Mortgage Market Conditions Getting Looser

In today’s Money Morning…the dubious rise of non-bank lenders…the likelihood of a ‘meaningful moderation’ in housing and credit…the RBA’s hesitancy to raise interest rates…an economic trap of our own making…and more…

US markets had another good session overnight. The Dow Jones and S&P 500 index both jumped around 0.5%. Commodities were up too, with gold, oil and iron ore posting decent gains.

That means the Aussie market should have another good day, building on yesterday’s 0.75% rise.

While the stock market gets on with it, worries about Australia’s housing market continue to build. As Bloomberg reports:

Investors are lapping up mortgage bonds in Australia even as regulators and credit assessors step up their warnings about risks from the nation’s housing market.

New residential mortgage-backed securities issuance has more than doubled so far this year to A$10.5 billion ($7.8 billion) from A$5.1 billion a year earlier, data compiled by Bloomberg show. More than half of the issuance has been fueled by non-bank lenders. Those firms have fewer funding options compared with major Australian banks, which have been favoring unsecuritized debt at a time when costs are close to historical lows.

I’ve said it before and I’ll say it again: When interest rates are this low, the market will find a way to create more debt. It doesn’t matter what the regulators do to try and stop it.

In the case of residential mortgage-backed securities, it works like this:

Non-bank lenders want to raise money to make loans. They can’t do so like regular banks. They don’t have the credit rating. They would have to pay too much to access funding in the wholesale markets.

So non-bank lenders package up existing mortgages and sell them as ‘residential mortgage-backed securities’. And because the interest rate environment is so low, there is increasing demand for these securities. As the Bloomberg article states:

‘…“It’s very much a demand-driven phenomenon,” said Peter Riedel, finance chief of non-bank lender Liberty Financial Pty, adding that fund managers in particular need to put “capital to work in an environment where cash isn’t giving you any return at all.”

Investment managers such as Kapstream Capital in Sydney are attracted to RMBS because their credit spreads currently have “more juice” than senior unsecured bank debt, according to money manager Raymond Lee. While mortgage arrears have been climbing, they’re ticking up from a low base, and sound quality loans coupled with tighter lending practices since the financial crisis provide comfort to investors, he said.

So the money flows in, and the non-bank lenders have fresh capital to make new loans. This works beautifully because the regulators have just cracked down on the banks making new loans to investors and interest-only repayments.

If you can’t get a loan at a major bank, where do you go next?

The next tier down — the non-bank lenders. And thanks to persistently low interest rates, they seemingly have plenty of capital to fill demand for these loans.

Meanwhile, credit rating agency S&P issued a new warning about the financial sector. Again, from Bloomberg:

‘…S&P Global Ratings said Australian financial institutions face an “increased risk of a sharp correction in property prices” which would lead to a “significant rise in credit losses,” according to a May 22 statement. The credit assessor, which affirmed the big four banks’ ratings while lowering the scores of 23 of the nation’s finance companies, said last week that Australia’s top AAA grade will only rest on a firm footing once there’s a “meaningful moderation” in housing and credit.

I can’t see a ‘meaningful moderation’ in housing and credit until the RBA raises interest rates. And it really doesn’t want to do that.

An interest rate rise would push the dollar higher, which is something the RBA definitely doesn’t want. It would also put pressure on consumers, at a time when retail sales growth is weak and consumption growth in general is beginning to slow.

In short, the Aussie economy can’t handle an interest rate rise now. Which leads to the perverse situation of more debt in the economy, which in turns leads to greater risks.

There is no doubt we are caught in an economic trap of our own making. The only solution is easier and easier money. That will go on until the whole thing blows up.

I’m not in the camp that says a housing bust is around the corner. I still think the corner is at least a few blocks away. Busts nearly always occur because of a tightening of credit. And as you can see by the increase in mortgage bond issuance, credit is only getting looser.

Regards,

Greg Canavan,
Editor, Money Morning


Greg Canavan is a Feature Editor at Money Morning and Head of Research at Port Phillip Publishing.

He likes to promote a seemingly weird investment philosophy based on the old adage that ‘ignorance is bliss’.

That is, investing in the Information Age means you have all the information you need at your fingertips. But how useful is this information? Much of it is noise and serves to confuse, rather than inform, investors.

And, through the process of confirmation bias, you tend to read what you already agree with. As a result, you often only think you know that you know what is going on. But, the fact is, you really don’t know. No one does. The world is far too complex to understand.

When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases.

Greg puts this philosophy into action as the Editor of Crisis & Opportunity. As the name suggests, Greg sees opportunity in a crisis. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines traditional valuation techniques with charting analysis.

Read correctly, a chart contains all the information you need. It contains no opinions or emotion. Combine that with traditional stock analysis and you have a robust stock-selection strategy.

With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the basic, costly mistakes that most private investors do every time they buy a stock.

To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Money Morning here.

And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here.

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