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MOODY'S: Banks face a growing problem with residential investment loans

Photo by Ezra Shaw/Getty Images

The strong rise in house prices over recent years has driven rental yields in Sydney and Melbourne to “record low levels” and that’s a problem for investors according to Credit Rating Agency Moody’s Investor Services in a report released today.

Moody’s also says that while Sydney and Melbourne house yields are at record lows “rental yield on apartments in these cities are at their lowest levels in 10 years”.

As a result of the low rental yields Moody’s says “the net costs involved in servicing a housing investment (investment loans costs less rental income) have increased relative to household incomes, making investment properties less affordable”.

The result is that “deteriorating affordability increases the risks for Australian residential property investors and therefore for residential mortgage-backed securities (RMBS) backed by loans on investment properties,” Moody’s said.

But it’s worse than that because Moody’s said the decline in rental yields “has increased the level of ‘cashflow’ losses suffered by residential property investors over the past three years and made investors dependent on greater levels of house price appreciation to cover their losses. A greater dependency on house price appreciation makes residential property investing, and in turn, investment loans more risky”.

On average, the net annual cost of servicing an investment in a median-priced 3 bedroom house in Sydney funded with an 80% loan-to-value (LTV) mortgage was $41,300 as of 31 December 2015, up 78% from three years earlier. In Melbourne, the cost was $26,674, up 63% from three years earlier” Moody’s said.

“Investors in Sydney houses require 39.6% of net household income to service their investment properties, while Melbourne house investors require 26.5%, both record highs,”the company added.

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The end result Moody’s says is there is an increase in “the risks and default probability for Australian residential property investors”.

That neatly summarises why Australia’s banking regulator, APRA, clamped down so hard on the growth of investment lending across Australian banking in 2015.

Just last week Charles Littrell, APRA’s executive general manager of supervision and support said that the bank’s concentration on housing loan was troubling the regulator.

“It is a significant issue of concern to us that close to two-thirds of [the big four banks’] balance sheets are exposed to property… mainly housing loans,” he said.

Like Moody’s part of that concern Littrell holds is “because of the point we are at in the cycle”.

It’s a concern investors appear to also hold with the big four major banks languishing near the bottom of this years range at present as they grapple with the headwinds of the credit cycle and the associated demands of the regulator to build up capital buffers to cope with the very headwinds they banks do, or may, face.

Moody’s says it thinks investment loans that were lent during the height of the lending boom in 2014 and 2015 are going to perform poorly relative to those issued in other years and behind the overall deterioration in performance across the sector.

While Moody’s is talking about RMBS APRA’s rules require such structures to be representative of overall bank lending still held on balance sheet.

That means Moody’s is also implicitly saying that the performance of investment loans – that is how well they are repaid relative to the terms of the loan – across the entire banking sector is likely to deteriorate through 2016 and 2017.

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