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Housing Wealth is Uncertain, but Mortgage Debt is Very Real

14 August 2017
Perhaps unsurprisingly, little attention was paid to what the boss of Australia's biggest bank had to say about its latest results beyond the money laundering scandal it's embroiled in.

But a thoughtful response by Ian Narev to the final question in last week's analyst briefing raises an issue far more important to Australia's financial system in the long-term than dirty money.
 
That issue is Australia's immense household debt.
 
The question was almost a Dorothy Dixer, with the analyst effectively asking whether concern about Australia's record levels of household debt was overblown.
 
Ian Narev didn't give the answer the analyst was probably expecting.
 
"It should cause questions, because this is an outlying chart relative to global experience," he responded.
 
"The first question we've got to ask ourselves is what's underlying it and are we comfortable with it."
 
As you'd expect from the head of Australia's biggest mortgage lender, he said he remained relatively comfortable.
 
Mr Narev said taking into account household wealth makes Australia's almost uniquely high debt burden appear less concerning.
 
 
However, he also noted that Australia's household wealth is not as certain as many people assume.
 
"Underneath the effective wealth of the household is a whole lot of mark-to-market of what's my property worth and what are my assets worth, whereas the debt is debt," Mr Narev warned.
 
"So you've just got to be very careful about the role of asset values in that."
 
Basically, the head of Australia's biggest bank is warning that a large part of your wealth can evaporate quickly if property prices fall, but your debts will remain the same.
 
That can leave over leveraged home owners and investors in negative equity, where they owe more than their property is worth.
 
At that point, the borrower has few options. They can't sell the property to pay off the debt, so they just have to try and keep up with the repayments.
 
If their income falls (say through job loss) or interest rates rise and they can't meet the repayments, they will be at the mercy of the bank or bankrupt if the debts are called in.
 
So, on paper right now, most Australian home owners look like they're doing just fine, even fantastically well.
 
But it only takes a fall in the market value of their real estate to put them on the knife-edge of bankruptcy.
Mortgage repayment buffers not as big as they appear
 
One factor reducing this risk is the large repayment buffer Australian households have, in aggregate, the nation is well ahead on its mortgage repayments.
 
That means, should a serious downturn and rising unemployment strike, many borrowers could ride out a long period without defaulting on their mortgage because they are so far ahead on repayments.
 
But Mr Narev again had a word of caution against being too complacent.
 
"We've just got to make sure we don't take comfort just of the averages," said Mr Narev, adding that the bank was focused on identifying "the risks in the tail."
 
That statement would please the Reserve Bank, with assistant governor Christopher Kent making essentially the same point in a speech this morning.
 
"What matters when it comes to financial stability is not what the average borrowers are doing, but what the more marginal borrowers are doing," he said.
 
If you get to a situation where average borrowers are defaulting, you're probably already in a financial calamity of the scale of Ireland or Spain in 2008/2009.
 
Even in the US during the financial crisis, the bulk of defaults were people at the extreme margins of loan quality, the so-called subprime and NINJA (no income, no job, no assets) mortgages.
 
Dr Kent said there is evidence in the Reserve Bank's analysis of a large bundle of mortgages that it is precisely the riskiest borrowers, who have borrowed the largest amounts relative to their home's current value, that have the skinniest repayment buffers.
 
"For both investor and owner-occupier loans, adjusting for offset balances leads to only a small change in the share of loans with current LVRs [loan-to-value ratios] greater than 80 per cent," he said.
 
"This suggests that borrowers with high current LVRs have limited repayment buffers."
 
Given this data, and RBA research suggesting that a third of mortgage borrowers have little to no repayment buffer, the financial regulators will be hoping Mr Narev's words are backed with actions by his bank and the other majors.
 
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