Spare a thought for Phil Lowe & Westpac’s mortgage book
What’s on our mind: We spare a thought for Phillip Lowe and then take a quick look at Westpac’s mortgage book.
What happened this week: AUS unemployment rate increased to 3.7%, RBA governor Lowe says “more rate hikes needed,” and the US inflation rate fell to 6.4%.
What we are watching next week: Canadian inflation numbers, Australian wage price index data, New Zealand cash rate decision and US economic growth numbers.
Prelude:
What’s on our mind:
It's Monday morning, the central bank governor Phil Lowe wakes ,up and the following are on his mind:
Rampant inflation - Inflation at 7.8%, levels not seen since the 1980s.
A property bubble - Worth $9.7 trillion - worth almost 6x the Australian economy.
A highly leveraged consumer - Australian household debt at ~120% of GDP.
Low consumer confidence - Consumer confidence back down to Pandemic levels.
Lowe is stuck between a rock and a hard place and is left with two choices:
He increases the cash rate to try and bring inflation in check to the detriment of just about everything else.
He does nothing and the public revolt as inflation runs wild and things become more expensive.
Somewhat sensibly, for the last ~12 months, Lowe’s gone down the first path - we don't blame him for doing so.
Just about every macroeconomics textbook/model tells you that the only way to reduce inflation is to; increase interest rates and kill demand in the economy.
What the macroeconomics books fail to consider though is the impact of credit on the economy and inflation.
This is why for much of history we have seen boom-bust cycles happen one after the other.
Almost always they occur because there is a period of increasing credit growth (bringing forward demand) and then a period of deleveraging leading to a bust.
The image below shows how it impacts the property sector.
The Australian property market has for a long time avoided the latter (the bust) because we have continued throwing more and more debt at the problem.
This has worked for 20+ years because interest rates have gone in one direction - DOWN.
From the early 1990s the cash rate has gone from ~17.5% to a low of 0.1%.
The increasing levels of debt meant house prices moved in the opposite direction - UP.
Whenever the property market felt shaky and close to a correcting, the central bank turned on the taps and pumped more credit into the system.
Usually, this meant interest rates would be lowered to new historical lows.
This worked until the Reserve Bank of Australia reduced rates to 0.1% in 2020.
The Reserve Bank basically hit the lower bound for interest rates - the only lower the bank could take rates is by making them negative which simply doesn’t make any sense.
We think the old trick of throwing more credit at the problem just wont work the next time the property sector is on shaky ground.
Instead, we think that the highs of 2021 will not be seen for at least the next 5-10 years.
Our only caveat to all of this is that one should never discount the creativity of federal governments, after all, no one could have predicted the billions of $ in homebuilder grants and the JobKeeper program where the government paid people not to work…
Just because rates can't go lower, it doesn't mean the government won't get creative.
We’d rather “wait and see” instead of placing our bets on creative government policy, BUT we are a lot more prepared to take advantage of any short-term opportunities that come in the event there is a short a “deleveraging event”.
In a deleveraging event, mortgage delinquencies would rise, servicing would become too onerous and property owners would look to sell to try reduce debt balances.
We dont think the domestic market is there just yet, but we think the next 6-9 months may push people into this territory.
To try get a sense of the fundamentals of the market we took a look at one of the big four banks reports from earlier this week.
Westpac put out some reports on its mortgage book which we think is of interest to anyone who owns or is looking to buy property.
A look at Westpac’s reporting this week:
Here are our key takeaways from Westpac’s numbers:
A small uptick in mortgage delinquencies.
Westpac reported a minor increase in delinquency rates with 30+ day delinquencies now making up ~1.24% of the bank's books.
Historically this is still relatively low at almost half of where the number was pre-pandemic - at face value, there is no cause for concern...
However, we think potentially stressed mortgage holders are likely hiding away in the 0-30 days delinquent numbers.
We also note that this data is as of 31 December 2022 and the full impact of the rate hikes is unlikely to have been felt yet.
$85 billion in fixed-rate mortgages to expire.
Westpac reported a total of $85 billion in fixed-rate mortgages expiring this year.
With most of these loans written back in 2020-2021 at interest rates 2-3x lower than today’s, these loans are likely to become a problem over the next 12 months.
For some context, Westpac’s total residential mortgage book is ~$471 Billion.
This means that ~18% of Westpac’s books will need to be refinanced at much higher interest rates than the borrowers are paying today.
Watch this space.
68% of customers are ahead on repayments.
The final one is the % of Westpac customers that are ahead on mortgage repayment’s (68%).
Stating the obvious this means ~32% of Westpac customers are NOT ahead on repayments.
Interestingly, ~32% of Westpac’s mortgage book is also made up of “Investment Property Loans”.
We suspect that there is an overlap between the two groups of customers.
Higher interest rates hurt investors the most and we expect this cohort of borrowers to slowly head toward the exit doors (selling/deleveraging) as rates continue to rise.
As a result, these two indicators will be ones to watch over the course of the year as leading indicators for mortgage stress.
Thanks for reading,
Aus_Prop team.
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Via email at Auspropertymarket@gmail.com
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