Is Australia looking down the barrel of increased mortgage stress?
There are probably few people better placed to comment on the prospect of mortgage stress than the founders of Brisbane-based Gryphon Capital.
Who? I hear you ask. It's a fair question, and the reality is that you're more likely to find Ashley Burtenshaw and Steven Fleming, Gryphon's founders, with their heads buried deep in a spreadsheet than splashed across the pages of the financial press.
But don't be fooled. The highly approachable pair love talking about their asset class, which Burtenshaw describes as one of the most lucrative on the planet.
That description is apt not because of the size of of the returns but due to the highly-consistent and predictable stream of distributions coupled with low capital volatility.
Since listing in June 2018, Gryphon Capital Investments (ASX: GCI ) has paid 51 consecutive monthly distributions above its target of 3.50% above the cash rate, while preserving 100% of investors' capital. As of August the distribution yield coming off GCI was an annualised rate of 6.45%.
"If you think about the design of what we did with GCI, we actually said we do not want to invest outside the jurisdiction of Australia. That was a conscious decision, not some fluke, because the returns that we extract here for our investors, for the risks involved, we firmly believe are the best in the market." - Ashley Burtenshaw
Gryphon invests in the performance of mortgages originated in Australia. These mortgages are sold in the public markets using a bond structure referred to as RMBS and ABS bonds. In the case of Gryphon, they are floating rate bonds, so every month, the cash rate moves up or down, and the level of interest paid is reflected in GCI's returns.
"For our investors, these bonds deliver sustainable and repeatable monthly income at yields we believe to be some of the highest risk-adjusted available in the market, whilst preserving capital at all costs."
Gryphon's track record of delivering on this promise has enabled them to more than double funds under management to $484 million in the Gryphon Capital Income Trust (ASX: GCI ) since it floated in 2018. The GCI listed investment trusts sits alongside $3 billion of mandates that Gryphon manage on behalf of institutions that value capital stability and predictable, consistent distributions.
Is Australia looking down the barrel of increased mortgage stress?
Property is a perennial hot topic in Australia. The RBA's Head of Domestic Markets, Jonathan Kearns, recently used the AFR Property Summit to tackle the issue of rising interest rates and the property market.
Kearns took the long route in highlighting that rising interest rates resulted in higher loan repayments and a reduction in borrowing capacity. He concluded that this could hit house prices – but the quantum and timing are unclear.
But he didn't talk in detail about the impact of increased mortgage payments on existing borrowers and the highly anticipated 'rate shock' for those currently on fixed-rate loans. This is an area that the team at Gryphon have spent a lot of time analysing using extensive data sets to inform their decisions.
"We know which loans are fixed rate, the interest rate, when the loan originated, the term of the fixed rate, and the remaining term before resetting. We know details such as the postcode, the borrower type, the loan balance, original loan-to-value (LTV), current loan-to-value (LTV), and the list goes on." - Ashley Burtenshaw
So, what does the analysis show?
Well, to put it bluntly – there's nothing to see here, says Burtenshaw. Those borrowers most impacted by the increase in rates have mitigating factors, such as long payment histories and low leverage.
The RBA stated that households had been saving heavily and were well placed to deal with rising interest rates. This is an essential factor, and Burtenshaw adds that 2021 saw house prices surge by 22% on average, resulting in a significant build-up in equity, creating flexibility to refinance if required.
Burtenshaw also points to strength in the broader economy, where unemployment is low, and wage inflation has started to climb.
"So, when you roll it up with low unemployment and wage inflation, which has also started to climb, the basic message is the resilience of the Australian household is well and truly in place." - Ashley Burtenshaw
The chart below shows the changes in the minimum loan repayments for mortgage holders in Gryphon Capital's RMBS investments. The firm's analysis in to the prospect of a payment shock has focused on the ~25% of borrowers that will experience an increase in minimum payment of 40%+ (far right column).
Gryphon's risk assessment takes into consideration factors such as the age or seasoning of the loan, repayment habits, how much equity they have and indeed the change in house prices. The analysis of these loans found that average weighted seasoning was five years resulting in substantial equity build up and low levels of gearing.
In addition, a substantial build up in savings means borrowers in this group are well place to cover the rising costs of mortgage repayments.
But there's a twist, an opportunity (and a Buffett quote!)
Right now, it is fair to say that there is significant pessimism and fear surrounding the property market. You don't need to look too far to find predictions of house price falls of 15% to 25%.
And whilst property prices are falling, and the sentiment is cool, the risk-adjusted returns in residential mortgage back securities (RMBS) are better today than at the peak of the cycle, according to Burtenshaw.
Gryphon ran modelling comparing loans issued in 2021 with loans issued in June 2022. The June 2022 bonds have longer payment histories, lower gearing levels, and identical credit ratings and yet are trading at similar margins above the interbank rate.
"The rub here is that our internal modelling revealed the bond issue in 2021 to be close to 4.5 times riskier than the bonds issued in 2022. As a specialist investor, we took lower leverage, more predictability with seasoning, and got paid a similar return, but took far less risk."
Burtenshaw says on a risk-adjusted basis that the returns in RMBS today are better than they were 12 months ago.
"Be fearful when others are being greedy and be greedy when others are fearful." - Warren Buffett.
The one thing that matters most for mortgages
Despite this positive tilt, there are several risks the team is monitoring. These are split into big-picture macro factors and local factors that relate to individual mortgages.
- Sovereign insolvency – in particular, he is following developments in Europe where there are some highly indebted countries such as Italy and Greece.
- Bond markets - Burtenshaw looks for signals in the bond markets and follows the term structures (or steepness) in the yield curves. He notes recent inversions in the US treasury market, which can be seen as precursors to recessions, don't happen that often.
- Cash out and refinancing – an increase in cash-outs and refinancing activity is a red flag that the team looks for.
- Part-time/casual labour – right now, Burtenshaw says he is aware of some of the staff shortages in the hospitality industry, so they are doing work to be across lenders in this space.
Above and beyond all the risk factors above, there is a single factor that can influence the mortgage market: the strength of the financial system and the availability of credit.
Burtenshaw believes lessons have been learned from the GFC and that APRA has done an excellent job introducing measures, such as the 3% serviceability buffer in 2021, that have strengthened Australia's financial system.
"Borrowers need oxygen, and they need credit. That comes from having a very stable financial system. If you go back to '07 and '08, the initial reaction was taking the access to credit away. Bernanke's lesson from the Great Depression was that you've got to give credit to the marketplace.
A property market statistic for your next barbecue
The season is turning, and many Livewire readers will soon gather with friends, cracking a coldie whilst chucking the proverbial 'shrimp on the barbie'. Property will be (as always) a hotly debated topic. So, I thought I'd furnish you with a cracking statistic to ensure you can speak with authority on the topic du jour.
Contrary to the popular narrative, mortgage arrears are falling. That's right, as interest rates rise, the percentage of mortgages in arrears is falling. By how much, you ask?
According to Gryphon's analysis, the percentage of 90 days+ loans in arrears fell from 0.37% in January 2022 to 0.26% in July 2022. That's a 30% decline in the face of five consecutive months of rate hikes from the RBA.
Learn more about Gryphon Capital Income Trust (ASX: GCI)
GCI’s investment objective is to produce regular and sustainable monthly income while keeping capital preservation as a primary concern.
GCI targets the highest risk-adjusted returns sufficient to deliver on its target income distributions of RBA cash rate + 3.50% pa. Click here for more information
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