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Credit agency S&P flags risks to banks over apartment glut
The Australian 12:00am June 11, 2016
Michael Bennet
Credit ratings agencies and bank debt investors are paying greater attention to the worsening apartment glut, fearing property investors could be setting themselves up for “repayment shock” when interest-only periods run out.
Amid heightened concern more settlements will fall through in the oversupplied high-rise market, Standard & Poor’s yesterday said the biggest risks were interest-only loans and investor defaults as they protect their own home when faced with “severe economic stress”.
It came after JPMorgan warned there was a national oversupply of 70,000 apartments and as banks increasingly revalued off-the-plan dwellings approaching settlement “well below” the purchase price.
The Reserve Bank has noted the “considerable supply of apartments” set to hit the market in coming years along the east coast capital cities as it held the official cash rate at 1.75 per cent and flagged imminent further cuts were unlikely.
In its report assessing risks to residential mortgage-backed securities, or RMBS, from the investment lending boom in recent years, S&P claimed that most top-notch AAA tranches were “relatively well placed” to weather a downturn in investment loans.
While arrears for the 2010 vintage were above 2 per cent, S&P said “a potential loosening of lending standards before 2014” wasn’t being borne out.
But the reports author’s, Alisha Treacy and Erin Kitson, cited risks around interest-only periods in place due to the “tax deductibility” of the payments, citing how these make up around half of investment loans in prime RMBS portfolios.
“The typical tenure of the interest-only period is one to five years, though it can be up to 10 years ... creating the possibility of repayment shock when the interest-only period ends,” they said.
“Declining interest rates during the past three years have had a more pronounced effect on interest-only loans than on amortising loans. Combined with ongoing low growth in rental incomes, however, this trend could reverse when interest rates rise.”
The authors said the sensitivity to payment shock would depend on the banks “stringency” on debt serviceability when loans were written. “When refinance opportunities are limited, higher interest rates could be a problem for investment loans that are approaching their interest-only expiration dates,” they warned.
Banks have $546 billion of interest only loans, or 40 per cent of total home lending. While the major banks recently reported tiny actual losses from mortgages, Moody’s this week revealed that 30-plus day delinquencies for prime RMBS soared 18 per cent in the first quarter to 1.51 per cent.
Moody’s also warned that the re-acceleration in house prices this year and ever-growing household leverage were “credit negative” for banks.
The analysis reflects unease across the market despite record low interest rates and buoyant housing conditions, including a resurgence in prices in the major cities of Sydney and Melbourne.
“This better trend now — likely boosted by the RBA’s May rate cut — does increase the risk of a ‘worse later’ scenario ahead, even without the usual trigger of a spike in unemployment or rates,” said UBS economist Scott Haslem.
“This is especially given the impact of tightening of finance conditions — to domestic and foreign investors — will only become fully evident in the next year, leaving lingering worries over settlement risk, particularly for high-rise apartments.”
Since the global financial crisis, the lift in home building approvals is almost entirely driven by “high-rise” units of four-plus storeys, holding a record 33 per cent share in recent years, according to UBS.
Private multi-storey dwellings almost tripled since 2010 to 135,000 annualised in the fourth quarter of last year.
“While inner Melbourne remains a cause for concern for many, the clearest standout for oversupply risk is inner Brisbane,” Mr Haslem said. “The flow of residential building approvals have spiked this year to an unprecedented 9 per cent share of the existing dwelling stock, up sharply from ... a pre-boom trend of 1 per cent. Inner Sydney approvals have also edged up to a new high.”