Market Crash? A different perspective on IO

An intersting analysis of the ANZ Bank annual results this morning.

How the doomsayers got it so wrong on interest-only loans

Seems the bank has yet to experience the carnage some analysts have foretold.

 

Its a bit of a limited article. Just seems to be a 'AHA!' article, without any substance or any meaningful info to back up his point.

In any case, the RBA's 2018 Oct FSB report talks a lot about this and provides some real analysis and insights (not that he quoted this though). General gist:
- Minor problem is being managed well
- Taking some liquidity out of market
- Borrowers have options, most are NOT impacted.
- No macro impact on consumption - a lot of analysis here as it impacts inflation/savings rate/etc. Nothing material really.
- IO2P&I rollover has no material impact on supply and won't cause housing supply issues (forced selling). This is largely because borrowers have refinance options on the table, or are well prepared.

The two major markets have fallen 5%+ this year. Its impossible to break down every little bit of this 5-10% and work out what attributed to it, but I think having liquidity taken out of lending markets has played some role in this.

Nonetheless, in general, I do think his right. This was an issue - a problem that warranted good analysis and management. They were pretty quick on this and its been well managed. Also, there's a lot of time to go before the full liquidity impact is felt too.

 

So

So you think the Sydney median rising 200k in a year was well managed?

 

I don't think my post was relating to what happened to pricing, rather the management of a debt issue. Nonetheless, I don't think its healthy for a society to have prices rise that fast for an asset class like housing.

Goal: reduce exposure to IO lending and stock of IO debt.
Result: relatively well managed.
Should IO lending have been allowed to get to ~40-50% share of total new lending. No I don't think so. Its why they needed the goal in the first place, to rectify a growing problem.

 

I think the next 2 to 3 years will be the real litmus test. If everything is fine after this period, then we may be in the clear. Otherwise....

 

Thanks @Redom for detailed replies, there is so much to learn for you posts, highly appreciate you taking time and posting here.

As per APRA report a year ago, there is close to 360bn of IO reset marked for 2019/20/21 (close to 120 bn reset each yr), just curious is there any figure on how much of these have been preemptively switched by now?

Year 2018 was also marked for an additional 120 bn expiry, and we had close to 9.5% CL index fall (in Sydney house for eg) during this period, I presume you are putting this fall majorly on credit env change and not on forced selling.

Curious, Why would seller take such a big loss at such a short span? we cant put all of this on divorce etc, I think there is more to this element of urgency in selling then whats projected given the rate and extent of fall but I don't have any data to prove it.

 

Markets rise and fall.

Its completely normal for the market to fall right now; even if credit didn't tighten or in the absence of IO2P&I.

Why:

• Prices have risen a LOT in a short time frame. When prices rise, demand for housing falls. This is obviously the biggest driver. If banana prices rise 70%, less people will buy banana's.
• Supply has risen this year. Housing supply lags growth. Construction activity has peaked online in 2018 in Sydney/Melb.

Credit is part of the story. But if you didn't have any tightening in lending conditions, the market will still move in this way because of the above parameters. The actual CLindex would definitely be different, but it'd most likely go down because of the above parameters.

Also note:

• That the supply rise is NOT associated with a IO2P&I rollover. It is new construction coming online. IO2P&I will materialise in supply increases with lag, the precursory events would be; arrears/defaults dramatically increasing, stock on market increasing from existing sellers, probably job losses too, etc. None of these are actually happening and this makes complete sense. The IO2P&I rollover should only be a very marginal & concentrated supply increase. Definitely in outer areas where investment activity made up a very large share of total activity. Lending standards were not nearly bad enough for the IO2P&I rollover to actually force any homeowner to sell (interest rates have fallen 100-150 bps since these loans were written, swapping to P&I has a very small impact on repayment amount).
• House market price movements is relatively unique as an asset class because of the emotive and 'need' nature of it. We need housing. We don't want to sell. We're more attached to it than a stock. Transaction costs are very high. Downside factors move in a very different way to other asset classes. The natural 'countercyclical' impact of this is less people sell during down conditions. This is what we're seeing. Add to that supply levels will begin dropping off through 2019, 2020 & 2021, and population ramping ahead, we'll naturally move to a bigger 'undersupply' level in major capitals over time.

Combine the two: no forced sellers, less people wanting to sell. You have a supply shortage that builds up over time. Now demand begins to rise too...why? Prices have fallen and more people are willing to buy at these prices. This then normally will turn market forces the other way.

We don't need APRA to magically allow DTI's to go to 9 or some major change to structural lending. The above is the 'normal' scenario.

 

So it is NOT the end of the world as some were predicting .

 

This demand that you talk about was influenced heavily by investors.
The % of investors taking on new loans was way higher than the long term trend.
Also, should Labor win the next election the proposed changes to NG and CGT will make housing even less appealing as an investment. Add to that the inevitable increase in interest rates. Have u taken this into account?
Also, there is a lot of angst about unsustainable population increase amongst the voting majority, you would be silly to think that immigration levels won't be curtailed to win votes and keep the public happy.

 

Beware people "talking their book",

Look up what Bernanke had to say about the possibility of a housing correction........just before it corrected rather monumentally.

Bear in mind nothing was truly done to deal with the structural problems that caused it, in fact worse, he effectively rewarded the banks for their turpitude. ( hence Trump....utterly ****** off voters) We dodged the downturn here very expensively, by blowing the war chest. It's coming back.

Be ready, be ruthless.

 

Agree

But it can be the end of the road for some not well prepared investors (in the worst case scenario).

For some leveraged to 90% LVR at the peak, IO convert to PI, with limited cash buffet, it is a disaster.

 

Totally agree.

End of the road is nowhere need the end of the world.

When my in-laws were in their fifties, they lost everything (due to a poor property decision on their part) and had to go bankrupt.

Roll the clock forward 30 years. Now they are in their eighties, they are in their own home (fully paid for), have some cash reserves (but not enough to self fund their golden years), receive the full Aged Pension, ...

They are happy and live a comfortable lifestyle (not luxury) AND they had to work long and hard to get to where they are now. BUT they were like that before they went bankrupt.

Wasn’t the end of the world for them!!!

Wasn’t even the end of the road!!!

BUT it was a bloody, big pothole in their life journey!!!!!!!

 

Yep....hearing from my broker about someone who bought in Wentworth point for 2x2x2 plus study for over 940k....val came back at 740k!

Its starting....also happening with houses now.....

 

Let's break the above down. I'll use my analysis of probability of each event

Probability of Labor winning the next election: 80%

• Based on polls and current sentiment.
• The current government is in a mess

Assuming Labor wins, probability of the government following through with NG and CGT policy changes: 30%

• People like to do what's comfortable and in most cases that's nothing. This applies to our politicians
• These days, politics around the world is about "what's going to be popular and get us voted back in for another term?". Remember what happened to the proposal to have a $7 GP co-payment? What do you think Labor will do if they get serious about going through with the changes and the opinion polls start telling them that that's a bad idea? With a few exceptions, our politicians have been all bark and no bite.
• Most Australian household wealth is tied in their home. If the general consensus is NG and CGT will have a negative impact on household wealth, at a time when national prices are already trending down,will the general public support it then?

Probability of home interest rates increasing meaningfully in the next 3yrs (say, >0.5%): 30%

• Just because interest rates are at all time low does not mean they will start going up right away.
• Other than U.S, Australia still has a reasonably high cash rate relative to the rest of the developed world.
• Would RBA want to destabilise the property market further by adding fuel to the fire with rate hikes?

Policy 180 on migration: 20%

• Refer to above on NG and CGT. To put it bluntly, I doubt any political party would have the courage to do this anytime soon.
• Migration is probably the primary reasons why we haven't had a recession in ~27yrs. Having one of the highest growing populations in the developed world is a massive tailwind for GDP.
• Incentives - does Labor want to risk being the government that puts us into a recession?

So that leaves us with a 1.44% probability of the scenario you painted planning out. Certainly not zero and can't be ignored, but I wouldn't go all-in and base my decisions on this model playing out. Just my 2cents

 

hat off to your in -laws, tough ppl survive tough times.

 

good analysis.

sadly enough, current politics is a popularity test, not leadership and vision

 

not a good look, isn't it?

 

Nope....huge amount of this coming through in units the Hills, Ryde, Olympic Park, Zetland, Rose Bay, Parramatta, Liverpool, Sutherland/Miranda, South West, West, Lower/Upper North shore, Inner West...going to get interesting...

Houses in West, SW, and Hills are also being impacted....

 

Can I borrow your crystal ball once you are done with it?

 

None of this matters if you have strong cash flow