24 November 2008
Key Points:
It is a good time for companies to focus on establishing their corporate governance and risk management policies.
The term "sub-prime" means that the borrower is below that of a "prime" mortgage candidate. In the USA, lenders have given these poor credit risk borrowers who have low levels of income, little or no equity and a poor credit history, variable interest rate mortgages. Many of these high-risk loans are now in default, particularly now that initial low interest rate honeymoon periods have expired. Lenders have packaged such loans together and sold them to other institutions. To make matters worse, many of the institutional buyers have used borrowed funds (sometimes up to 90 percent), to buy these packages. This worsened the situation by adding another layer of debt on top of an existing fragile foundation. The shares of these companies were then bought by insurance and pension fund companies.
This practice has reverberated into all areas of the financial markets. Institutions are collapsing and others are responding by restricting their lending. The USA is currently experiencing a serious credit squeeze. Consumers in the USA are facing difficulties in securing loans even to buy a car. The word "recession" is starting to form on people's lips.
Banks around the world typically lend money to each other. Previously, banks could be confident that other banks were a low risk and thus the interest rate was quite low. However, with the uncertainty of who has lent money to whom and of just how much of these loans are going into default, the interest rate at which banks charge each other has increased.
The global credit crunch is continuing and will not come to an end until the value of the US housing market stops falling. We have not yet seen the bottom of this fall.
Australian lenders have been more conservative in their lending practices (because our banks rely on deposits to finance 50 percent of their advances which, some people argue, is still too low), but nonetheless, the sub-prime fallout has affected our market. Lenders seeking to raise money in the capital markets have seen the interest they need to pay increase significantly and they are passing those additional costs onto their Australian customers.
Australia's economy is slowing noticeably.
Michael Baker, international retail adviser for property and economics consultancy Urbis, recently said:
"The sub-prime crisis in the US brought the roof down on retail. There, people are very stock market aware and when there is a fall in the market they respond by not spending. In Australia when the stock market falls we are only really concerned about the effect on our super. But if housing prices fall it is a different story. Then we feel threatened and become very cautious in our spending...
Take away our equity in housing and that's when we stop spending. Forget about rising income and employment rates, housing is the real indicator in Australia. And once housing growth goes into the negative, strap yourself to the mast and hang on."
The retail sector, which is said to be a good measure of our socio-economic temperature, is sending out some alarm signals. In late 2007, consumer sentiment was positive, retail sales were showing strong growth despite two interest rate hikes and sales of household goods were healthy. Just months later, in March and April 2008, retail sales growth across the country took a nose-dive and then fell again. In June 2008, consumer sentiment was the lowest seen in 16 years. Consumers are dieting in terms of spending.
Australia is seeing the weakest building approvals data in seven years; they are not too far off recessionary levels according to ICAP senior economist, Adam Carr.
Alistair Meadows, director of sales and investment for global real estate adviser DTZ, estimates that over 50 percent of commercial assets are available for sale off-market.
One real estate agent recently claimed that developers in Parramatta previously needed 30-40 percent commitments by tenants before they could secure funds for developments. He claims that now developers need over 70 percent tenancy commitments to secure funds.
A number of large property investors, such as Becton Property Group, are laying off employees, particularly in their development acquisition divisions.
In terms of the residential market, in September 2007, Australian families required 36.6 percent of family income to pay an average home loan which is the worst affordability result since REIA started measuring this 22 years ago.
The squeeze on finance being advanced to the construction and development industry has a multiplier effect: Master Builders of Victoria, Executive Director, Brian Walsh, claims that for every construction dollar spent, that multiplies to 2.8 times that amount to the rest of the economy.
It is comforting that our current Federal Treasurer and the Leader of the Opposition have both publicly confirmed that Australia is well placed to weather the global economic downturn. The Federal Government has recently announced that it will invest $4 billion to boost competition in the mortgage market.
US President George Bush is emphasising to the American people that Congress is taking bold measures to ease the credit squeeze and he repeatedly refers to the will and spirit of the American people which will help the USA get through its current crisis.
Similar spirit is needed here. Action needs to come not only from the finance industries, but also the Australian Government, the Reserve Bank and businesses themselves. It is time for companies to go to their doctor, have their financial temperature gauged and to make bold decisions. These may involve consolidating, or even spending, if appropriately cashed up. It is also a good time for companies to focus on establishing their corporate governance and risk management policies and ensuring that these policies are accepted and understood by each appointed company risk-taker in the future.
For further information, please contact Peter McMahon and Eva Oraham.
