Australian Banks’ Risky Loans Fueling House Price Gains

Australia’s biggest banks, whose lending standards helped the nation avoid a property crash during the global credit crisis, are raising concern with home loans helping to fuel record house prices.

The proportion of mortgages that represented more than 80 percent of a home’s value -- the loan-to-value ratio -- rose in the third quarter to the highest since the second quarter of 2009, data from the banking regulator show. Mortgages in which borrowers pay only interest also increased to the highest in at least five years, according to the figures.

The Reserve Bank of Australia’s 2.25 percentage points rate reduction in the past two years is luring buyers counting on home prices, which jumped the most in three years in the 12 months through Oct. 31, to extend gains. As the proportion of risky loans climbs -- allowing some people to purchase homes who otherwise couldn’t -- lenders, home-buyers and mortgage insurers are more exposed to any decline in prices.

“We could be laying a potential bear trap later if the property market comes off and those investments don’t translate into as good returns as people were expecting,” said Martin North, principal at data company Digital Finance Analytics, who has been partnering with JPMorgan Chase & Co. to produce mortgage reports for more than nine years.

An increase in unemployment in Australia or rising interest rates in the U.S. could lead to a surge in defaults, North said.

Rising LVRs

Mortgages with loan-to-value ratios higher than 80 percent rose to 35 percent as of Sept. 30 at Australia’s four big banks -- Commonwealth Bank of Australia, Australia & New Zealand Banking Group Ltd., Westpac Banking Corp. and National Australia Bank Ltd. -- the highest since June 2009, according to the Australian Prudential Regulation Authority.

The average ratio at the major banks rose to 67 percent in the third quarter from 65 percent a year earlier and a low of 63 percent in the second quarter of 2009, according to Digital Finance Analytics, the data company.

“It’s not that we’ve changed any of our policies, but the mix of demand is changing,” Phil Chronican, chief executive officer of ANZ’s Australian business, said in an interview in Sydney on Nov. 27. “More people are trading up and people who trade up tend to go for higher loan-to-value ratios.”

ANZ’s average ratio increased to 70 percent in the six months to Sept. 30, from 64 percent a year earlier, according to regulatory filings.

The big four banks held 85 percent of the country’s A$1.2 trillion ($1.1 trillion) of outstanding mortgages in September, according to the banking regulator.

In 2008, after the September collapse of Lehman Brothers Holdings Inc. that helped trigger the international credit crisis, Australia’s biggest banks remained stable as they maintained their lending rules.

Lending Standards

“The Australian banking sector’s less fierce competitive environment relative to some of the global peers has contributed to less-risky lending standards, reflected in lower loan-to-value ratios in the residential mortgage sector,” Standard & Poor’s said in a report in July 2009.

Aside from existing home owners trading up, investors are also piling in. In New South Wales, the country’s most populous state, investor mortgage approvals accounted for about 40 percent of all home loans by value, the highest since 2004, the RBA said in its semi-annual Financial Stability Review on Sept. 25. The average LVR on loans to this group has risen to about 80 percent from about 60 percent in 2009, according to Digital Finance.

Investors are betting on further capital gains after house prices started to rise in early 2013.

Record Prices

The average home price in Australia’s biggest cities rose 8 percent in November from a year earlier, the biggest annual gain since the year ended Oct. 31, 2010, to an all-time high of A$606,003 according to the RP Data-Rismark home value index. Prices in Sydney surged 14 percent in the 11 months to Nov. 30 to a record A$724,628.

SQM Research Pty, a Sydney-based data company, forecasts price gains of as much as 11 percent in 2014.

Australian tax rules support investment in housing by allowing investors to offset any losses on rental real estate against other income.

Along with higher loan-to-value ratios, banks are writing a greater proportion of interest-only loans, which accounted for 39 percent of the biggest banks’ lending in the three months to Sept. 30, from 37.5 percent a year earlier and a low of 28 percent in the first quarter of 2009, figures from the prudential regulator show.

Interest-Only Loans

National Australia Bank has seen a “slight increase” in interest-only loans in recent months, which it attributes to investors returning to the property market, Nick Higginbottom, a spokesman for the bank, said in an e-mailed response to questions. Younger home-buyers and those who rely on a single source of income are also taking out these loans, he said.

Interest-only loans allow people who otherwise wouldn’t be able to afford it to buy, while letting others acquire more expensive properties than they could with an interest-and-principal mortgage, said Andrew Wilson, senior economist at real estate data firm Australian Property Monitors.

“In a rising market, people become more risk-inclined, and banks are promoting” these loans because people want them, Wilson said. “There’s always a danger that if markets correct, it could present problems particularly for investors with a short-term focus.”

Risk-Inclined Borrowers

On top of a decline in the average variable interest rate on standard housing loans to a four-year low of 5.95, banks are offering discounts to some customers.

“Australian house prices already looked in the ‘bubble region’ even before this 2013 spring surge so why are they reaching new highs?” Brian Johnson, a Sydney-based bank analyst at CLSA Ltd., said in an October report. Aside from low interest rates, “Australian banks are aggressively offering ‘package discounts’ to headline standard variable rates, rebating cash to borrowers, lowering credit underwriting standards.”

Westpac is offering to reduce the headline variable rate of 5.98 percent on its Rocket Investment Loan to as low as 5.08 percent on mortgages approved before Dec. 20. NAB will reduce the 5.38 percent interest rate on its Tailored Home Loan product to 5.03 percent on mortgages of more than A$500,000.

Lenders are offering these discounts as their own cost of funding falls, Scott Manning, a Sydney-based banking analyst at JPMorgan Chase & Co., said in a media briefing last week.

Banks’ borrowing costs in Australia are near their lowest level in more than five years, with the average yield premium over the swap rate for financial company bonds touching 96 basis points on Nov. 26, the narrowest spread since February 2008, according to a Bank of America Merrill Lynch index.

Discounted Mortgages

“All of the major banks, if you borrow A$500,000 or more, have at least 80 basis points advertised” as a discount, Manning said. These are “very early signs of a quite aggressive response” as the cost of funds improves.

First-time buyers, who are seeing the biggest challenges to buy as prices climb, are increasingly taking out loans with LVRs of more than 80 percent, the highest in at least five years, according to figures from DFA.

Commonwealth Bank requires borrowers to have a minimum deposit of 5 percent and demonstrate an ability to save, spokeswoman Tracy Hicks said in an e-mailed response to questions last week. The bank’s maximum loan-to-value ratio was increased to 95 percent from 90 percent for eligible borrowers in February 2011, she said. Westpac spokesman Danny John didn’t respond to e-mail and voice-mail messages seeking comment.

No Limits

Unlike other countries that faced spikes in speculative housing activity, including neighbor New Zealand, Australia’s banking regulator is yet to impose any limit on the lending.

APRA is monitoring both high loan-to-value and interest-only home lending, and will “take supervisory action” if a lender skews its loan portfolio too heavily in favor of these mortgages, Chairman John Laker said in an Oct. 29 speech.

New Zealand required banks to limit loans with ratios higher than 80 percent to 10 percent of their total mortgage lending to curb price gains without raising interest rates. The share of new high-ratio loans fell by 50 percent to 12.8 percent in October from the previous month, central bank figures released last week showed.

Sweden in October 2010 capped mortgages at 85 percent of a property’s value and Canada reduced the allowable LVR to 80 percent from 85 percent in June 2012.

The risks of default on high-ratio mortgages are bigger for lenders’ mortgage insurers, rather than the banks, said APM’s Wilson. Banks require mortgage insurance on loans with a loan to value higher than 80 percent to cover them if the borrower is unable to make payments. There is some easing of this requirement, with some mortgage brokers advertising mortgages of as high as 85 percent without insurance.

“Transferring part of the risk to lenders’ mortgage insurers does not negate your responsibility to maintain the quality of the lending book,” APRA’s Laker said.

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