index and isn’t “shorting” the big lenders, argues the financial system looks “vulnerable” because old lending disciplines had been dispensed with.
…The fund identified several potential catalysts, including the corporate watchdog’s legal action against Westpac over responsible lending.
That might prove to “the seemingly small shock” that forced lenders to request more information. That, in turn, could reduce the borrowing capacity of future buyers.
Another catalyst could be further the steps taken by concerned regulators to reign in a dangerous build up in household debt.
“Credit fuels a bubble, and its ultimate rationing and eventual withdrawal deflates it.”
Just to remind you, this is your sovereign wealth fund telling you that your housing market is a disastrous bubble on the scale of that of the US and Ireland…
Clearly the Future Fund needs some radical reprogramming via MB’s Spruikbot Telephunken U-47. New models are available:
He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.