Strong rebound in housing loan growth in CY2006 despite marked slowdown in new housing starts

Housing loan growth has rebounded strongly in the first nine months of 2006 on the back of a modest upswing in housing prices and an increased willingness by borrowers to gear into residential property, the latest mortgage industry report from JPMorgan and Fujitsu Consulting has found.

The Australian Mortgage Industry Report (Vol. 4: September 2006) is a joint effort between JPMorgan and Fujitsu Consulting, focusing on recent developments in the Australian mortgage industry, based on Fujitsu Mortgage Market and Yield Improvement Modeling.

“Australian mortgage loan outstandings surged to 16 per cent on an annualised three month rolling basis to A$785.4 billion in July 2006 – up from a recent low of 10.8 per cent in September 2005,” said Brian Johnson, banking analyst at JPMorgan.

“This reflects a modest upswing in national housing prices – stable in Sydney, but growing in every other capital city – and the continued willingness of borrowers to take on more risk,” he said.

Based on normalised housing starts of 150,000 per annum and a typical home renovation cycle, any growth in housing credit over and above four per cent per annum is entirely attributable to rising house prices and/or increasing Loan to Valuation Ratio (LVR) on lending.

“Any weakness in national housing prices, particularly outside of Sydney, accompanied by a more conservative stance by new borrowers with regards to LVRs, would trigger a sharp slowdown in housing lending growth,” said Mr Johnson.

In the past year, the profit signatures of loan portfolios have become more extreme with the most profitable customers becoming more profitable and unprofitable customers becoming more unprofitable. The Fujitsu Consulting industry model shows that a Queensland portfolio is intrinsically more profitable on average compared with New South Wales.

“The combination of high LVRs, rising interest rates, stalling house prices, and a doubling of repossessions over the last two years indicate that there are inherent risks in NSW portfolios,” said Martin North, managing consulting director, Fujitsu Australia and New Zealand.

The LVR on new lending has continued its upward trajectory and is estimated to be 60% on new lending and possibly as high as 70% through the non-proprietary broker channel.

“The level of variable rate home loans remains high at approximately 85% of total home loan outstandings, which leaves borrowers exposed to rising global interest rates. Each 25 basis point increase in interest rates increases the interest burden on home loan borrowers by an estimated A$1.6 billion,” said Mr Johnson.

“However, this is balanced somewhat by the fact that those households that took on debt to enter the housing market in the last decade were the households best placed to service the debt,” he said.

With a long run negligible loss rate, Australian home lending has been viewed as riskless with extremely low arrears rates, even lower default rates and negligible housing losses in event of default.

“There is clear structural downward pressure on mortgage lending spreads, risk is increasing given the introduction of riskier home loan products and distribution is increasingly through third party channels,” said Mr Johnson.

“Despite significant competitive pressures in the past six months, Australian home loan margins remain high, masking significant cost inefficiencies relative to global peers,” said Martin North.

The interplay between structurally declining home loan spreads, increasing housing risk (thus increasing reliance on valuations), and the need to improve mortgage efficiency will provide a major management challenge.

“The need to improve mortgage processing cost efficiency, while becoming increasingly vulnerable to any slippage in valuation disciplines, will likely see the industry adopt Automated Valuation Models (AVMs) to manage the mortgage valuation process,” said Mr North.

AVMs are computer programs that use real estate information, such as demographics, property characteristics, sales prices, and price trends to calculate a value for a specific property.

“Most data is from public sources and there is no physical assessment of the property. Companies such as RP Data and Rismark are planning to launch a service in Australia.

“Rismark will have exclusive access to RP Data’s property resources, and using this information will further refine advanced house price indices, automated property valuation methodologies, sophisticated portfolio construction techniques and predictive property price models,” said Mr North.

These results suggest that the banks face major challenges in rebuilding their home loan distribution effectiveness, which was severely eroded by the branch closure program between 1998 and 2004. The survey results suggest that Australian banks will find it increasingly difficult to recapture the distribution function from third party brokers.

“Bank market shares have stabilised, but are distorted by differential rates of reliance on third party mortgage brokers which has weakened their distribution strength and ultimately their pricing power,” said Mr Johnson.

“In response, banks are actively reinvesting in branch networks in an effort to regain strategic flexibility and the pricing power associated with the distribution function,” he said.

An interview with Mr George Beatty, General Manager Product Management Group Wealth Management & Retail Financial Services at St George Bank, is also included in the report.