Thursday, 13 March 2008

Severe Mortgage Stress to Hit Aussie Households

Whilst the Australian employment picture looks rosy, the position of Australian households is decidedly less so and could get a lot worse according to a report from JP Morgan and Fujitsu Consulting. From the SMH:

Mortgage stress to hit 300,000: report

An alarming 300,000 Australian households will be under severe mortgage stress by mid-2008 and at significant risk of losing their homes, as interest rates and living costs rise, a new report shows.

The worrying finding raises questions about banking sector profitability, which is already under downward pressure due to the global credit crunch and rising funding costs, report authors JPMorgan and Fujitsu Consulting said.

"The banks have passed on nowhere near their increased cost of funding," JPMorgan lead banking analyst Brian Johnson told reporters.

"When you speak to them behind the scenes, they'll tell you that probably they'll have to move another 15 basis points."

The JPMorgan/Fujitsu Australian Mortgage Industry Report for March follows decisions by the major banks to increase their standard variable home loan rates by more than the 25 basis point increase engineered by the central bank on March 4.

ANZ Banking Group Ltd, St George Bank Ltd and Commonwealth Bank of Australia have all raised their rates by 35 basis points. Westpac has approved a 30 basis point increase and National Australia Bank Ltd a 29 basis points rise.

The report, based on the results of telephone interviews with 26,000 Australian households, estimates more than 700,000 households will be experiencing some form of mortgage stress by June this year, a four-fold increase on last year.

It identified mild stress as occurring in households that had prioritised or curtailed spending to pay their mortgages.

But around 300,000 households will be experiencing severe stress, meaning they will have missed repayments, be in the process of refinancing or received a foreclosure notice.

The report also pointed to a rise in `affluent stress' amongst high net worth borrowers suffering from rising rates, school fees and margin calls on shareholdings.

It also called on the banks to review their use of mortgage brokers to win market share and to make mortgage processing more efficient.

Meanwhile, the Australian Securities and Investments Commission (ASIC) released its own report, warning borrowers to be careful of "fringe lenders" offering refinancing services at a high cost.

"The crucial questions are whether the repayments will be lower on the proposed loan, and whether they can afford those repayments over the long run," ASIC acting executive director of consumer protection Delia Rickard said.

"If their broker doesn't talk through this issue with them they should be very careful or consider approaching a different broker."

JPMorgan's Mr Johnson described claims by banks that their home loan books were in good shape as "a bit fanciful".

JPMorgan and Fujitsu believe bank methods testing for financial stress are questionable, given that credit bureaus only collect data on impaired credit records, as opposed to the total amount of debt held by individuals.

There are telltale signs that bank mortgage books are under pressure, Mr Johnson said.

Firstly, the amount of money banks will lend has increased dramatically over the past 15 years.

Secondly, banks have reduced the interest rate safety buffer on their loans to about 100 basis points from over 200 basis points.

"Now the scary thing about that is we've seen 75 basis points of interest rate rises come through," Mr Johnson said.

The Reserve Bank of Australia this month raised the official cash rate to 7.25 per cent, from seven per cent.

It was fourth time it had hiked rates in the current financial year. But banks have added additional, internal hikes of between 20 and 30 basis points since January.

Mr Johnson questioned the banking industry's use of the Henderson Poverty Index to assess a client's risk profile and cited conflicts of interest in the lightly regulated broking industry - where mortgage brokers get more commissions for selling bigger loans.

Additional financial stress was also being hidden by credit card debt, Mr Johnson added, with the average Australian's credit card balance currently equating to about three months of disposable income.

With all the extra stress on borrowers, JPMorgan believes recent, sharp falls in bank share prices are justified.

"Rising interest rates impacting borrowers capacity to repay, coupled with tighter global liquidity forcing lenders to ration credit, likely signals subdued housing growth expectations over the near term," the report said.

Mr Johnson believes Australia's banks are facing their worst operating environment in 16 years.

While he declined to question some banks' forecast for earnings growth of between 10 and 12 per cent in fiscal 2008, he said earnings were likely to fall significantly in fiscal 2009.

"Australian households are still highly geared," he said.

"A 25 basis points increase in interest rates increases the interest burden on home loan borrowers by an estimated $1.7 billion."
No doubt banks earnings are going to come under pressure in fiscal 2009. There seems to be a perception that since bank stock prices have fallen as much as -35% or more over the past 4 months that they can't fall much further. However if earnings take a dive P/E ratios that currently look cheap can get expensive very quickly.


Glen said...

You'll notice I did a bit of a roundup of some of the Oz banks on the blog. I wouldn't mind your feedback, because I'm not great with fundamental stuff, clearly. It might be of interest for your analysis as well.

In regards to banks and their P/E's, from memory, Van Tharp reckons you are better off buying for the long term on high P/E's. I guess it makes sense, because at this time, the P/E is only reflective of current earnings, not forward looking earnings. When at high P/E's, all the bad news is already factored in I guess...


The Fundamental Analyst said...

I'm not familiar with Van Tharp's work. However just on the face of ti, buying high PE stocks of any kind including banks is usually the worst option for long term investing.

A study by Sanjoy Basu, of McMaster University showed that over a 14 year period from 1957 - 1971, low P/E stocks vastly outperformed high P/E stocks.

Roger Ibbotson conducted a similar study using every NYSE listed stock and found from 1966 - 1984 that low P/E stocks vastly outperformed high P/E stocks.

Adding another variable, that of market cap, shows that low P/E low market cap stocks consistently outperform their peers over the long term.

Glen said...

Yeah, there is a lot of evidence to suggest that low to mid cap stocks have better returns over the long term. I guess because big caps have all their long term growth factored in, their reason for getting there is no longer valid into the future etc. etc.

As to Van Tharp, I couldn't find where I thought I'd read it. I may have been imagining it, but you'd imagine there would have to be some kind of cut off criteria or screening.

But they are very interesting studies, especially for someone like I or has no idea about specific fundamentals. (Apart from communism atm! Lol!)