It is mildly amusing to observe the sanctimony of the banks when it comes to lending standards. We have tightened our lending policies, they say; no more 95 per cent LVRs (loan to valuation ratios), they say, we have lifted home-loan rates by as much as 30 points.
Perhaps, but they are merely getting others to do their dirty work for them. As in the last cycle, where the banks happily blamed rogue mortgage brokers when their high-risk loans went pear-shaped, they have outsourced their high risk loans once again.
This time it is to the non-bank lenders; the likes of Bluestone, Liberty Financial, Pepper Group, Firstmac and Resimac.
Simply Google “no deposit home loans” and you’ll be swamped with options. Tap in “Pepper Group” and you’ll find: “What you get with Pepper – borrow up to 95 per cent of the property … “No LMI (lenders mortgage insurance) approval required … Apply with or without up to date tax returns … We accept 100 per cent of rental income for income serviceability … Interest only loans for five years available …”
Where does Pepper get its money? The big banks. When you see the word “warehouse”, it simply means loan, in this case from one of the majors to the non-bank lender. Westpac, ANZ and Commonwealth are the biggest players in this market.
A potent cocktail is brewing: property prices have run 30 per cent in three years – 46 per cent in Sydney – household debt versus income again hovers at record heights, and interest rates at record lows, while the banks are effectively financing high-risk low-doc loans with just 5 per cent deposit down.
It’s just that they are doing it via warehouse loans to third parties. The party will end for these third parties at some point. And when it does, the banks will enjoy a modicum of protection. Their warehouse loans are usually for 12 months.
During these 12 months, the non-bank lender (NBL) tries to pull together enough loans to issue RMBS (residential mortgage backed securities) to investors, typically professional debt investors, to lay off its risk. Still, what the Big Four are essentially doing is renting their taxpayer-backed balance sheets so the ex-merchant bankers running the NBLs can chop out high-risk mortgages.
Should these go kaput, they will enjoy the luxury of being incorporated as “Limited Liability” companies. Their promoters will have made millions already, their shareholders will cop it on the chin, and management will trot out the “sorry, it’s a perfect storm” line, as did Allco and Babcock & Brown in the wake of the Global Financial Crisis. As secured creditors, the banks will stand first in the queue to claw back the leftovers from their receivers. The regulators, for their part, will say the system has been protected as only shareholders of non-bank lenders will feel the pain.
There is an ethical angle to all this. Via the Reserve Bank’s Committed Liquidity Facility – essentially a government bail-out mechanism – banks luxuriate in a taxpayer guarantee. Despite all the talk about competition, they are quasi-government enterprises run by people on large executive salary deals linked to short-term performance. They, too, will be rich and gone by the time the party ends. As will the revellers from Macquarie. They hate to miss a party.
As most of the financial details of the non-bank lenders are contained in private companies it is hard to get an intimate idea of what is going on but a couple, such as Pepper, are listed on the Australian Securities Exchange.
It might be midnight, but the party-goers from Pepper sent their emissaries on a mission to get some more grog, via a tilt at Esanda. They listed last July at $2.60 a share, now trade at $3.84, and, despite a market cap of $700 million, were up against Macquarie which just won the Esanda tender at a not very tender price of $8.2 billion.
Interred in the catacombs of the prospectus for the Pepper float are 14 warehouse facilities. It’s furtive stuff, no big bank names attached. The asset classes range from “prime insured residential mortgage loans” through commercial equipment and car loans, to unsecured and point-of-sale loans, to a couple of uninsured portfolios and three with “non-conforming residential mortgage loans”.
All five of their securitisations contain “non-conforming residential mortgage loans”. No doubt the structure is finely engineered to spread the risks – indeed via Pepper Investment Holdings, thence Pepper Europe Holdings and Pepper Netherlands and Pepper Europe Investments the risk is spread as far afield as a bevy of entities in the Caymans.
Nonetheless, the risk of collateralised debt obligations (CDOs) were once well spread and finely spliced and diced too.