ABC News – 26 August, 2014
They triggered an economic meltdown in the United States and sparked the global financial crisis, but subprime mortgages are staging a revival in Australia.
Ratings agency Moody’s says Australian lenders have doled out $3 billion worth of the non-conforming home loans over the last 18 months.
Prime mortgages are those that typically go to people with good credit scores, secure jobs and existing, well-serviced loans.
Moody’s analyst Robert Baldi says non-conforming, or subprime, borrowers tend to have patchier personal financial histories.
“We’re looking at things like prior bankruptcies or prior defaults in their credit history past,” he explained.
“If the borrower is a non-resident, for example, or it’s a jumbo loan, these would all fall outside of the lenders’ mortgage insurance criteria and would classify the loan as non-conforming.”
Essentially, subprime loans are those going to borrowers with a much higher risk of default that a typical loan.
Australia ‘out at the front’ of subprime market
While subprime remains something of dirty word in the economies hardest hit by the GFC, Australian lenders are increasingly willing to step up and fund subprime loans by selling what are known as residential mortgage backed securities (RMBS).
“Australia is out there at the front of the market, I would say, so we are the ones that have continued with issuance in this space,” Mr Baldi said.
“Since the beginning of 2013, we’ve seen 10 new transactions in the RMBS market from non-conforming issuers and that’s totalled about $3 billion, so that’s quite a pick up in volume considering the market did shut down post the crisis in 2008.”
While $3 billion sounds like a large amount of money, Mr Baldi says it is a relatively small share of the home loan market, and of RMBS issuance.
“[In] the year to date we saw roughly about $15 billion of RMBS transactions. Of that, about $1 billion was non-conforming, so we’d say about 7 per cent of issuance this year has been from the non-conforming market,” he added.
Moody’s says most of these loans are being written by non-bank lenders.
However, Mr Baldi is confident that there is enough regulation in place to avoid a subprime crash similar to that in the US in 2008.
“One of those is the National Consumer Credit Protection Act, and this basically requires lenders to take reasonable steps to verify a borrower’s financial position and their ability to repay the loan,” he said.
“Essentially this gets around the fact that in the US you saw those loans being written to borrowers pre-2008 with little to no income verification. In Australia that just can’t happen.”
The United States is still managing the fallout from its subprime crisis.
Last week, finance powerhouse Bank of America Merrill Lynch agreed to an almost $US17 billion settlement for its role in the crisis.
Australia’s biggest danger in prime mortgages
Despite that history, banking analyst Martin North sees Australia’s non-conforming market as much safer.
“Most of the investors now, the people who are buying these mortgage-backed securities, are now Australian investors rather than overseas investors,” he said.
“So there is a bit of a feedback loop going on, and that does mean that some of the other players who might be buying those securitised loans now are essentially home-based rather than offshore-based.”
Mr North says the subprime segment of Australia’s market is so small that it is unlikely to destabilise the financial system, even if a lot of the loans go bad.
However, he says Australia’s banks, households and the economy in general is too heavily reliant on real estate.
“This is a very small proportion of a much bigger question about leverage into property,” he warned.
“We have a massively leveraged financial services system into property more broadly.
“If we have the sorts of defaults we’re talking about in the non-conforming sector, then you would also be having, I think, similar defaults more broadly across the market, and it’s those broader defaults across the market that would be of much more concern rather than the non-conforming element, which I think is quite small and quite isolated.”