Correction over?

The gap has closed for sure. I think that's a really fair observation you've made, but I don't think its closed enough to be confident it's aligned with today's lending ceilings - not in SYD or MEL anyway. I think it would need to have closed by 50% to confidently state it had aligned in SYD, and @ 35% to confidently state it had aligned in MEL. I use those figures because 3.5 - 4 years ago, when this was all starting to unfold, I recall APRA's chairman stated at some point that SYD had a median price of something around 10.3 or 10.4 x median income and MEL was somewhere around the 9.5 range from memory . So for the purposes of the debate lets say those figures are correct. It allows us to calculate that if Lender calcs are basically tapping people out at around 7 x income nowadays, the pre APRA SYD market was therefore @50% higher than todays limit of 7 x income. It means that the pre APRA MEL market was @ 35% higher than todays limit of 7 x income. I dont think either market has corrected that much. And I dont expect either of them will - just so Im clear . Im just pointing out that I think it's premature to say we are at a point of alignment. But I would agree that we are probably closer to the end of this correction than the beginning ie the worst of it is probably over

Whats going to be just as interesting a debate over the next 12-24 months is how long the period of absolute blah will be once the correction is over.... I suspect that while DTI ratios stay capped at 7 x income (ish) it could be a good while.....

In the meantime - Head down. Bums up. Pay down debt . One day this will pass, and those who are deleveraged will be well positioned to take advantage.

 

I don’t think APRA wants to go back to the days of easy credit so can’t see any of these being introduced.

 

I think you're on the money. It's seasonal. I'd be waiting till well into Spring before I even thought about a potential recovery, because the market tends to go downhill during Winter at the best of times.

 

Well if it's comparing the number of new listings 12 months ago, wouldn't we have been heading into winter as well in 2018?

 

Different part of the construction cycle, fewer commencements and more completions accounting for additional stock in the market.

 

Peter, this would seem to be a shortcoming of using a ‘floor’ assessment rate that is not readily adjusted with interest rate movements. Noting that using 7.25% is inherently more restrictive in an environment when actual rates are (say) 3.5% v 5.0%.

 

Yeah it's inflexible...but that's kind of the point. They wanted a robust floor rate ( 7% P&I) that ensured DTI's land at or around 7x median income on lender calculators . It's been quite deliberately engineered to produce that outcome. They have never had to formally embrace a policy on DTI ratio's though, because the floor rate takes care of it for them by stealth. It is all designed to facilitate a migration to P&I and force debt reduction to start occurring, in order to make Australian banks - reliant all too heavily on wholesale and RMBS funding - GFC/credit crunch proof . This has always been APRA's end game; getting the banks houses in order ( excuse the pun ) They have never had actual house prices on their radar.

The conundrum that's now facing the RBA - which I called 3.5 years ago when all of this started - and they must SURELY have seen coming 3.5 years ago themselves - is that house prices in the two largest and wealthiest markets in the country are now declining to a point where there is starting to be serious spillover into peoples spending ( or not spending) on cars, retail, etc.... and mortgage delinquencies have also started creeping up as the P&I cliff bites some IO FHB borrowers now in negative equity , or over leveraged speculative investors carrying too much IO with weak yields. This now crosses over from APRA's territory and places the politics squarely in the RBA's territory.. and in an election year. And in an election year where NG and CGT may be under pressure for reform.

When I called this way back at the beginning of APRA's intervention, I said then that the RBA faced a serious conundrum. And so it is proving 3.5 years later. I said that by mid - late 2019 rate cuts would likely happen. Here we are approaching mid 2019 and its become clear to every man and his dog, every economist and her dog, and every journalist and their dog that either rate cuts have to happen - which will do very little to slow the decline because household cash flow isnt the reason people arent spending - house price corrections are..... or the RBA wll need to try and convince APRA to relax the floor rate ... which would be more effective at arresting the decline in house prices and would have more flow on effect to the economy ...

But right now, everyone at the regulatory level appears to be in ongoing denial about this.... including the RBA. They continue to argue its a lack of wage growth causing this. They continue to argue that most borrowers can get lots more money if they want, and that most borrowers have plenty of spare capacity . They need to get their heads out of their bottoms, walk down and see APRA and have a chat about a 6.5% or 6% floor rate.... because it's all about credit. They need to explain to APRA that they can still meet their objective of deleveraging the system with a 6.5% floor rate or a 6% floor rate.... and that it will stop the declines and stop the broader economy suffering.

Chances? Probably buckleys and none But it's what they should be doing....

Instead...the RBA will do what it always does... wait. They'll probably cut the cash rate soon and then hope that wage growth will come and rescue things. I think they will be disappointed though.

This is why I said 3.5 years ago that this was a decade to deleverage...because it wont be a decade of capital growth. It’s also why it’s premature to call the correction over ...

 

As always a very insightful post.
Can I ask then as a man on the ground who pumps out servicing on the daily what your take is on the capacity decline based on say a fairly vanilla setup?
Let’s say a couple with 1 child, 6k CC and $400 monthly liability (secured or personal).
What was their pre APRA borrowing and post APRA borrowing purely as a percentage difference?
From previous posts I thought it was around 15-20% but could have read that incorrectly?

 

O/Occ buyers havent suffered all that much, especially when compared to IO borrowers. We have to remember that new money. ie the money you were asking for with the new application, was always buffered on servicing calcs, usually by 1.5%-2% above the actual rate you were getting. It was only the "other debt" or "exising debt" that was treated at "actuals" .

So if you were borrowing at 5% even in the pre APRA days you were assessed at 6.5-7%. If you were borrowing at 4.5% you were assessed at 6-6.5%. If you were borrowing at 4% , you would have been assessed at 5.5-6%. etc etc etc. So the floor assessment rate of 7% P&I ( yes, most are using 7.2% but 7% is the actual floor rate) is not a devastating step up from that position, if viewed from that lense.

Investors who used to be assessed at actuals though..... well, 7% P&I hurts capacity quite a bit - especially if you are carrying quite a lot of 4-4.5% IO debt....

Quick and dirty example FYI...

$1 Million at 4% IO ( whether for 5 or 10 years ) used be deemed to be costing you 40K per annum.
But that same $1 Million at 4% IO for 5 years is now deemed to be costing you 7.2% P&I over 25 years... which works out to be about the same as 10-11% because we know that loans are @ 50% dearer when they revert to P&I after 5 years of IO.
Its worse still if you are carrying 10 years IO as the debt is going to be deemed at 7.2% P&I over 20 years ... which is why I said the news of ANZ 10 year IO being reintroduced is good for some, but bad for many others ...

Then you need to factor in living expenses/HEMS, and how various lenders approach that....

But in a nutshell... O/Occ P&I max capacity is probably down 15-20% or thereabouts, and INV IO is down 50% ish, or thereabouts - although there are some variables here . The calcs are not so homogonised that it's a one size fits all answer..... you'll get different results on Liberty, Pepper, Bluestone etc.... and FMac to a lesser degree

But yeah, I'd suggest 15-20% is probably a "fair" estimate of the general impact on stock standard P&I FHB capacity, all other things being equal.

 

If we're talking about finding an 'equilibrium' price for a market, i think the affordability limits that @euro73 are definitely worth understanding and unpacking. Affordability theoritically really sets the upper limit for prices assuming a closed housing market (i.e. no international money, etc). Nonetheless, it's also worth not overplaying DTI's, etc and assume prices need to be at a certain level because of it.

Also in general, my experience tells me that people demand a loan when they're in a relatively higher point of their income life cycle. There's a relatively strong degree of flexibility here for borrowers when an economy is performing well (unemployment is low). A young family where both parents have gone back to work are more likely to seek a loan than a young family where parents are staying at home. Loan data origination is at the point of when they seek the loan, but macro median income data includes families are lower points of their income life cycle.

The price & availability of credit has always and will always continue to be one of the biggest drivers of demand (and supply, albeit with a lag). Borrowing capacity reductions/changes are part of the story of the availability of credit. So are deposit limitations & the flexibility of credit decision making. But breaking down the aggregate loan data, borrowing power isn't really an issue for the vast majority of borrowers who go no where near their limitations. Neither is deposit limitations, where most loans are originated well under their upper limits. What the last 5 years show though, is that when the credit taps are very easily flowing (& cheaper), investor behaviour does change. Investors drive volatility. They come in with a herd mentality & fast, and run away quickly too.

 

I just went and spoke to the local broking outfit down the street a couple of hours ago. Put a number of scenarios to them. Here's the summary in a nutshell.

- 2 units, (1 PPOR, 1 investment). Looking to upgrade. No partner, no dependents.
- Have $275,000 cash available for deposit for next PPOR. Would like to keep the 2 units.
- 2 units are worth $1.1m with loans of $700k against them. (The $275k cash is held in offsets at present). The 2 units would overall be neutrally geared to slightly cash positive if both were rented.
- Current surplus cash over and above living costs is $1200 per week.
- Just took out an additional credit card, limit $15k (for Qantas FF point bonus, will cancel immediately after points received, I promise!) Never paid a $ in CC interest.
- One property has a fixed rate loan finishing in August, once that comes off, I'd refinance the $700k loans and basically save a further $5000 a year in interest.
- P&I assessment rate was 7.25%,

The calc said I could only borrow an additional ~$250k, for a max borrowing limit of $950k. ~$350k if I cancelled both the credit cards (other one is $12k limit). Adjusting things at the margins might be able to add an extra $50k or so to the borrowing power, but there was nothing that could be done to get it up to the $550k+ I needed.

Only way for me to move forward would have been either to sell one of the properties, or liquidate the share portfolio (which provides $12k in dividend income) and slap down a 65% deposit for the new PPOR.

The poor broker was beside himself with frustration at the rules. He said basically everyone who walks in the door now can't get a loan or refinance to another bank because they fail servicing.

Best they can do is try and ask for a better rate with a customers' existing bank.

Told him I guess I'll have to keep buying shares and come back to him in August to deal with the refinancing of my existing loans.

My take out of this is that prices in Sydney have a lot further to fall. If I max out at $1m borrowing capacity, that majority with lower income and children and child care and school fees and car loans and average living expenses, are going to max out well under that. It's not sustainable for half the city to have house prices above $1m in that scenario - it's going to keep coming down.

 

Sentiment.... the one thing we cant measure with a calculator

In the end... we are all making "best guess"....

My "best guess" is that we are 1-2 years away from being able to state with confidence ( excuse that pun @Redom ) that the corrections in SYD and MEL are behind us, and we are another 5,6,7 years away after that from seeing any material return to capital growth...

My disclaimer, as always ... if APRA relaxes or reverses current settings... those time frames will shorten ( excuse that pun as well dear voters)

 

Now who is game enough to go tell the armchair experts at RBA their assumption of borrowers are nowhere near their borrowing limits and it's the demand for loans which is the problem not the borrowing capacity is completely out of touch with the real world.

Based on some back of the envelop calculations at the saving rate of $1200 you should be able to service $1.5million loan at 4% interest only but because they want to use P&I and higher rate let's half the borrowing which brings it to $750K which is still way more higher than what you have been quoted.

I also fail to understand this new servicing calculation especially regarding living expenses. I have bank statements showing $XX dollars being saved each and every month for such a long time (years) and they would still apply their ridiculously high living expenses when calculating how much I could borrow. It's like ignore the facts (money saved each month) and apply rule based living expenses that is completely wrong for my situation.

Cheers,
Oracle.

 

although this is all accurate. Don't only like .5% of australians own 3 properties. Which basically means that as exciting as this is - that there isnt a high enough % of people who want to buy in this situation for it to really impact the market. Sure this is like 70% of people on this forum, but this isnt exactly a fair sample of the population.

Thoughts?

 

Fair call as always. Your disclaimer about APRA is the real game changer here.

Would two RBA rate cuts be tantamount to a change in APRA standards? I know they are not exactly the same thing, but it is all about the cost and availability of credit.

Would two quick rate cuts move your time horizon from 1-2 years down to say 6 months?

 

My properties are somewhat lower value than the Sydney median.

One terrace shack within 10km of the city, or one 4 bed home in the north west is worth more than the value of the prospective three I would be holding.

Those mortgages required would still be in the order of $1.5m (assuming 80% lend). Which, obviously can’t be obtained anymore for the ordinary punter.

 

No.

Rates could be 0.01% and the floor assessment rate of 7%P&I would mean Zero improvement to borrowing capacity . However , the reduced rates ( assuming banks passed them on) may improve household cash flows and assist with some debt reduction .... but it would be a pretty minimal impact .

You have to distinguish between what YOU pay and what the calculators DEEM you to be paying . It's the point everyone seems to keep missing. Lower rates "to borrower" are not the same as lower assessment rates. The two are now completely de-linked . All the rate cuts in the world do not reduce the DEEMED assessment rate, Im afraid. It's why I’ve said many times - different ingredients at play now - same cake cannot be baked with different ingredients . Think about it this way; when lenders accepted "Actual" repayments and applied no buffering, every rate cut from the late 90's to APRA was like yeast that helped everyone's cakes rise . But APRA has effectively hard capped the amount of yeast available to borrowers (pasty chef's) now . So only ongoing , consistent debt reduction or large pay rises can provide enough yeast to start cakes rising again.... or at least stop the cake deflating .....


Or we can use the coffee analogy. I own the last cup in the land and 25 Million coffee drinkers want to buy it. I paid $5 for the coffee, so with such limited supply and such strong demand I should be able to re-sell at $6 easily., right? Thats what we are all taught...supply v demand. .... and the person who buys for $6 should be able to sell for $7 easily... and the person who buys for $7 should be able to sell for $8 easily... and so on... But if those coffee drinkers can only get $4 from the bank ..... you see where I'm going?

APRA has stated more than once that they want DTI's in the 6-7 x income range. They have engineered policies that effectively deliver those outcomes by stealth, to all but the most cashed up buyers. All non cash buyers ( and that means most buyers) are using debt to participate, so those are the ingredients they must work with..... so those are largely going to be what dictates what happens in most markets . SYD and MEL prices are above those 7 x income levels, still. TBH I don't know by how much. I havent seen any recent data on that.... but I do know they were @ 10.4 x in SYD and @ 9.5 x in MEL before APRA stepped in in 2015... so my guess would be they are hovering @ 8-8.5 x in MEL nowadays, and maybe 9 ish - mid 9 in SYD. Rate cuts dont magically change that to 7 x income unfortunately... which is where the cap sits....... only debt reduction or pay rises can do that .... So again, unless APRA relaxes or reverses the assessment rate, which would in turn relax the DTI to maybve 8 or 9 x income.... it's difficult to make an argument that the correction is quite over yet.... and even more difficult to make an argument for growth once the correction has slowed to a halt.

 

and HEMS keep soldiering onwards and upwards - for those excited by ANZ being “back”
with 10 year IO ...

Their calc is still one of the worst.... and while this wont make it much worse...its a modest change... it's not exactly bringing them "back" to the sharp end of things is it?

 

My disclaimer doesnt change anything The APRA changes that have been in place became an actual game changer , actually 3.5 years ago. ie the game changed 3.5 years back...not as a result of any disclaimer I made

The point of my disclaimer was to point out that unless or until APRA reduces the floor assessment rate, expect further downward pressure on prices for a while yet.... and lets be really clear - while I think a reduction to the assessment rate would be the smart way to play this, now the corrections are hurting the broader economy, there's been absolutely zero indication that either APRA or the RBA feel the same way...so its a very very very very very very long shot they will do anything with the assessment rates....

which brings us full circle to.... the correction very probably isnt over

a median price above 7x income isnt supported by servicing ceilings of @7 x income.... it's just that simple.