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by Matthew Smith | 24 Aug 2016

The “other” issue banks still have on their plates — the so-called residential housing property bubble — continues to loom large over the economy, a local funds manager presenting at his investment firm’s overseas headquarters, points out.

While regulatory capital and cost of funding issues have taken centre stage in recent weeks and months, rising property prices and high household debt to GDP remain key concerns for investors and the economy as a whole, says Simon Mawhinney, Allan Gray Australia’s chief investment officer, speaking at his firm’s recent investment conference in Cape Town.

The so-called residential property bubble dominated the public discussion in the middle and towards the end of last year before it was cooled off when the Australian Prudential Regulatory Authority forced banks to tighten their lending standards.

Mawhinney uses the forum at the firm’s offshore investment conference to highlight the risks that lay ahead in the economy stemming from 20 years of high single-digit credit growth which has fuelled residential property prices and led the banks and other related companies to perform well over this time.

“We think this will end so we’ve chosen not to invest in sectors exposed to this,” Mawhinney says.

Allan Gray’s fund invests mostly in materials and energy companies such as oil and gas companies as well as gold and aluminium producers.

“When we look back some years from now, we’ll say, with the benefit of hindsight, that this was an extreme bubble that everyone could see from a mile away,” Mawhinney says.

He points out that as a result of very high property prices, household debt to GDP has risen considerably and now is at 185 per cent of GDP.

“Australian households are the most indebted households in the world,” he highlights.

Household finances

“Yet loan delinquencies in Australia have been very low,” he continues.

Meanwhile he points out that house prices have risen, businesses have performed well and there has been very little bad debt.

“Australia has very high residential property prices, which have probably surpassed every other country. Property prices growing faster than inflation is simply impossible to maintain over the long term. You can’t have a salary that rises with inflation and property prices that rise faster than inflation; in the long run something breaks,” Mawhinney says.

Housing prices

Non-performing loans are very low and impaired loans only represent 0.33 per cent of the total loan book, he says, referencing APRA data.

“This is extraordinarily low and delinquencies are likely to get worse from here, which would challenge bank earnings,” Mawhinney highlights.

He notes that compared to the benchmark his local funds are “very underweight” the financials sector.