While the Assuies have not have a recession in 25 years, Australia’s household debt has long been a concern among many. Indeed, in 2016 JPMorgan called Australian housing shorts the new “widow maker” as hedge funds were unable to profit off of the bearish bets. Specifically, Bloomberg noted at the time:
“Shorting the Australian housing market has been a widow-maker trade and I think it will continue to be the case,” Dey wrote in the note. “Australia is a unique housing market and sometimes offshore investors don’t realize the key differences,” he said, pointing to factors including tax breaks that spur demand.
Others disagreed ad the time and still disagree as we noted in a recent article on the topic.
This hot trade among Hedge Funds has been around for some time, but so far bank stocks have proven short sellers wrong time and again. A Morgan Stanley prime brokerage report from March 2016 stated the following regarding Australian funds: Hedge Funds continue to be the most net short they have been since 2010.
But it is not just hedge fund managers from Australia targeting the country’s banking sector.
Marc Chatin of Parus Fund pitched a short of Australian banks at last year’s Sohn London conference, following other funds such as Lakewood Capital which has gained a reputation for its aggressive short exposure since its founding in 2007.
John Hempton and John Tepper are also Australian banking bears.
But will that trend end? Only time will tell, but count one rating agency among the bears.
The Australia Prudential Regulation Authority’s recent measures to curb higher proportion of interest-only lending won’t affect the growth of household debt, as investors anticipate a continuous rise in house prices, believe analysts at Moody’s Investors Service. In their April 10 research piece titled “New Mortgage Rules Will Help Mitigate Housing Market Risks,” Marie Diron and team caution that Australia’s GDP will be substantially affected in the event of a negative shock from a housing downturn.
Australia’s household debt is the second highest in the world
Last month, APRA introduced new macro prudential rules to target risky lending by banks and imposed curbs on the flow of new interest-only lending to 30% of total new residential mortgage lending. The regulator cautioned that lending on interest-only terms represents almost 40% of the stock of residential mortgage lending by banks. The regulator highlighted that such a number is quite high, both by international and historical standards.
Touching upon the rationale behind APRA’s recent measures, the Moody’s analysts point out that at over 120% of GDP, Australia’s household debt is the second highest behind Switzerland. As can be deduced from the following graph showing data from the Bank for International Settlements, Australia’s household debt is the largest in the Asia Pacific region, surpassing New Zealand’s 94.4% and Korea’s 91.6%. Of note, when compared to the housing peaks, Australia’s household debt is higher than even other developed economies such as the U.S., and even in troubled economies such as Ireland and Spain.
Diron and colleagues argue that as opposed to less-leveraged borrowers, highly-leveraged households will likely trim their consumption spending, ultimately crimping fiscal revenues and economic growth. As households’ debt in Australia is higher than their liquid financial assets, the analysts believe that any drop in housing prices will hamper the country’s GDP growth.
With Australian banks’ exposure to the sector constituting about two-thirds of banks’ household lending, the Moody’s analysts believe such high exposure will be a source of sovereign risk, though the banks’ strong capitalization could cushion the risk of a banking crisis.
Australia’s household debt – APRA caps interest-only lending at LTV above 80%
The Moody’s analysts highlight other restrictions imposed by APRA to curb the continued rise in housing prices and household leverage. For instance, APRA has imposed strict internal limits on the volume of interest-only lending at loan-to-value ratios above 80%. Additionally, lending institutions will be asked to provide justification for any instances of such ratios exceeding 90%. However, the regulator reiterated its 2014 guidelines, whereby lending institutions were asked to ensure that growth in housing investment loans will remain below 10%.
Diron and team believe the recent measures initiated by APRA could weigh on property demand, though thanks to the low interest regime, household debt could continue to grow, the analysts conclude.
All this analysis does not even get into the question about a possible slowdown in China, which would hit Australia pretty hard.