Western Sydney ground zero in interest-only mortgage bust


It’s all so bloody predictable. Via the AFR:

Selling agents are starting to reveal the truth behind recent listings in Sydney’s west with Belle Property Strathfield’s Jimmy Kang saying up to 50 per cent of his clients were asking him to sell their homes in Sydney’s western suburbs because they can no longer afford their new principal-and-interest mortgages.

…A couple asked him to sell a two-bedroom weatherboard home in Veron Street in Wentworthville, 27 kilometres west of Sydney, for $950,000 when it was only worth about between $820,000 and $830,000. They bought the home for $790,000, two years ago.

“I asked them where they got that number from and they said that was the number they need to pay back the $200,000 they borrowed from family to buy the home as well as repay their interest-only loan,” he said.

“A lot of them initially paid $2000 to $2500 a month on their interest-only loans, and now they have to pay $4000.”

Auctions in Western Sydney’s mortgage belt have collapsed:

This is exactly what happened in the 2003 Sydney bust. Western Sydney is basically a low income ghetto that occasionally catches the house price bug then is astonished when its paltry income can’t support the prices.


This is going to melt down worse than 2003. Back then it was bailed out by the mining boom, rising rents and wages. As well, other city house prices took off and supported consumption. Today Western Sydney is the epicentre of the mass immigration wages crush and falling rents, and it’s increasingly national.

Worse, recall the Variant Perception hedgie mortgage sting of several years ago:

> 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.

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.


And it will be made worse by this, also at the AFR:

The Chinese government has tapped apartment developer HPG, a subsidiary of Chinese conglomerate Hailiang, to divest its overseas investments, as pressure to claw back capital in China mounts.

HPG has been shopping quietly off-market for a partner or a buyer for its $600 million flagship apartment project, “One Sydney Park”, a 400-apartment project spanning 2.1 hectares in Erskineville, 6 kilometres from the Sydney CBD, sources have said.

…HPG will not be the only private company to be asked to repatriate their capital to China. It is widely known the Chinese government has issued instructions through major Chinese newspapers for private Chinese companies to relinquish its investments outside China, this time in its effort to strengthen its economy as the trade war with the US escalates.

Western Sydney is ground zero as the interest-only mortgage reset detonates.

About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. 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.