30/03/2020 – G’day. Mortgages downunder

By now you know that I have a penchant for selling the Aussie…

If you didn’t know that, well, I do.

At the end of May last year, I wrote this piece.

It explained the extent to which Australian mortgage holders would be affected by the change from interest only mortgages, which had been gorged on for years, to interest + principal…

Which would add an extra $400 onto the average Australian household’s monthly expenditure.

I want to go back to revisit a few things, but also to see what the situation is now.

Let’s start in 2018.

A report was conducted by the Royal Commission to better understand the banking practices occurring in Australia.

To put it bluntly, it found that the banking culture in Australia was total dogshit, and it was largely similar to practices occurring in the US pre-GFC.

But especially in mortgages.

See, banks had been fans of lending on an interest only basis to Australians since it’s pretty much cheaper…

That whole thing about future discounting comes into play…

People would rather accept short term gratification because they discount the pain that they perceive to be years away.

So Aussies gorged on these ‘cheap’ loans.

Of course, Australian banks should have been more prudent in lending, but after seeing how governments bailed out the financial system even after banks took on excess risk in the US, who can blame them (sarcasm)?

But, even after this report was released and people became more aware of the issues in the banking system, the APRA (Australian Prudential Regulation Authority) lifted the restrictions on interest only lending in December of 2018…

A mere 3 months after the report was handed to parliament.

A bit ridiculous, ay?

This was largely due to the decline in Sydney and Melbourne house prices the week prior.

Even more ridiculous.

So let’s frame this in the current context.

We’re largely expecting a big decline in employment because of the Corona Virus, whilst more and more loans are reaching the end of their interest only period.

When their fixed term ends, a significant portion will be forced to sell if they cannot extend their loan or sell the property if they are unable, or unwilling, to switch to a principal and interest loan.

What’s that likely to lead to?

A fire sale.

But against the backdrop of these decreasing employment conditions, there could be the catalyst of many people rushing to sell their home for liquidity – they need money due to their insecurity of employment.

With current credit illiquidity, it’s probably the right assessment to make if we conclude that banks are unlikely to lend to these subprime borrowers, 80% of which have been refused or have had offers of limited credit from lenders in the past year.

Alongside this is that backdrop of declining house prices – what if there is mass selling amidst a lot of negative equity?

I mean, the boom years probably gave Aussies a nice boost to their house prices, but interest only borrowers have no equity in their home.

In the current circumstances, can anyone give me a good reason as to why the bid for houses won’t be dramatically lowered?

Even if interest only borrowers would be able to switch to principal + interest, it would hamper spending in other parts of the economy due to the increased costs…

And even with the RBA lowering rates, do we truly think this will translate to more lending at a time where the existing borrowers who would desperately need credit are the sub-prime of the sub-prime?

And if they roll over to P&I in the midst of a property downturn, they’re paying more for a home which is not worth as much…

Not a good situation.

Let’s reflect on what this might mean for Aussie banks.

Well, the APRA comes into this again.

Last year, they raised the capital buffer requirements by 3%, but not as much as what the market expected.

Lo-and-behold, that article says that they eased mortgage lending standards…

And fair enough, house prices had some recovery in the latter part of 2019..

However, I think we’re seeing a top in this recovery.

40% of home auctions were withdrawn just this weekend due to Corona Virus social distancing rules that had been imposed by the Australian government.

Personally, I think this article written in mid-March is far too generous in terms of what the downturn will look like.

And I think the Aussie housing situation is one aspect to continue building our short AUD thesis on.

This week, we have a load of Aussie data coming out.

Specifically though,, we want to be focused on the data that is property and credit focused…

Tonight or tomorrow morning (basically at 12am GMT on Tuesday), we have new home sales for February (just missing the key time for the Corona Virus to have hit Australia but important nonetheless) and private sector credit half an hour later…

Wednesday at 1am GMT we have Aussie building permits…

And Thursday at 9.30PM, we have the performance of the construction index.

If we get a poor beat on these, I seriously think we can expect to see further AUD downside.

If this also coincides with a more risk off environment, we will be in prime position to add to Aussie shorts (apart from me because I’m already risked 3% on AUDJPY, so for some of us, it could be a good time to de-risk (some of us being me 😉))…

I am out of AUDJPY shorts above the 25th of March high – that tasty pin-bar where price hasn’t really been tested as of yet!

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