Sydney and Melbourne house prices could fall by 15 to 20 per cent in a repeat of the late 1980s and ’90s, an independent equity research firm has argued, citing the “largest regulatory credit crunch in 30 years” as the cause for the slide in property values.

Endeavour Equity Strategy said in a detailed 30-page report that more evidence had emerged to support its claims that about 40 per cent of all mortgages were “non-prime”, based on the level of borrower’s income relative to debts, as it called on the prudential regulator to force the banks to increase their disclosures of mortgage risk.

A crackdown on the use of measures that understated borrower expenses, and overstated their borrowing capacity, would reduce loan values by up to 30 per cent and have a profound impact on property prices.

“Our base case suggests expense ratios will increase sharply, serviceability ratios will decrease proportionately, and loan sizes and property prices will suffer in the order of 15 to 20 per cent in real terms,” the report written by Endeavour’s Douglas Orr, and circulated to fund manager clients, concluded.

A fall in house prices would lead to a decline in building activity resulting in a “modest increase” in arrears as incomes tied to the sector fall. Meanwhile “lower house prices would reduce the ability for stressed borrowers to trade out or finance”.


The report, which urged caution when investing in the big four banks, comes as higher borrowing costs and tougher lending standards weigh on house prices.

On Wednesday Core Logic data showed a further fall in national house prices, with a 0.6 per cent monthly decline driving a 1.6 per cent annual slide – the largest in six years.

Tighter lending standards and higher rates would “put the financial system on a surer footing in the long term”, Capital Economics analysts said.

“But the danger is that house prices fall too far, too quickly and undermine economic growth in the near term.”

Endeavour also called on the prudential regulator to force the banks to disclose metrics such as “debt serviceability to income ratios” and said the “commercially conflicted” Household Expenditure Measure, or HEM, used to assess borrower expenses boosted serviceability by 15 per cent to 20 per cent.

The firm said that given the systemic importance of the banks, “taxpayers are entitled to know the loan metrics banks are accepting”.

“Mandatory disclosure of serviceability metrics would achieve this and offset real concerns that the current regime allows banks to ‘commission their own risk goal posts’ – by relying on HEM,” the report said.

Endeavour Equity Strategy was founded 15 years ago by Douglas Orr, a former ABN AMRO research analyst, and currently has close to 20 funds management clients subscribing to its research.

The firm’s strategy team is bearish on the domestic economy, and therefore the banks, favouring a cash weighting above 10 per cent, companies with profits tied to the health of the US economy, and select miners.

“We see credit growth over the coming 12 to18 months as likely flat to negative, margins under pressure, heightened legal risks and bad debts set to increase as equity turns negative for a significant portion of leveraged home owners and investors.”

The report said a sample of 420 Westpac mortgages, made public as part of the Hayne royal commission, supported its prior view that 40 per cent of all outstanding mortgage debt was “non-prime”.

This was based on the “internationally accepted” measure of “non-prime” being a mortgage in which more than 40 per cent of income was being used to service interest payments on debt.

” ‘Non-prime’ mortgages areas have default rates three to five times higher in a downturn,” Mr Orr told The Australian Financial Review.

The Westpac loan sample has already attracted controversy and led banking analyst Jonathan Mott of UBS to downgrade his price target amid concerns about the bank’s loan quality.

On Wednesday, Mr Mott said that as banks tightened lending standards and assessed customer living expenses the availability of credit would continue to reduce.

“We estimate that maximum borrowing capacity has reduced by about 10 per cent for owner-occupiers and about 20 per cent for investors since 2015. However, we believe there is further tightening to go, of up to 30 per cent.”

Westpac has since strongly dismissed concerns about credit quality raised by the dataset when it presented its interim profit numbers in May. The bank claimed the data was incomplete and it had more information than was presented in the sample, which formed part of a review conducted by PwC.

Meanwhile, Standard & Poor’s home loan data showed that mortgage arrears remained low with just 1.38 per cent of loans it tracked past due in May, while non-conforming loan arrears slid to 3.65 per cent, a record measure for the month of May.

Last week, Westpac chief executive Brian Hartzer once again dismissed concerns raised by the loan data, and the broader quality of its mortgage book.

“When we underwrite loans we build lots of buffers into them,” he told a luncheon in Sydney, adding that cash flow coverage levels were at average levels.

“In the last couple of years when we have made lending decisions we have assumed they are higher than they are.”

Westpac is tightening its credit policy, as it recently undertook its fourth round of tightening in the past six months.

The changes, effective from last Saturday, are aimed at improving borrowers’ capacity to service their loans by detailed examination of total expenses and all forms of income used to service repayments.

The Endeavour report described the banks’ lending buffers as “illusory” because the HEM understated expenses for most households, and therefore overstated how much income borrowers had available to service debt even after a buffer was factored in.

The Westpac loan sample also showed the extensive use of the HEM to assess borrower expenses. In that loan sample, 97 out of the 100 loans originated by mortgage broker RAMS relied on the HEM, while 86 per cent of Westpac’s loans relied on the measure.

A more “realistic” assumption around living expenses would substantially reduce the funds available to service a loan to a household on $150,000 of annual income from $76,000 to $56,000.

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