House Price Boom Must End, Says David Gonski

ANZ chairman David Gonski has warned Australia's booming housing prices cannot go on forever and the market will eventually experience a correction.

The former Future Fund chairman said ANZ and all the big banks were "very aware of history" when it came to financial lending in the residential mortgage market.

"There will come a time when there will be a correction," he told the Australian British Chamber of Commerce.

"The fact is, anyone who believes prices always go up is, I think, a fool."

Mr Gonski's comments come as the housing market heats up as spring approaches. Capital city markets had their strongest winter since before the lead up to the financial crisis, according to figures released on Monday by RP Data.

Sydney and Melbourne house prices lifted 5 per cent and 6.4 per cent respectively over the three months to the end of August. The surge represents year-on-year growth of more than 16 per cent in Sydney and almost 12 per cent in Melbourne.

Brisbane, which was one of the weaker-performing cities, recorded a 1.3 per cent property value increase in the three months to the end of August.

The Reserve Bank warned in its submission to the Financial System Inquiry that moves to boost competition in the home loan sector could increase risk in the financial system.

Regional banks, credit unions and building societies have urged the federal government to change regulations that give the big banks a significant cost advantage when making home loans.

Mr Gonski also backed ANZ's Asian strategy, questioning why some in the market consider ANZ to be "riskier" than its peers because it is in Asia.

"I believe it's quite odd, I have to say, that we are regarded as a riskier investment because we have investments outside Australia.

"I could very well argue that a good investor has some money in Australia and some money overseas. That's exactly what the ANZ has done."

Australia 'at the Front' of Growing Subprime Mortgage Market

Australia 'at the Front' of Growing Subprime Mortgage Market

They triggered an economic meltdown in the United States and sparked the global financial crisis, but subprime mortgages are staging a revival in Australia.

Ratings agency Moody's says Australian lenders have doled out $3 billion worth of the non-conforming home loans over the last 18 months.

Prime mortgages are those that typically go to people with good credit scores, secure jobs and existing, well-serviced loans.

Moody's analyst Robert Baldi says non-conforming, or subprime, borrowers tend to have patchier personal financial histories.

"We're looking at things like prior bankruptcies or prior defaults in their credit history past," he explained.

"If the borrower is a non-resident, for example, or it's a jumbo loan, these would all fall outside of the lenders' mortgage insurance criteria and would classify the loan as non-conforming."

Essentially, subprime loans are those going to borrowers with a much higher risk of default that a typical loan.
Australia 'out at the front' of subprime market

While subprime remains something of dirty word in the economies hardest hit by the GFC, Australian lenders are increasingly willing to step up and fund subprime loans by selling what are known as residential mortgage backed securities (RMBS).

"Australia is out there at the front of the market, I would say, so we are the ones that have continued with issuance in this space," Mr Baldi said.

"Since the beginning of 2013, we've seen 10 new transactions in the RMBS market from non-conforming issuers and that's totalled about $3 billion, so that's quite a pick up in volume considering the market did shut down post the crisis in 2008."

While $3 billion sounds like a large amount of money, Mr Baldi says it is a relatively small share of the home loan market, and of RMBS issuance.

"In the year to date we saw roughly about $15 billion of RMBS transactions. Of that, about $1 billion was non-conforming, so we'd say about 7 per cent of issuance this year has been from the non-conforming market," he added.

Moody's says most of these loans are being written by non-bank lenders.

However, Mr Baldi is confident that there is enough regulation in place to avoid a subprime crash similar to that in the US in 2008.

"One of those is the National Consumer Credit Protection Act, and this basically requires lenders to take reasonable steps to verify a borrower's financial position and their ability to repay the loan," he said.

"Essentially this gets around the fact that in the US you saw those loans being written to borrowers pre-2008 with little to no income verification. In Australia that just can't happen."

The United States is still managing the fallout from its subprime crisis.

Last week, finance powerhouse Bank of America Merrill Lynch agreed to an almost $US17 billion settlement for its role in the crisis.
Australia's biggest danger in prime mortgages

Despite that history, banking analyst Martin North sees Australia's non-conforming market as much safer.

"Most of the investors now, the people who are buying these mortgage-backed securities, are now Australian investors rather than overseas investors," he said.

"So there is a bit of a feedback loop going on, and that does mean that some of the other players who might be buying those securitised loans now are essentially home-based rather than offshore-based."

Mr North says the subprime segment of Australia's market is so small that it is unlikely to destabilise the financial system, even if a lot of the loans go bad.

However, he says Australia's banks, households and the economy in general is too heavily reliant on real estate.

"This is a very small proportion of a much bigger question about leverage into property," he warned.

"We have a massively leveraged financial services system into property more broadly.

"If we have the sorts of defaults we're talking about in the non-conforming sector, then you would also be having, I think, similar defaults more broadly across the market, and it's those broader defaults across the market that would be of much more concern rather than the non-conforming element, which I think is quite small and quite isolated."

Don't Get Burnt by The Property Market

Don't get burnt by the property market

How seriously should property investors take recent warnings that Australian property prices are 20 per cent to 30 per cent higher than they should be and that there is an impending apartment glut in 2017? 

Whatever the fundamental basis for these and similar warnings, existing and new property investors need to be aware of the potential downside.

The basic issue is to understand the risks involved with  investments already owned or being purchased. While less popular for purchases of listed assets including shares and property trusts as well as managed funds, large levels of borrowing are widely used to help acquire direct property holdings.

This high level of gearing helps to drive up property prices in good times such as the present and down when markets turn down, for example due to increased levels of vacancies and/or falling rents. Currently, strong foreign buying interest, low interest rates and a shortage of available stock is forcing and encouraging new investors to bid up prices.

While it may be some time off, a similar downward ratchet in prices will start when interest rates rise again and when new housing developments result in an oversupply in the major locations. Compared with share market falls which can be brutal and swift, downward property price movements are generally protracted as sellers holding out for higher prices ultimately are forced to lower their expectations.

A special feature of the apartment market can, however, result in distressed forced sales. This is when a large number of off-the-plan sales negotiated before or during construction fall through. A recent example of this occurring is the setback in the Canberra apartment market due to over-supply and reduced public sector employment opportunities.

In this situation, a significant percentage of off-the-plan  buyers were either unable or unwilling to complete their purchases. The resulting forced sales depressed asset valuations and made it more difficult for heavily geared purchasers to obtain credit to meet their commitments.

The key message for individual investors is to be aware of these and other risks before entering into off-the-plan contracts. While one benefit of off-the-plan purchases is what can often be a lengthy time lag before money is required to complete the purchase, this can be a negative if personal circumstances change or property valuations fall before the settlement date..

The chances of both of these changes increase with the amount of time before completion. The risks are also greater in situations such as the present time when contracts are entered into in a buoyant market. So even if the warnings of problems ahead don't prove accurate, they are a timely reminder to avoid becoming over-committed to a future large heavily geared property purchase.