7/3/2018 How Australia’s Banks Became the World’s Biggest Property Addicts

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Since the turn of the century, politicians Down Under have sold the “Australian Dream” by encouraging locals to take out mortgages
and secure a stake in the property market. Photography: Lisa Maree Williams/Bloomberg

How Australia’s Banks Became the

World’s Biggest Property Addicts
By Michael Heath, Emily Cadman and Hannah Dormido
June 28, 2018
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7/3/2018 How Australia’s Banks Became the World’s Biggest Property Addicts

Australia is riding out a huge gamble on property. The bet: 27 years of recession-free economic growth
—during which Sydney home prices surged fivefold—would continue unabated and allow borrowers to
keep servicing their debt.

The gamble has turned dicey. Tighter lending rules are deterring investors, and lofty prices are
starting to deflate. A banking probe is exposing dod y practices, and a mountain of risky loans that
helped fuel the bubble needs refinancing—just as global borrowing costs rise. Now Australians are
stuck with the highest household debt levels among G20 nations.

Australia household debt exceeds 120 percent of GDP

120% Australia

Canada

90 South Korea

U.K.

U.S.

60
France
Japan
Germany

30

1992 2000 2008 2017

Note: Household debt as % of GDP

Source: Bank for International Settlements

“Historically, we’ve seen that after economies have run up leverage, they’ve faced a hangover,” said
Daniel Blake, economist at Morgan Stanley in Sydney.

He cites Bank for International Settlements research showing that household debt starts dragging on
future economic growth once it’s equivalent to 80 percent of gross domestic product. Australia is
sitting well on the extremes of that range, at above 120 percent.
While Australia’s banks remain well-capitalized and are still churning out massive profits, the millions
of customers backing their biggest assets aren’t. Wage growth is elusive as indebted workers struggle
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7/3/2018 How Australia’s Banks Became the World’s Biggest Property Addicts
of customers backing their biggest assets aren t. Wage growth is elusive as indebted workers struggle
to cling to their jobs, and consumption—which makes up more than half of the economy—is pressured
as households scrimp to meet mortgage repayments.

Australian banks’ mortgages are equivalent to 80 percent of the economy

GDP A$1.73T

A$418B A$406B A$258B A$253B

Banks Commonwealth Westpac ANZ National
Bank Australia Bank

Sources: Australian Prudential Regulation Authority, Australian Bureau of Statistics

Since the turn of the century, politicians Down Under have sold the “Australian Dream” by
encouraging locals to take out mortgages and secure stakes in the property market—traditionally seen
as an easy path to wealth.

When growth stumbled during the global financial crisis, the government started handing out checks
to help buyers scrounge up deposits, bolstering the economy in the process. As the mining-investment
bonanza to feed China’s demand for commodities started to splutter from 2012, the central bank rode
to the rescue, cutting interest rates to record lows.

The exuberance got out of hand. Investors gorged on “interest-only loans” that required them to repay
not even one cent of principal for up to five years. The frenzy for such loans peaked in June 2015,
when they accounted for 46 percent of all new mortgages.

Now it’s time for those borrowers to start paying up: About A$360 billion ($266 billion) of those loans
revert to interest and principal payments over the next three years, just as global borrowing costs are
set increase.

The Reserve Bank of Australia isn’t yet pressing the panic button, saying its research suggests the
damage from the loan rollovers should be minimal. Still, the household debt pile-currently at 189
percent of disposable income—has required it to tread warily. The RBA has kept interest rates
unchanged since August 2016, the longest stretch in its modern history.

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Natasha Arens, the borrower

For an immigrant from Russia and 47 year-old mother-of-three Natasha Arens, establishing a foothold
in the property market was central to securing her family’s future in Australia.

“I was trying to give my family their share of the Australian Dream, which is owning property,” she
said. “Some might say it’s crazy, but that’s what people seem to do.”

Arens said she followed a traditional strate y of betting that prices would go up in Australia. She had
planned to eventually pay off the mortgage on her house by selling the additional properties after
their value had risen.

“Many Aussie borrowers have bought into the housing market bubble and gone up to their eyeballs in
debt,” said Andrew Charlton, director of consultancy AlphaBeta in Sydney and a one-time economic
adviser to former Prime Minister Kevin Rudd. “They’ll stay afloat, so long as interest rates stay low and
the economy is steady.”

How an investor’s repayments could almost double

From 2014-2019 A$1,885

From 2019 A$3,173

Plus 1 rate hike A$3,241

Plus 2 rate hikes A$3,310

Plus 3 rate hikes A$3,379

Plus 4 rate hikes A$3,449

Note: Monthly repayments for A$500,000 interest-only mortgage borrowed at 4.5% over 25 years, switching to interest
and principal mortgage after 5 years.
Source: Australian Securities & Investments Commission

Neither scenario is guaranteed. While the economy is forecast to grow at an above-average pace
through 2020, the central bank has repeatedly warned that its biggest threats are external and real—
and mainly from its biggest trading partner.

Australia is the developed world’s most China-dependent economy, and the RBA regularly cites
China’s mountain of corporate debt as a major worry. Furthermore, as the U.S. ramps up trade war
threats with the No. 2 economy, a significant hit to Chinese exports would see Australia caught in the
crossfire. A shock erupting from either risk would see Australians start to lose their jobs and be unable
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crossfire. A shock erupting from either risk would see Australians start to lose their jobs and be unable
to meet mortgage repayments.

Higher rates just a question of time

80%
70
60
Better than even chance of a rate rise 50
40
30
20
10
0
05/2018 11/2019

Note: Swap traders’ expectations of RBA's next interest-rate move

Source: Bloomberg Data

And then there’s interest rates. RBA Governor Philip Lowe has stressed they’ll eventually rise, but only
once the sticky jobless level—currently at 5.4 percent—nears the central bank’s full employment
estimate of 5 percent and inflation climbs closer to target. While markets and most economists don’t
expect a hike for at least a year, U.S. tightening will inevitably lift costs for Australian banks, which tap
foreign funding to finance their lending.

“The worst case is where interest rates rise very, very rapidly overseas—and not just the central bank
rates or overnight rates, but bond rates,” said Roger Montgomery, founder and chief investment
officer of Montgomery Investment Management Pty. “That could be a problem because we know that
even prime borrowers, if they have negative equity, that significantly increases the propensity to
default.”

Australia’s banks are on notice. Alarmed by the free-for-all in risky loans and the deterioration in
standards that accompanied lenders fighting for market share, regulators slapped them with curbs
that included restrictions on interest-only lending. The value of new interest-only lending, which is
the preferred option of investors, is down 57 percent on a year ago.

Banks are handing less money to investors

50%
Curbs
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l d 5/9
7/3/2018 How Australia’s Banks Became the World’s Biggest Property Addicts
placed on
interest-only 40
loans

30

20

10

–10

–20
First of two
RBA rate cuts
–30

2011 2012 2013 2014 2015 2016 2017 2018

Note: The year-on-year change in the value of outstanding and newly approved housing loans to investors.
Source: Australian Bureau of Statistics

Edward Doueihi, the developer

Builders are delaying residential projects because prices have soared out of many Australian buyers'
reach, while some Chinese investors have left the market altogether, said Edward Doueihi, 46 year-old
managing director at Sydney property developer Ceerose.

Some developers are putting jobs on hold, either because developers can’t get pre-sales to make a
project work or they can’t get funding, he said. The result is that the 30-year industry veteran is now
looking for alternative opportunities.

“We’ve been looking at going international."

The adequacy of lending standards has been a key focus of an independent inquiry into financial
misconduct. The Royal Commission has heard of banks failing to verify borrowers’ finances and staff

falsifying loan documents to collect bonuses. Analysts are betting the revelations will lead to greater
regulation of the mortgage market and force banks to tighten lending standards further.
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regulation of the mortgage market and force banks to tighten lending standards further.

How resilient will Australian households be in the event of an economic downturn? The RBA last year
estimated that the average borrower has a buffer equivalent to 2 1/2 years of repayments. Drilling
down, the picture is somewhat darker: One-third of borrowers have enough funds to cover just one
month’s mortgage payment, if that.

Redom Syed, the broker

Sydney-based mortgage broker Redom Syed said he has seen a “material clampdown” since the start
of the Royal Commission banking inquiry, with lenders ramping up verification of borrowers’ income
and living expenses.

The rise and fall of Australia's risky mortgages

Outstanding interest-only loans Interest-only loans as portion of total bank loans

A$600B 50%

500
Interest-only lending
has almost tripled 40
since 2008 ... 400

300 30
... but issuance
as a portion of total
lending has plunged
200 since the regulator
tightened rules. 20
100

0 10
03/2008 03/2018 03/2008 03/2018

Source: Australian Prudential Regulation Authority

“Banks are very nervous, and it’s making the approvals process tricky and uncertain and is naturally
having an impact on the market” said Syed, 28, who set up his firm Confidence Financial after leaving
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having an impact on the market said Syed, 28, who set up his firm Confidence Financial after leaving
the Australian Treasury, where he advised on international financial markets.

Syed is also seeing a number of “surprised” interest-only clients, who were unaware that their
repayments are set to increase and are now scrambling for options. For every A$1 million of mortgage
debt, a borrower now needs roughly A$40,000 more in household income than three years ago, Syed
said. For those on the wrong side of the new restrictions, options are limited: Find the money for
higher payments, move to another interest-only loan at a non-bank lender or sell the property.

“Many Australians are sailing close to the wind and will be in trouble if a storm comes,” said
AlphaBeta’s Charlton. “If interest rates rose materially, it would push many Australian households into
severe mortgage stress.”

Editors: Chris Bourke and Malcolm Scott

Photography: Lisa Maree Williams, Brendon Thorne and Brian Cassey
Additional design and development: Adrian Leung and Cedric Sam
Additional work: Kimberley Verschuur

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