Gillard Urged to Copy Bernanke as Australia’s Lenders Squeezed: Mortgages

Australia’s Prime Minister Julia Gillard may be forced to follow U.S. Federal Reserve Chairman Ben S. Bernanke by increasing mortgage purchases as house prices slump and the nation’s biggest banks extend their grip on the home-loan market.

Non-bank lenders including Greater Building Society and CUA say more government purchases of residential mortgage-backed securities will be needed as Europe’s debt crisis saps investors’ appetite for risky assets. The Australian Office of Financial Management has spent 73 percent of the A$20 billion ($21.4 billion) allocated to keep smaller lenders competitive after the credit freeze following Lehman Brothers Holdings Inc.’s collapse in 2008.

Australia’s four biggest banks have increased their share of outstanding mortgages to 86 percent as of the end of last year, up from 75 percent when the program started, according to regulatory data. Mortgage costs are a sensitive issue for Gillard as her Labor party prepares to face voters by the end of next year in a nation that has the second-least affordable homes behind Hong Kong and nine out of 10 borrowers pay variable interest rates.

“If the federal government is serious about supporting competition in the Australian home-loan market, the AOFM will need more cash,” said Greg Taylor, chief financial officer of Greater Building Society, the Newcastle-based lender that was founded in 1945. “Our cost of funding is higher than the major banks but we have been absorbing this to still offer products and services that are competitive. This practice is becoming increasingly challenging.”

Debt Funding

Packaging home loans into securities and selling them to raise cash is the largest source of debt funding for Australian lenders outside the biggest four -- Commonwealth Bank of Australia, Westpac Banking Corp. (WBC), Australia & New Zealand Banking Group Ltd. (ANZ) and National Australia Bank Ltd. (NAB) The smaller lenders accounted for 59 percent of outstanding RMBS as of Sept. 30, with A$90.7 billion on issue, according to Standard & Poor’s data.

The AOFM program, which is not open to the big four banks, has helped 20 lenders fund home loans by investing in their RMBS sales, a federal website states. There have been no offerings so far this year.

The Australian government has already increased its RMBS budget from the A$4 billion announced in September 2008. It made A$607 million from interest payments on its mortgage bond holdings in the year to June 30, a return of 6.1 percent, according to the AOFM’s annual report.

‘Four Pillars’

AOFM Chief Executive Officer Rob Nicholl declined to comment on the outlook for the RMBS market in 2012 or whether the government should increase its investment budget. There was less interest from other investors in the deals the AOFM backed in late 2011, compared with sales earlier in the year, he said.

“We continue to assess proposals on a case by case basis as they come forward,” he said.

Commonwealth Bank, Westpac, ANZ Bank and National Australia, which all hold AA- ratings from S&P and have readier access to global credit markets, have sold more than $27 billion of other types of bonds in 2012, the busiest start to a year in Bloomberg records dating back to 1999.

The so-called “four pillars” boosted offerings after the government changed laws in October to allow sales of covered bonds, a different type of mortgage-backed debt that has a dual guarantee from the issuer and an underlying pool of loans.

New Benchmark

The legal change, announced in a package of reforms aimed at spurring banking competition, has ended up skewing the playing field by giving bigger banks a new source of funding and driving up spreads on all other types of debt. While smaller lenders are permitted to issue the securities, it’s more difficult for them to get the AAA ratings on the notes that investors demand. None have attempted a sale.

Australian RMBS sellers will have to pay higher premiums to compete as a result, according to Pacific Investment Management Co., manager of the world’s biggest bond fund.

“The recent issuance of covered bonds has established a new AAA benchmark and spreads for primary RMBS will need to similarly adjust in order to represent value,” said Robert Mead, Pimco’s Sydney-based head of portfolio management. “Pimco did not participate in the most recent RMBS issues from late 2011 as we perceived those as being priced too tightly, yet we perceived the initial covered bond issues to be attractively priced.”

‘Tough Out There’

Australian home prices slumped 4.8 percent in 2011, the biggest calendar-year drop on record, as concerns about the European debt crisis kept a lid on demand, according to the statistics bureau. The nation has the second least affordable homes behind Hong Kong’s, according to a Demographia study of prices in Australia, New Zealand, Ireland, the U.K., the U.S., Canada and Hong Kong.

Credit to home purchasers rose 5.4 percent in December from a year earlier, the smallest annual increase since 1977, when central bank data begins.

The challenge for banks is “coming to terms with ‘life in the slow lane,’” John Laker, Chairman of the Australian Prudential Regulation Authority, told lawmakers in Canberra this week, according to a copy of his remarks on APRA’s website.

The RBA said in a quarterly statement published Feb. 10 that retail spending remains subdued in Australia and the property market was weak.

“It’s tough out there,” said Tony Taylor, chief financial officer of CUA, the nation’s largest customer-owned lender. The AOFM’s budget for RMBS purchases “should be reviewed quite regularly by those in charge. I have no doubt that an increase will be required at some point.”

Debt Surge

The mortgage bond investment program puts the government’s finances at risk if the housing market’s slide turns into a rout, said Steve Keen, associate professor in economics at the University of Western Sydney and author of the book “Debunking Economics.” He expects Australian house prices to decline between 6 and 10 percent in 2012 after adjusting for inflation.

“Putting more money into this would be putting more money into a mistaken project,” he said. “The expansion of competition in mortgages is what gave us a dramatic rise in mortgage debt. It was damaging to the economy in the long run and competition led to a race to the bottom.”

Australian household debt as a proportion of disposable income tripled over the past 20 years to 150.3 percent in the quarter ended Sept. 30, according to central bank data. That compares with 133 percent in the U.S. at the height of the subprime-mortgage boom.

Homes in the nation’s cities cost 6.7 times the median household income, compared with 3.1 times in the U.S. and 5 times in the U.K., according to Demographia. Borrowers spend 33.6 percent of their income on loan payments, the Real Estate Institute of Australia’s housing affordability report show.

‘Political Issue’

Australian mortgage-holders with floating-rate loans weren’t given any relief when the Reserve Bank of Australia unexpectedly left its key rate unchanged at 4.25 percent on Feb. 7, judging that two cuts late last year would help the economy weather Europe’s debt crisis.

Traders see a 33 percent chance that the benchmark will be reduced to 4 percent in March, cash-rate futures show.

If further rate reductions aren’t passed on by banks, it becomes a “political issue where the government of the day is not doing enough to put pressure on large players,” said Fariborz Moshirian, director of the Institute of Global Finance at the Australian School of Business. “It is seen that the large banks are controlling the Australian monetary system because regardless of what the Reserve Bank does, banks are determining the home loan rate.”

Switch Lenders

All four of the biggest banks boosted interest rates independent of central bank policy this month. Gillard and Treasurer Wayne Swan condemned the actions, urging customers to switch lenders.

Australia’s Labor government, holding a parliamentary majority of one seat after brokering a deal with independents to stay in power in 2010, is seeking to bolster its fading popularity by focusing on the economy and asserting authority over the banking system. Gillard this month pledged to make economic management the main political battleground in 2012; her opponent Tony Abbott replied: “make my day.”

Gillard’s Labor government trails Abbott’s Liberal-National coalition in opinion polls. An election is due by the end of next year.

National Australia Bank said Feb. 7 that, while its cash profit for the three months ended Dec. 31 climbed 7.7 percent to A$1.4 billion, its net interest margin, a measure of the profitability of its lending business, had narrowed.

Slower Growth

Commonwealth Bank, the nation’s biggest, and Westpac also said this week that the gap between their lending rates and their funding costs had shrunk. ANZ said today that credit growth is unlikely to return to pre-crisis levels in the “foreseeable future.”

The four biggest banks and their units had a combined A$932.5 billion of housing loans outstanding as of Dec. 31, from A$499 billion four years earlier, according to APRA data. They took advantage of the market turmoil in 2008 to acquire smaller rivals, with Commonwealth Bank buying Bank of Western Australia Ltd. and Westpac purchasing St George Bank Ltd.

Australia’s government introduced its mortgage bond-buying program in September 2008 to help smaller lenders maintain access to funding as the meltdown in securities linked to U.S. subprime home loans triggered the global financial crisis.

Spreads Widen

The extra yield above the bank bill swap rate that investors demanded to hold Australian RMBS averaged 20 basis points before the credit freeze, according to the RBA. It surged as high as 450 basis points, or 4.5 percentage points, in early 2009.

The rationale for the program differed from the U.S.’s purchases of mortgage assets because the nation’s financial system wasn’t under threat, Swan said in a statement when the investments were announced in 2008.

The Federal Reserve has bought more than $1.25 trillion of mortgage bonds since 2009 to help drive down home loan rates and spur a housing recovery. It started in October to reinvest proceeds from debt that’s being paid off into additional bond purchases. The value of U.S. housing has fallen 5.4 percent since the start of that year, and is down 33 percent from its 2006 peak, according to an S&P/Case-Shiller index.

President Barack Obama announced a separate package of proposals designed to jolt the housing market Feb. 1 by helping homeowners refinance mortgages into lower-rate loans, his latest effort to spur the economic recovery.

Late Payments

The share of U.S. prime mortgages that were more than 30 days behind on payments was 5.2 percent as of Sept. 30, compared with 1.52 percent in Australia, according to the Mortgage Bankers Association of America and S&P.

Funding costs for financial firms globally have surged as Greece seeks to stave off default. The extra yield investors demand to hold global financial debt instead of sovereign bonds has climbed 79 basis points to 292 since the beginning of 2011, Bank of America Merrill Lynch index data show.

Bank of Queensland Ltd., Bendigo & Adelaide Bank Ltd. and CUA say they’ll seek AOFM support with future mortgage bond sales.

“Challenges are likely to continue in 2012,” said Brisbane-based Tim Ledingham, treasurer of Bank of Queensland, citing slow lending growth, rising funding costs, increased unemployment and slipping house prices. “Until RMBS transactions are achieving wide and diverse distribution I would expect that the market will benefit from the AOFM’s involvement.”

To contact the reporters on this story: Sarah McDonald in Sydney at smcdonald23@bloomberg.net; Nichola Saminather in Sydney at nsaminather1@bloomberg.net

To contact the editors responsible for this story: Shelley Smith at ssmith118@bloomberg.net; Rob Urban at robprag@bloomberg.net

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