The Reserve Bank of Australia’s 125 basis points of interest rate cuts since November have failed to spur demand for mortgages, deepening concern one of the world’s costliest housing markets will extend its record decline.
The annual growth of outstanding home loans has slowed to the weakest pace since at least 1977 as Australians repay loans and boost savings instead of borrow for housing. Home prices are down 6.1 percent from their mid-2010 peak and have slumped for a record five-straight quarters.
That contrasts with the last two periods of declining interest rates. After the 2008 credit freeze, demand for mortgages picked up within two months of the first of six interest rate reductions, helping fuel a 21 percent surge in home prices to their high two years ago. Rate cuts in early 2001 also spurred a surge in lending growth that helped propel Australian home prices to 2 1/2 times U.S. levels today.
“Prices have started to come down, and we haven’t yet seen the normal reaction to lower interest rates,” said Shane Oliver, head of investment strategy at AMP Capital Investors Ltd., which manages almost $100 billion. “Attitudes towards housing have changed, so in the past, there was sort of a solid confidence that house prices only rise, and therefore as soon as interest rates come down you’d see a pretty quick response, whereas this time around the response has been a lot slower.”
The annual pace of growth in Australia’s A$1.2 trillion ($1.23 trillion) of outstanding housing debt slowed to 5.1 percent in May, the weakest since central bank data begins in 1977. The median price of dwellings, including apartments, in the country’s capital cities was A$460,000 last month, according to the RP Data Rismark home value index. That compares with $189,400 in the U.S., according to the National Association of Realtors.
The nation of 21.5 million people has the second-least affordable homes behind Hong Kong’s, with dwellings in its cities costing 6.7 times the median household income, according to a Demographia study of prices in Australia, New Zealand, Ireland, the U.K., the U.S., Canada and Hong Kong. Homes in the U.S. cost 3.1 times income, and 5 times in the U.K., it said.
“It is a very dangerous idea to think that dwelling prices cannot fall. They can, and they have,” RBA Governor Glenn Stevens said in a speech in Sydney yesterday. “But it has to be said that the housing market bubble, if that’s what it is, seems to be taking quite a long time to pop - if that’s what it is going to do.”
From the RBA’s perspective, and that of holders of Australian bank debt, the newfound restraint among buyers is welcome. The slowdown in demand for loans means the nation’s banks are funding an increasing share of lending from deposits, helping insulate them from rising global funding costs stemming from Europe’s ongoing fiscal crisis.
The deposit share of Australian bank funding has climbed to 53 percent, allowing lenders to “be selective about accessing global wholesale funding markets,” the RBA said in minutes of its most recent board meeting released July 17.
Stevens last month said decisions to cut interest rates in November, December, May and June were made easier by the board’s judgment that there was a low risk of reigniting a boom in borrowing and home prices. The board paused this month, holding the rate at 3.5 percent.
“One thing we should not do, in my judgment, is try to engineer a return to the boom,” he said in a June 8 speech in Adelaide. “The intended effect of recent policy actions is certainly not to pump up speculative demand for assets.”
That’s what happened in the last easing cycle, when the central bank cut its benchmark rate from 7.25 percent in September 2008 to 3 percent in April 2009. House prices surged 21 percent in the 15 months to June 2010, according to government data, boosted also by increased handouts to first home buyers of as much as A$21,000.
Lending and prices also took off after the overnight cash rate was lowered from 6.25 percent in February 2001 to 4.25 percent in December of that year. House prices almost doubled in the following decade as household’s debt-to-disposable income ratio jumped from 97.7 percent in March 2001 to a high of 156.3 percent in September 2006, according to central bank data. That ratio was 149.7 percent in March this year.
The slowing housing market isn’t stopping offshore investors from piling into Australian mortgage-backed debt, seeking assets in an economy that’s expanding for a 20th straight year.
Commonwealth Bank of Australia, the nation’s largest bank, is the third-biggest seller of covered bonds globally in 2012, accounting for 4 percent of the market, according to data compiled by Bloomberg.
Australian lenders have issued the equivalent of $34.8 billion this year of the securities, which are typically rated AAA and remain on the bank’s balance sheet, the data show. The nation’s government passed laws in October allowing covered bond offerings for the first time.
Australian covered bonds sold in Europe, where the securities were invented in the 18th century, yield an average 62 basis points more than government debt, according to a Bank of America Merrill Lynch index. That compares with spreads of 106 basis points on notes sold by British lenders and 619 on Spanish covered bonds, the gauge shows.
Westpac Banking Corp., the nation’s second-biggest lender, priced 1 billion euros of seven-year covered bonds to yield 55 basis points more than the benchmark swap rate on July 2. Euro covered bonds due in five to seven years offer an average spread of 144 basis points, the Merrill Lynch index data show.
“The positive sentiment currently surrounding Australian covered bonds always needs to be considered against most investors being very well aware of the housing price developments in Australia,” said Leef Dierks, head of covered bond research at Morgan Stanley in London. “Provided no soft landing can be achieved, the price declines might dampen demand for mortgage-backed debt going forward.”
Smaller lenders are also returning to offshore funding markets with RMBS issues, leading the busiest three months of such issues since the second quarter of 2007.
Resimac Ltd., which issued Australia’s first residential mortgage-backed security in 1988, and Members Equity Bank Pty led $670 million of U.S. dollar sales last quarter, according to data compiled by Bloomberg. The two lenders say they’re planning further offerings while Brisbane-based Firstmac Ltd., which manages A$5 billion of mortgages, is considering its debut sale, according to company executives.
Offerings of residential mortgage-backed securities, where the home loans are parceled up and removed from the seller’s balance sheet, peaked at A$59.7 billion in 2006 before slumping after the U.S. subprime collapse, according to data from Standard & Poor’s.
There has never been a default on an Australian prime RMBS, according to S&P. Among non-conforming transactions, there has only been one missed interest payment on a subordinated portion. Non-conforming RMBS are backed by loans that don’t meet traditional lending criteria, such as proof of income.
“A slow adjustment to house prices gives borrowers time to adjust and lenders time to work through their problem loans,” said Vera Chaplin, a Melbourne-based managing director of structured finance at S&P. “For the performance of structured finance transactions, it contributes to stability.”
Government reports since the RBA’s latest decision have painted a mixed picture of the economy: retail sales rose by more than twice the pace forecast and consumer confidence strengthened, while the unemployment rate increased in June and home-loan approvals unexpectedly sank.
Powering the Australian economy is the biggest resource boom since prospectors set off a gold rush in the 1850s. The latest bonanza -- for iron ore, coal and natural gas -- is bringing investment projects the government estimates to be worth A$500 billion. The nation’s unemployment rate, at 5.2 percent last month, is lower than 8.2 percent in the U.S. and 11.1 percent in the euro area.
“With recent signs that the domestic economy had a little more momentum than had earlier been indicated, members saw no need for any further adjustment to the cash rate at this meeting,” the RBA’s minutes released in Sydney July 17 showed.
“Australian householders remain firmly in de-gearing mode, hence the subdued credit growth and house prices that we’re now seeing,” said Chris Viol, a credit analyst at UBS AG in Sydney. “Together with the advent of new funding sources like covered bonds, the result has been an improvement to Aussie banks’ wholesale funding profiles. This is music to rating agency and credit investors’ ears.”