Outlook for Housing Reverses – Implication for Bank Loan Losses

In the early months of the pandemic, forecasts for house price movements were between a 10% and 20% fall.  The major banks were generally expecting a 10% fall but were planning for a realistic worst case scenario of a 20% reduction and in some cases 30%.  The RBA even ran stress tests on banks of a 50% fall in prices.

To avert a collapse in the housing market, the RBA and the federal government effectively got out “ahead of the curve” and pre-emptively implemented policies to support the housing market before it started falling.  Principal among these policies was the reduction in the cash rate and the introduction of the Term Funding Facility that lowered banks’ borrowing costs to 0.25% initially and most lately 0.10% allowing them to pass these savings in interest rates onto borrowers.

Extending the JobKeeper and JobSeeker programs and the banks’ policies on mortgage payment deferrals also were important ensuring no homeowner was a forced seller of their property at least in the short-term.  While largely symbolic, the repeal of the responsible lending laws signalled the government’s intention that banks be encouraged to lend to home buyers without the threat of future court cases if the mortgagee subsequently found themselves in financial difficulties. 

There was special encouragement for first home buyers with increased grants, the proposed changes to stamp duties in NSW and the RBA stating it will not raise interest rates for three years allowing the typical first home buyer being a household early in their careers to potentially take on more debt.  This initiative appears to have been effective with first home buyer loans up over 40% year on year, with increases of 10,451 in July, 12,302 in August and 13,040 in September (significantly above prior months all of which were below 10,000).  Commentators report a “FOMO effect” (Fear Of Missing Out) among this group with a pervasive sentiment that if they do not get onto the property ladder now and prices rise, they will be unable to do so later.

The pandemic has also caused significant and potentially permanent changes in the market with people working from home, demand for properties with more space and not necessarily within easy commuting of the city centre increased.  It is entirely plausible some businesses will not return to all staff working 5 days a week in the office as for some businesses it makes sense both for employers (who save on office space) and employees (who save on commuting time) to continue working from home either on a full-time or part-time basis. With border restrictions and many institutions working remotely, there was also a fall in prices in the rental market by up to 10% in the inner cities as overseas students were taking courses remotely and people were unable to travel to holiday destinations; therefore many properties were vacant. These issues have negatively affected the investor market.

While house prices fell a collective 2.1% between April and September of this year, October showed a modest increase and November prices were up 0.8% on a national basis. Houses have generally performed better than units.  The overall market was moving upwards earlier in 2020 before the pandemic and the market is currently up by 3.1% for the calendar year.  Now the fall in prices has been arrested, buyers are likely to have more confidence and with lower interest rates this should fuel additional growth in 2021 and 2022 according to economists.

In the short term, most market indicators are positive with stock on the housing market being about 25% lower than the five-year average, auction clearance rates averaging 70% (higher than the ten year average of 61%), mortgage applications up 25% over the last six weeks and seasonally adjusted new dwelling approvals at the highest levels since February 2000.

In the medium term, the largest concern for the market is lower population growth due to reducing net immigration.  Population growth is forecast to increase only 0.2% this year as compared with longer run averages of 1.7%.  Net migration was running at 240,000 people entering Australia prior to the pandemic, but it is forecast to reverse with 70,000 people leaving this year and 20,000 people leaving next year.  Ultimately, this should reduce demand against a background of increasing supply from new dwelling approvals.

Most forecasters are now predicting modest but uneven growth in house prices over the next two years as the market adjusts to working from home changes due to the pandemic and uncertainties regarding immigration numbers (and the various destinations of immigrants) are resolved. However, just like forecasts earlier in the year of steep falls in prices that never materialised, lessons learned should be the government and RBA will try to manage the market to achieve the most desirable outcomes.

A cautious view has been expressed by S&P Ratings Agency who have warned that forced sellers from those who lost their jobs in the pandemic have not yet emerged either in the housing market itself or in the loan arrears statistics for the major banks, although they expect this to occur early in 2021, creating some selling pressures in the market. However, it appears the risks of a national or state-based house price collapse are now very much reduced.  The RBA has clearly stated it is targeting unemployment as the key variable to grow the economy and it is unlikely employment will be growing strongly while house prices are falling.  Changes in unemployment are strongly linked to changes in house prices as consumer demand is the largest driver of GDP growth which is necessary to create more job opportunities.  Consumer demand in turn is linked to house price growth because household formation is a driver of consumption, consumers can borrow to spend against their homes and because of the wealth effect.  If consumers feel wealthier due to the major asset (their home) rising in value, they feel more financially confident.

If house prices do not fall it is difficult to envisage material losses for lenders. For a loan loss to occur two factors need to occur. Firstly, the mortgage holder has to be unable to meet his payments of principal and interest in the medium to longer term as the banks are exercising forbearance for those with short-term difficulties and the value of the house has to be less than the loan amount after re-possession and selling costs are taken into account. In practice, loan losses rarely occur in a rising housing market as the most efficient method of resolving the issue of the borrower being unable to repay is for that borrower to willingly sell the property and repay the loan and walk away with the capital gain made. In contrast if prices are falling, there is less incentive for a borrower to repay and crystalise a loss and even less if the value of the home falls below that of the loan as it is the bank that is exposed to further falls in house prices while the homeowner receives the benefits of a market recovery. Hence, house prices are the key determinant of loan losses for ADIs and thankfully, it appears as if the policy interventions of the RBA and the government have prevented what appeared to be a large risk from being realised.

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