Housing credit crunch 

Freely available credit has long helped fund a love affair with property investment, with Australian household leverage up 23 of the last 25 years. Hamish Chalmers from Watermark told us:

"Investors in Sydney and Melbourne were taking anywhere between fifty and sixty percent of mortgage flow... that's a witheringly high number. There is no international precedent for numbers anywhere near that high." 

However, the efforts of regulators to stem the flow of housing related credit are now starting to bite, and investors’ borrowing capacity has fallen 10-20% already, with more coming.  

In this thematic discussion, our panel takes a closer look at this topic including the sectors and stocks most exposed, and a counter-consensus view on the mortgage banks. 

Panel: Jeremy Hook, TMS Capital; Hamish Chalmers, Watermark Funds; Daniel Moore, Investors Mutual.

Edited transcript 

Q. Are tighter lending standards having an impact and where is it being felt?  

Daniel Moore: We're definitely seeing the banks change their lending standards, particularly around loan to income ratios, which has been pulled back quite a bit. They're now sort of having a max of about six times income, which is reduction in the past. And that's having an impact on loan approvals and clearance rates of the market. 

Q. Self-managed super funds have been pulled back from some of their lending. Westpac initially, some of the other banks, is this another part of that puzzle and is it getting worse?  

Hamish: We actually are more focused on investor lending. The investors in Sydney and Melbourne were taking anywhere between 50 and 60% of total mortgage flow at the peak about a year ago, which by international standards is just a witheringly high number. There's no international precedent for numbers anywhere near that high. So, it's true that the banks are pulling back from lending to self-managed super funds for real estate. At Watermark, we're much more focused on the impact of investors pulling back. The work that we've done suggests that borrowing capacity of investors is down anywhere between 10 and 20% and we think it's going to keep going. We know from channel checks with mortgage brokers that not all of the banks have rolled out the new loan serviceability requirements, they will do throughout the rest of the year. 

So the tightening should continue to go in our view.  

Q. So a negative for the economy or is there something positive we can say about it?  

Hamish: No not really. I guess long-term it rebalances the economy and millennials can afford a house. If you're a millennial that's probably a positive. So, lower house prices impacts the economy in a bunch of different ways. Directly it's through something called residential investment. Residential investment is building of new houses, renovating existing houses, and dwelling transfers. And there's a lot of literature that says when that peaks as a contribution to GDP as it has done in Australia about 12 months ago, that's a very good leading indicator for an economic slowdown and usually a recession.  

So there's not a lot of good news about the housing market and residential investment rolling over.  

Q. Daniel, housing affordability getting better certainly helps and makes the economic story a bit more sustainable, is that a positive or is there absolutely none as Hamish is suggesting?  

Daniel: I think the one positive you can say is that the royal commission happened before the crisis rather than after. Improving lending standards is a good thing, but there's no doubt the short-term impacts are negative. There's a very close correlation between house prices and household gearing level. So as banks are less willing to lend consequentially you would expect house prices to fall. 

Improving lending standards is a good thing, but there's no doubt the short-term impacts are negative.

Q. If we're looking at the ASX listed stocks who is going to be most affected by this, and what should we be aware of there? 

Daniel: So if you look at probably the leading ... so the companies that are right at the pointing end, so the companies that are leveraged to house prices, or new housing. We sort of look at the property developers, we look at building material companies, and probably the retail sectors which sell household goods particularly the most expensive household goods.  

Q. So into that discretionary side, what are the areas that are really flashing red lights for you? 

Hamish: I wouldn't disagree with anything that was said before. Most of the work that we've done that informs our view on Australian housing and its impact on the economy was based on what happened in the Netherlands and the UK earlier in the decade. And exactly as described, the mortgage banks actually do reasonably well, it's the rest of the economy that disintegrates. So, retailers go bust, commercial real estate collapses, people stop going to the movies, people stop going to restaurants, but they pay their mortgages. So, we're focused on many of the same areas.  

The mortgage banks actually do reasonably well, it's the rest of the economy that disintegrates.

Q. What would you do portfolio wise? Are there things you'd sell if this thing was going to take hold?  

Hamish: Again, what you would sell is reasonably obvious. I think the one area that might be a little counter consensual is owning the housing banks. So again, when we looked overseas in the Dutch downturn houses prices fell about 20%, the banks lost four basis points on their mortgage portfolios, which is not a lot. That same number in the UK was six basis points, which is not a lot. And in Sweden it was about one basis point.

To answer your question in an interesting way, a counter consensual view that we have is that the housing banks actually will do reasonably well in this scenario, and then the businesses that will do badly are the ones that we described before.  

Q. Daniel you mentioned some of the housing stocks, building materials, any of those particularly a sell for you at the moment?  

Daniel: I think if we think of the building materials companies, the one that's most exposed to residential housing in Australia is CSR Limited (ASX: CSR), so despite the multiple looking quite reasonable we think those earnings are at the top of the cycle.

In terms of retail probably the stock that's right at the pointing end, which has had a really good run in terms of earnings growth is Nick Scali (ASX: NCK), they're a furniture retailer. So they're probably two stocks we think are right at the pointy end.  

So they've had a good run and now it's time that things are changing. Not all investments are as safe as houses.