Funding Trends – Historical Background
The diversification of capital sources – such as innovative crowd funding platforms - in the private sector to support property development is continuing. Looking at today’s trends, it is worthwhile to review the changes that have occurred in the last 25 years, to provide an understanding of the fundamental shifts during this period. This will help explain the dynamics of the current private money, online and non-bank market place for clients seeking development & construction finance.
It was in fact 27 years ago - when I began my journey through the world of mortgage finance in Sydney - that the residential property market (in Sydney) doubled in value in one year. Thats right. Doubled in one year ! This was due to a credit boom fuelled by the entry of foreign banks for the first time in 1986 and those good old foreign investors - mainly Japanese.
So the Treasurer Paul Keating (Labour) slapped a kneejerk ban on foreign owners purchasing residential property (didn't last long) and jacked the cash rate up to 18% which delivered variable mortgage rates of 22%. Ouch. Next ? The infamous "recession we had to have" ... which lead to voters waiting for Keating at the next federal election with a baseball bat. The market dived with everybody hitting the exit door at the same time and it took until 1995 for the market to reach its levels of 1989 again.
Funding Trends – Macro-Economic Factors
Interestingly residential investor mortgages - in the late 1980's to the mid 1990's - were priced a full 1% higher than owner-occupied mortgages but the increased competition soon evened that out. Now the same differential pricing has come back into the Australian mortgage marketplace. Not due to competition this time - all the big four aussie banks behave in exactly the same way - but due to macro-economic factors driven by the need to prevent another GFC.
The banks cant do anything about it either as they are now forced to apply different riskweights for bank capital on different mortgage exposures. This is so the banks have the capital structure that can bail themselves out next time. Called "Bail In" and directly opposing the global banking agenda of "Too Big To Fail". Inherent within this agenda is the government/taxpayer stepping up to the plate and bailing out the biggest banks. Well not anymore as that implicit guarantee has been replaced by the Basel Accords known as Basel 3 and Basel 4.
Over the Last 12 Months the Volume of Traders Short Selling Bank Stocks in Australia has Tripled.
The stockmarket value of the big four aussie banks has fallen by 15% on average so far this year and 20% to 30% in the past 12 months..- thats the Commonwealth Bank (ASB), the ANZ (ANZ), Westpac Bank (Westpac) and the National Australia Bank (BNZ) - as increased capital requirements - or share holder equity - dilutes returns. They were getting out of hand last year with an AUD 1.43 Trillion Dollar mortgage book with only 4.97% shareholder equity. The big four were happy to be flapping about out there on a 95% LVR !!. Now APRA and the Basel Committee are gunning for them. The top analyst at UBS calculated the big four had a 34 billion dollar shortfall in Tier One capital under Basel 3 which comes into effect on July the first this year.. Not surprisingly in December they all moved their variable interest rate on residential mortgages up by 0.2% without any movement in the cash rate citing the cost of compliance with the new capital controls under Basel 3. With the drop dead date of July 1 looming it is interesting to observe their behaviour.
Watch this space. NZ could well be in the firing line as the owners of our local banks start moving capital around. From NZ to Australia ? Time will tell. This is what is causing the credit squeeze in property development funding (riskweight 150% !!) and investor lending (riskweight on average doubling to 90% for mortgages within the 60% to 80% LVR range) so the six months from July to December this year could become a tough tough ball game.
Has the NZ bank sector passed its cyclical peak ? The answer is a definate Yes. Is it time to start short-selling NZ bank stocks ?
This is where people should get independent advice from their own financial advisor. However I have always said rather than save in a bank term deposit ... buy shares in the bank instead. Now I am saying rather than own shares in a bank ... short-sell shares in the bank.
Funding Trends – Post GFC
Following the 1989 crash, there was a shortage of both funding and demand for property development. Gradually, demand did return in the late 90’s and the conservative policies of the Banks saw the rise of private funding Groups, many of whom solicited funding from the retail market through the issuance of Prospectus’, offering returns well above deposit rates at the time. Such Groups flourished through the early 2000’s despite some notable collapses due to poor and often very questionable management from an ethical perspective. As in 1989, the GFC of 2008 saw the collapse and withdrawal of most of these Property Finance Groups, and the development finance market again went through a lean period due both to demand, and lack of financial capacity.
With a Subdued Recovery Underway From mid-2011 Driven In Part By:
- the shortage of housing particularly in Auckland
- low and relatively stable interest rate environment
- funding options from private sources which are again on the rise however in a different form.
Current Private Mortgage Market Structure in NZ.
The current market in the private money space is being driven by three significant factors.
- Increasing restrictionson Bank funding to the sector due to the Basel 3 and incoming Basel 4 international capital control protocols, which demand Banks make a higher capital allocation for development exposure and therefore reducing the portfolio allocation Banks are prepared to provide into the industry. According to UBS analysts the big 4 Aussie banks, which own the main NZ banks, have a $34 billion shortfall in Tier 1 Capital. In November 2015 they increased their floating residential mortgage interest rates by 0.2% to begin funding this.
- The ready availability/supply of private money due to historically low interest rates which cause such funds to chase attractive returns. The current conditions in the marketplace mean that the risk reward equation is sound.
- The lack of equity held by Development Groups as a result of the difficult environment over the preceding four years and therefore the demand for: senior debt above bank loan to cost and loan to value ratio’s, mezzanine finance facilities and where required, equity top up or recycle via the provision of Preferential Equity
The Market is Therefore Characterised by Entities Providing:
- Preferential Equity
- Mezzanine Finance
- Senior Debt
Unlike times in recent history, the sources of this capacity are more private, discreet, disaggregated and also in some cases, of international origin. Crowd Funding is disrupting the financial service sector in Asia and Australia with Development Finance solutions on the horizon here in NZ.
There are Six Major Sources Currently Looking to Support the Property Development Sector
1. Direct Private Family Money – available for Preferential Equity, Mezzanine and Senior Debt.
2. Private Institutional Funding – the origin of these funds emanate from Superannuation Funds, Listed and Unlisted Property Trusts which also aggregate Investor funds usually on a transaction specific basis.
3. Aggregation Groups – who have a portfolio of Private Investor Clients that will apply Preferential Equity, Mezz Finance and or Senior Debt to projects on a deal specific basis.
4. Private ‘Cash Box’ Investment Groups – who provide Preferential Equity, Mezzanine or Joint Venture capacity on an opportunistic basis. Some specialise in property alone, while others cover the business and the agricultural sectors.
(In my opinion these ‘private investor groups’ are the future of the non-bank lending sector. They are backed by super wealthy individuals with an Institutional funding line. No interest payments to retail investors required like the old mortgage debenture funds and contributory mortgage schemes. They understand how to make money in property development and investment because this is how they created their wealth in the first place)
5. International Investment Groups – often in conjunction with Hedge Funds – predominantly originating out of HK, Singapore & the US as well as Chinese private and Institutional investors taking advantage of the NZ/China Free Trade Agreement.
6. Online Crowd Funding and/or Peer to Peer Lending Platforms providing a new source of capital to bridge the difference between what the developer provides and the banks will fund.
The FMA and the Government really let the nation down by not fostering this sector of the financial services industry back in 2014. Coming out of the GFC development companies could have really used this exciting new source of capital supporting the property development industry.
Here is why. There is a housing shortfall in Auckland. The Government does not build houses – in fact they are selling existing public housing stock. They are leaving it up to the private sector to build the new housing stock required. Lets say there are 100 development companies in Auckland. Each does 1 x residential project a year with their available capital and bank funding. Now if crowd funding for property developers in 2014 became an internally competitive and highly liquid industry these 100 Auckland developers could use mezzanine finance to increase their return on equity and expend half the capital that is required for stand-alone bank funding. These development companies would become stronger financially and far more profitable. They could complete two projects at the same time rather than one project at a time. So that is 200 projects a year compared to 100 projects a year. Currently there are 7000 dwellings under construction in Auckland with 5000 pre-sold. How about 14,000 under construction?
Thanks FMA.. thanks Len Brown and John Key.. with some vision and leadership there could have been 14,000 dwellings under construction by now. This is the solution … but as usual NZ lags behind Asia and Australia due to … weak leadership and a lack of vision.
Or is this how the big boys want it? I will let you decide for yourself. But something is wrong.
It is abundantly clear to me that this new Fin-Tech industry is the ONLY solution to the housing crisis. But the Government and F.M.A twiddled their thumbs issuing new NZ banking licences to Chinese Banks. While leaving it to private entrepreneurs to set up the new source of capital for property developers who will build the houses Aucklanders need to live in.
This has created a property market bubble and increased risk in the banking sector who are now dramatically re-weighting their mortgage books accordingly. Now the Greens want to give Kiwibank $100,000,000 of tax money. Muppets. This will do nothing to create more housing stock in Auckland.
I genuinely feel sorry for all the fixed income workers lumped with huge mortgages for the next 30 years. Now is the time to sell property not buy. Even the experts say the “market” has 2 more years to run. So therefore the next cyclical buying opportunity is in 2 – 2.5 years. Savvy investors are cashing up and waiting for this time to profit over the next cycle.
A Solution ? Short-Sell the Bank stocks. Cash Up. Wait and buy again at the beginning of the next Cycle.
In summary there is no question that in this mortgage market the all up cost of accessing funding from these sources is higher than the pre GFC non-bank funders.
Increased competition from super wealthy investors and their new funding models seeking higher returns will drive competition into new areas and products not traditionally serviced by the non-bank sector. This will move interest rate and establishment fee costs downwards over time.
However even as it is in 2016 when a total return on hard equity from the Sponsors perspective is measured, the equation is acceptable and most importantly the funding enables sound projects backed by competent Sponsors to proceed.
