Real housing stress is rising in the shadows
One of the biggest warning signs around housing stress quietly flicked to amber in recent days. And it wasn’t inside the banks.
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As the hunt goes on for signs of stress across the housing market, it is likely everyone has been looking in the wrong places.
Indeed, one of the biggest early warning signs around housing stress quietly flicked to amber in recent days. But it wasn’t inside the big banks, rather the jump in the pain index has been in the so-called shadow banking sector.
The lightly-regulated non-bank lenders have been a big beneficiary of the housing finance boom of recent years, growing their market share where banks were required to stress-test prospective borrowers through interest rate buffers.
Non-banks have also been able to fill the lending gap for investor loans – often undercutting the major lenders in the process – and providing quick financing for commercial lending in areas where banks have pulled back. No one really knows how big they are (hence the shadow) but it is clear the sector has served a purpose in keeping the economy ticking over.
Since the GFC, non-banks too have been quietly building up the low-documentation loan market. That is lending to borrowers that have irregular income streams or even a patchy credit history.
As the economy has evolved, these borrowers range from ultra small businesses to “gig workers’’ and have become a feature of the market. But customers of the non-banks are often the first to feel any slowdown or rise in interest rates.
The best way to track the health of the shadow banking market is through the RMBS delinquencies. And figures released by Moody’s in recent days show some big strains emerging in the lower-graded loans. Indeed, the level of missed payments across non-conforming and sub-prime loans has surged to the highest levels since the initial hit of the Covid pandemic.
Strip the pandemic away, and arrears in non-conforming loans are now at the highest level since December 2016. Remember, there are real borrowers on the other side of the loans, and missed payments mean mortgage stress.
Prime vs sub-prime
Prime mortgages or bank-quality loans still make up the bulk of the RMBS market, and this is where the attention has been. Losses here, while increasing slowly, remain near historic lows and are fixed below the level leading into the pandemic.
Non-banks that rely on securitisation to fund their lending books are estimated to have as much as $100bn in loans across the Australian market, according to the Reserve Bank. In aggregate this is small, making up less than 5 per cent of the entire financial system, but regulators fear it can still lead to a build up of meaningful systemic risks.
The business models of lenders tend to involve even more leverage than banks and can often involve liquidity mismatches – that is using shorter-term funding for longer-term loans. Investors in RMBS too are usually super funds chasing yield in private credit markets.
All banks, big and small, are heavily-regulated and while this doesn’t mean risk-free, it certainly helps cushion the blow when it comes to lending losses. Higher levels of disclosure often mean that regulators (as well as investors and depositors) have more visibility of problems as they are building up.
In terms of raw numbers the share of low-doc home loans that were at least 30 days or more in arrears jumped to 4.04 per cent in March from 3.35 per cent in December last year, the Moody’s figures show.
There’s been two more interest rate rises since the end of March and expectations of another one to come, which all adds up to more pressure on non-conforming loans.
Compare that to RMBS numbers for “prime mortgages” which show those with at least 30 days late payments were 1.26 per cent at the end of March. This was from 1.05 per cent in the December quarter.
It is consistent with loans held on the books of the big four banks, which make up 80 per cent of the lending market. Collectively they are yet to see any meaningful rise in mortgage arrears even after the aggressive series of rate hikes.
National Australia Bank’s Ross McEwan recently spoke to The Australian about the deep dive his bank has run on its mortgage book. Coming out of this, NAB has identified 8600 mortgage customers that it considers most at risk from fast-rising interest rates. Of this group only 14 borrowers have so far requested any help with their loan.
It’s an extraordinary number, however McEwan knows all too well there could be a lag effect as stress compounds and more mortgages roll over from ultra-low fixed rates to higher variable rates.
The one bright spot to this remains Australia’s low jobless rate. All bank bosses closely watch this number as a barometer for future lending losses. As long as borrowers have an income stream they are likely to pay down their mortgages before anything else.
Right now the employment market is booming with record numbers in jobs even as the economy is clearly slowing. However at some point gravity will have to take hold.
Treasury’s way
A confidential briefing document prepared for Treasurer Jim Chalmers acknowledges as supply shocks are starting to ease, wages growth will again become the “main driver” of inflation across Australia.
However, the Treasury briefing paper argues additional capacity in the jobs market has allowed Australia to so far avoid a wages-price spiral. A slowing economy over the coming year is also set to keep a lid on wages.
The top level briefing note, prepared for Chalmers and also circulated to assistant treasury and competition Minister Andrew Leigh, stresses that businesses should be kept under close watch to ensure they’re not taking advantage of inflation to keep prices higher for longer.
The paper – released under Freedom of Information rules – comes at an important time as it offers some more clues into how Treasury boss Steven Kennedy’s department sees inflation evolving in Australia.
Treasury has argued inflation will fall away at a quicker pace, departing from the Reserve Bank, which is anticipating a longer runway will be needed for prices to ease. The paper was prepared by several units across Treasury, including the influential macroeconomic policy division.
The consultation paper says as inflation dynamics normalise in Australia “wages growth will again become the main driver of inflation, given that labour costs are, ordinarily, the largest cost for business”. It said higher labour costs and import costs combined represented around 60 per cent of Australia’s December quarter peak in inflation.
Kennedy last month told a Senate committee there are “no signs” of a wage‑price spiral developing in Australia, and momentum in wages is expected to soften as the labour market eases.
Kennedy’s view on wages growth is more aligned with the Albanese government’s support for wages. RBA boss Philip Lowe meanwhile has publicly urged restraint to avoid another inflation wave, particularly as productivity growth is slowing.
It just happens that Kennedy is widely seen as the leading contender in the field to replace Lowe, whose seven-year term expires in September. (Chalmers has said he would make a call on the RBA role this month).
Lowe is expected to discuss the outlook of inflation on Wednesday, after the RBA board (which includes Kennedy) this month decided to keep the official cash rate on hold at 4.1 per cent. The RBA is tipping inflation to hit 3.6 per cent by next June. Treasury is tipping 3.25 per cent over the same period and falling into the target band ahead of the RBA.
‘Inflation to ease’
The Treasury paper says like most parts of the world, the initial round of inflation in Australia was driven by supply shocks brought about through Covid and the Ukraine war. And this was exacerbated by the surge in demand triggered by massive pandemic stimulus programs.
As these pressures start to fall away, the pace of growth in non-labour costs should ease, or even fall in some industries. And this should put downward pressure on inflation.
Here the responsibility will be on business to ensure there is no gouging of prices.
“Attention should be paid to firm pricing behaviour to ensure that inflation moderates appropriately as input cost inflation normalises,” the Treasury paper says.
The Treasury paper also dismisses the suggestion corporate profits have been driving inflation in Australia. A widely quoted paper prepared by think-tank The Australia Institute made the assertion earlier this year.
Treasury says that analysis “significantly overstated” the role of profits in driving inflation in Australia. The analysis also incorrectly uses a pre-tax measure for corporate profits, it argues. Business input costs too are rising at a faster rate than prices, Treasury adds.
“Cyclical changes in income shares as markets adjust to supply and demand conditions are not themselves indicative of an increase in monopoly profits.
“Profits can rise temporarily until demand responds to prices or capacity expands,” Treasury says.
Even so, Treasury reminds Chalmers that the competition watchdog can be directed to monitor prices in specific markets that lack intensive competition, which would otherwise keep prices in check.
Currently, the ACCC has price inquiries into gas, electricity, childcare and digital platforms markets underway. It is also monitoring prices in petrol and domestic airline tickets.
johnstone@theaustralian.com.au
Originally published as Real housing stress is rising in the shadows
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