balmain + commercial + publications + april 2008
Comfortably navigating a "triple whammy" market
Michael Holm - Executive Chairman
April 2008
Even for those of you who did not read our last issue’s main editorial (“Does The Sub-prime Collapse Affect Your Mortgage?” - Issue 5 September 2007) the significant ramifications of the debt capital market’s collapse are now largely understood by everyone.
There is currently a very nasty “triple whammy” occurring for commercial borrowers in Australia. Firstly the cost of money is going up dramatically. The general perceived strength of the Australian economy has resulted in the RBA continuing to push cash rates up during the last two years (from 5% to 7.25% in 12 rises over the last two years) and bill rates, being a better indicator of the commercial reality of the cost of money, have risen by an even greater degree. Many commentators are of the opinion that the RBA has gone too far in using cash rates to slow the economy and that it has not recognised the extent to which the unavailability of credit is already impeding growth. If this view is correct then the likelihood of further cash rate increases is low especially as the effect of the credit squeeze tightens.
Whammy No. 2 is that lending margins are now rising steeply. For good examples of this happening take a look at what margins the banks themselves are now borrowing money. This year the major Australian trading banks are raising money at around 85 basis points (bpts) over cost of funds on offshore markets (last year the cost was 15bpts). There are numerous reasons that margins are rising but the most overwhelming by far is the absence of any effective debt market anywhere outside of Asia and the consequential absence of any investor support.
The real question about Whammy No. 2 is whether the absence of an effective debt market will result in a genuine liquidity crisis. This is hard to predict. The CEO of Fitch ratings, Tim Roche, comments, “local (Australian) banks may have to start rationing loans before the year is out”. John Stewart (MD, NAB) echoed this sentiment when he said, “At the moment, we're at a point where you can get credit but you have to pay a bit more for it. We could get to a point where there's a shortage even if you pay more; we're not there yet, but it concerns me.” Difficult times indeed.
Whammy No. 3 is the unfortunate but almost immediate flow-on effect that has occurred in the property markets. Yields are already softening and there is a general note of caution in the air notwithstanding that the supply-demand equation would still indicate that most Australian property markets should hold up well.
Not much good news so far then … benchmark rates up, margins up and values down.
The real question remains how long will this debt-led crisis last. A very close second comes the question of whether the property markets can withstand the debt market travails until they are cured. So what do we think?
It is a most unusual conflagration to see debt and equities markets in a bear run coincident with sharply increased pressure on property valuation fundamentals. Less surprising is it was caused by a liquidity crisis which effects all sectors. The ridiculously cheap bond prices in the secondary market and the overhang of debt assets on bank balance sheets that was destined for ‘sale’ into the debt markets means any recovery of the debt markets, no matter what the pricing, is some time off. Bad news out of the US is also still not over. Well over US$1 trillion of US Sub-Prime loans are still to default when ‘honeymoons’ end. Continued sub-prime related collapses will occur at the corporate level and further write-offs will ensure that confidence is absent and a recovery some time off. The knock-on effect to the US housing market is also taking its toll on the US economy which effects us all.
The old adage is you need two quarters with no bad news before a market can begin to recover. It is hard to see those two quarters occurring before June 2009. Any sustainable and relevant recovery must be a minimum of 12 months away.
Until then here is our guide for you. If your debt is secured past the 12-18 month horizon you may well escape the worst of the credit squeeze. If you are buying property please take good advice as to the availability and pricing of debt before you are committed. This is especially so if the property is in any way ‘unusual’. Advice is only a phone call away and is free.
If you have to refinance debt in the next 12-18 months you really will need to consider your options carefully. Generally speaking we think your existing lender should be a lot keener to keep your business than a new lender will be to win it. You will, inevitably, have to accept that both benchmarks and margins have moved up but at this stage your best advantage lies with negotiating with your incumbent mortgagee.
Those of you with bank borrowings may well be less lucky and be forced to accept amended loan terms on an annual review. We are already seeing this occurring and we are refinancing a number of our clients into the non-bank sector.
Every market brings with it opportunities and we know that many of our clients who have remained reasonably quiet in the last few years are now starting to slowly smile again.
There is a correction occurring and the private commercial buyer, squeezed out of the market for so long, will likely have their day in the sun again soon.
balmain + commercial + publications + april 2008
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