Why Fitch Can Be Wrong (Again)

We should think about statements like this:

“[First Time Buyers] considered the highest risk borrower in the [Bank] portfolios”

Few comments on this:

  1. Fitch has been wrong on mortgages in a big way in recent memory, so don’t take everything they say as gospel.
  2. First time buyers usually have much higher loan-to-value ratios than other buyers. Less buffer to absorb loss given default, so if house prices fall there obviously a higher credit risk potential.
  3. Investment property is potentially a higher risk.
  4. First time buyers with higher risk is a product of incredibly poor innovation by banks and a total unwillingness to invest in new lending products that would reduce risks to first time buyers.

Going through these comments:

Fitch has got things wrong before and is probably wrong again:

We are aware of huge miscalculations in mortgage securitisation (e.g US subprime mortgages), of which the assumption of ever increasing house prices led to a misunderstanding of risk.

In the Australian context, the error here is assuming first time buyers are more risky than investment loans. Here is why:

Investment loans, particularly where the investor has high leverage across multiple properties with reasonably high leverage has a risk driven from multiple reasons:

  1. The rental yield doesn’t cover the mortgage finance cost (interest rate). The investor may be reliant on tax deductions and ultimately price appreciation for a positive return. Momentum will eventually slow or reverse.
  2. The correlation across investment properties is high. The investor would be hit with price declines, potential negative equity and further net negative rental yields all at the same time.
  3. Many renters, in a recession, are likely to move to find new work or move in with parents if they lose their jobs. What is worse than negative net rent? No rent or a significantly higher vacancy rate which may be increased by higher apartment supply and an investor’s inability to cover the investment loan.

In short: investment property lending is more risky than lending to first time buyer owner-occupiers who will have a desire to live in the property over the long-term and protect their full recourse debt position.

Banks are not helping or showing any innovation to help first time buyers or those who need to take on additional debt to buy a home.

Australia has the highest OECD exposure to housing debt (home loans) but is 85% financed by variable rate loans. The remaining 15% is short-term fixed (less than 5 years). Banks are not innovating on lending products – and clear overseas examples exist as the US mortgage market is 90% fixed for 15 or more years yet no products exist here. This would reduce the risk to first time buyers proportionally more than other borrowers.

We can also show, this is our business proposal, how it is possible to offer these mortgages products with the correct features and still make 20%-30% return on equity for a bank.

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We can keep writing about housing risks as to whether they will or will not appear but with very little being done about it protecting against the risk. Who is ultimately responsible and who is innovating?

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