Issuing new loans against unrealised capital gains has created an Australian ‘house of cards’
THIS very common tactic used by investors in Australia could spell big trouble for our mortgage market “house of cards”. by Frank Chung
THE Australian mortgage market has “ballooned” due to banks issuing new loans against unrealised capital gains of existing investment properties, creating a $1.7 trillion “house of cards”, a new report warns.
The report, “The Big Rort”, by LF Economics founder Lindsay David, argues Australian banks’ use of “combined loan to value ratio” — less common in other countries — makes it easy for investors to accumulate “multiple properties in a relatively short period of time despite high house prices relative to income”.
“The use of unrealised capital gain (equity) of one property to secure financing to purchase another property in Australia is extreme,” the report says.
“This approach allows lenders to report the cross-collateral security of one property which is then used as collateral against the total loan size to purchase another property. This approach substitutes as a cash deposit.
“This has exacerbated risks in the housing market as little to no cash deposits are used.”
The report describes the system as a “classic mortgage Ponzi finance model”, with newly purchased properties often generating net rental income losses, adversely impacting upon cash flows.
“Profitability is therefore predicated upon ever-rising housing prices,” the report says. “When house prices have fallen in a local market, many borrowers were unable to service the principal on their mortgages when the interest only period expires or are unable to roll over the interest-only period.”
LF Economics argues that while international money markets have until now provided “remarkably affordable funding” enabling Australian banks to issue “large and risky loans”, there is a growing risk the wholesale lending community will walk away from the Australian banking system.
“[Many] international wholesale lenders ... may find out the hard way that they have invested into nothing more than a $1.7 trillion ‘piss in a fancy bottle scam’,” the report says.
The report largely sheets the blame home to Australia’s financial regulators, the Australian Prudential Regulation Authority and the Australian Securities and Investments Commission. “ASIC and APRA have failed to protect borrowers from predatory and illegal lending practices,” it says.
“Although ASIC has no official ‘duty of care’, APRA does, and will have some serious questions to answer in relation to systemic criminality within the mortgage market committed by the financial institutions they regulate. The evidence strongly suggests the regulators have done nothing to combat white-collar criminality in the mortgage market.”
A spokesman for ASIC said: “We are not going to comment on that criticism, other than to say we do not accept it.” APRA has been contacted for comment.
Australia now has the second highest level of household debt in the world, with a debt-to-income ratio of 190 per cent, and at least 60 per cent of banks’ loan books are related to housing.
Experts have warned that one in four mortgaged households are currently in stress, and modelling suggests if interest rates rose by just 0.5 per cent, that would jump to one in three households.
Last month, a young Sydney couple revealed how they had racked up $1.2 million in debt on a portfolio of five properties in just two years.
Roy Palleson and Rowena Ebona, appearing on the ABC’s Four Corners, said they had no concerns about their debt — nearly 10 times their combined income of $135,000 — and were hoping to expand their portfolio to 20 investment properties “initially”.
Prominent Sydney property investor Nathan Birch, who accumulated more than 200 properties worth an estimated $55 million by channelling the equity from capital gains into deposits for new purchases, earlier this year announced he was selling off some of his portfolio.
Mr Birch blamed the move on tougher loan serviceability restrictions by the banks. “Anytime you withdraw equity, you need to show income to service that new loan,” he said. “Sadly, the banks don’t value rental income as highly as they once did.”
Eddie Dilleen, a young investor with 10 properties worth about $2 million, last month said he was not fazed by tightening lending environment or talks of a housing bubble.
Mr Dilleen said the majority of his portfolio was positively geared, largely because he avoided borrowing against existing properties, instead saving up for each new deposit by working several jobs.
It comes as CoreLogic data for August confirms a slowdown in housing market conditions, particularly in Sydney. The median price in Sydney is now $909,914, unchanged from July, but still 13 per cent higher than a year ago.
Melbourne’s median house price has risen by 12.7 per cent over the past year to $695,500, with Brisbane up 3 per cent to $488,757, Adelaide 5.2 per cent to $430,109, Hobart 13.6 per cent to $383,438 and Canberra 12.9 per cent to $575,173.
Only Perth and Darwin median house prices have declined over the past year, with Perth down 2.8 per cent to $462,927 and Darwin down 4.2 per cent to $449,234. The national median house price is currently $537,137, 8 per cent higher than a year ago.