ADI Housing Credit Still Higher In June 2018

The latest data from APRA, the monthly banking stats to June 2018 show that the banks are still busy lending for home loans. Total balances rose in the month by $9.2 billion, to $1.64 trillion. Within that lending for owner occupied housing rose $7.1 billion, up 0.68% to $1.08 trillion and lending for investment property rose 0.38% to $558 billion. Investment lending comprised 34% of the portfolio, and fell slightly as a result.

The trend growth, over the months is accelerating.  Total credit is still growing at an annualised rate of 6.7%, scary, when incomes and cpi are circa 2% and we have some of the highest debt to income ratios globally.

Looking at the individual lenders portfolio movements, we see that Westpac have been focusing on owner occupied lending growth, while their investor balances fell a little, a similar pattern to the ANZ. On the other hand, both CBA and NAB grew their investor loan books, having given up share in recent months. But Macquarie bank lifted their investor loan book significantly.

Overall shares did not move that much in the month, with CBA still the largest owner occupied lender, and Westpac the largest investment loan lender.

We also updated our annual portfolio movements for investor lending (despite the APRA 10% speed limit no longer being relevant). We see that Macquarie shows the strongest growth in investor lending, alongside AMP Bank, and some of the smaller players. The market annual effective growth rate is 0.96%. ANZ and CBA are in negative territory across the last 12 months.

So in summary, home lending is alive and well, which given the current falls in home prices is a concern – but many households are refinancing to lower cost loans, taking advantage of the  wide range of deals out there, for some. But investment lending remains in the doldrums, if a little off its lows.

Clearly the regulators are betting that income growth will snap back up, allowing for households to service their massive debt burden, but as prices fall for the straight 10th month, and all else being equal its hard to see an easy way out from the debt bomb, as rates rise in the months ahead.

The Great GDP Question And The Road Ahead – The Property Imperative Weekly – 28 July 2018

Welcome to the Property Imperative weekly to 28th July 2018, our digest of the latest finance and property news with a distinctively Australian flavour.

Watch the video, listen to the podcast, or read the transcript.

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Today we start with local economic news. The latest headline inflation rate came it at 2.1%, but the relevant underlying rate was 1.9%. This is even below the 2.0% the RBA forecast in May and continues the trend here, and elsewhere. Economists are scratching their heads as to why, some referring to the not so trusty Phillips curve, globalisation, charging work practices, automation, or something else. We suspect the high consumer debt and limited spending power has played a significant role. Despite the low number, we do not expect the RBA to react with a rate cut.

Rising costs continue to hit households, for example, in annual terms, transport rose 5.2%, and tobacco by 7.8%, plus higher electricity costs, fuel and child care expenses. It also worth noting the regional variations. Sydney rose 2.1 per cent, Melbourne rose 2.5 per cent, Brisbane rose 1.7 per cent, Adelaide rose 2.7 per cent, Perth rose 1.1 per cent, Hobart rose 2.4 per cent, Darwin rose 1.2 per cent, and Canberra rose 2.8 per cent. For more, see our separate post “Debt Crisis – What Debt Crisis”  where we discuss the cpi figures in the context of household debt – here is the link and it’s in the comments below. Otherwise it was a quiet week for Australian economic data. But it’s worth remembering that policy interest rates less consumer price inflation is all still negative around the world. Not pretty.

The US Bureau of Economic Analysis released their GDP Data overnight. The US real gross domestic product increased at an annual rate of 4.1 percent in the second quarter of 2018. This is based on that’s called the “advance” estimate, so it may change ahead. The first quarter, real GDP increased by a revised 2.2 percent.  In addition to the rise in consumer and business spending, increases in exports and government spending also helped. Personal consumption expenditures rose 4 percent while business investment grew 7.3 percent and federal government outlays increased by 3.5 percent. Exports rose in part as farmers rushed to get soybeans to China ahead of expected retaliatory tariffs to take effect in the coming days. Declines in private inventory investment and residential fixed investment were the main drags. President Donald Trump himself tweeted a few days ago that the U.S. has the “best financial numbers on the planet,” while National Economic Council Chairman Larry Kudlow predicted on Thursday that Q2 GDP will be “big.” The administration has used a mix of tax cuts, deregulation and spending increases to push growth. White House budget director Mick Mulvaney told CNBC earlier this week that deregulation likely has had the most impact so far as companies feel more comfortable about committing capital. The next question will be whether the growth spurt is sustainable. There were several jumps in GDP under former President Barack Obama. In 2014 there was a 5.1 percent rise in the second quarter. But by the end of 2015, growth had slowed to 0.4 percent. Federal Reserve officials forecast GDP to rise 2.8 percent for all of 2018 but then to tail off to 2.4 percent in 2019 and 2 percent in 2020. Some economists worried that the jump in consumer spending for the April-to-June period may not be sustainable, adding to scepticism that the gains will continue.

However, the numbers support the Fed’s current plan of gradual interest rate hikes. Fed fund futures continued to price in a rate hike in September and the probability for a hike in December was last at 68.9%, compared to 69.5% before the release. Meantime the US Bond rates are continuing to push higher, with the 3-Month rate slightly up to 1.992, while the 10-year sits just below 3%, and the 30 Year at 3.085. Thus the compression between short term and long term rates continues to bite.

In comparison’ China’s GDP growth remains stronger at 6.8% in the first half, and the IMF is estimating a 6.6% full year out-turn, reflecting the lagged effect of regulatory tightening and softer external demand. Risks are tilted to the downside, with tightening global financial market conditions and rising trade tensions. If the authorities move more decisively to resolve the policy tensions now and focus on higher-quality growth and a greater role for the market, near-term growth would be weaker but longer-term growth would be stronger and more sustainable. An illustrative “proactive” scenario features faster reform progress, particularly state-owned enterprises (SOE) reform and resolving zombie firms, which also accelerates rebalancing from investment to consumption. If there is a risk of a too sharp slowdown, a temporary fiscal stimulus package with resources to support rebalancing could help cushion the near-term adverse impact.

The Chinese Yuan US Dollar fell 0.44% on Friday to 0.14, and the Chinese Yuan Australian Dollar fell 0.43% to 0.19.   The Aussie Dollar remains weaker against the US currency, and we expect this to continue.

The key question ahead is the extent to which the rate of quantitative tightening really starts to bite. According to Fitch Ratings, the combined net asset purchases of the four central banks that engaged in quantitative easing (QE) will turn negative in 2019, one year earlier than previously estimated. This underscores the shift in global monetary conditions that is underway – as strong global growth continues and labour markets tighten – and could portend an increase in financial market volatility.

The four “QE” Central Banks (CBs) – i.e. the Fed, European Central Bank (ECB), Bank of Japan (BOJ) and Bank of England (BOE) – made net asset purchases equivalent to around USD 1,200 billion per annum on average over 2009 to 2017. This is set to slow significantly this year to around USD 500 billion as the Fed’s balance sheet shrinks, the BOJ engages in de facto tapering and ECB purchases are phased out by year-end. More significantly, combined net asset purchases are expected to turn negative next year as the decline in the Fed’s balance sheet will be larger in absolute terms than ongoing net purchases by the BOJ.

They say that private sector investors will be called upon to absorb a much greater net supply of government debt in the coming years as CB reduce holdings and government financing needs persist in Europe and Japan and rise sharply in the US. This will put more pressure on bond rates ahead.

Then of course there is the trade wars question. An escalation of global trade tensions that results in new tariffs on USD 2 trillion in global trade flows would reduce world growth by 0.4% in 2019, to 2.8% from 3.2% says Fitch Ratings‘ June 2018 “Global Economic Outlook” baseline forecast. The US, Canada and Mexico would be the most affected countries. They modelled a scenario in which the US imposes auto import tariffs at 25% and additional tariffs on China, where trading partners retaliate symmetrically, and NAFTA collapses. They factored in new tariffs on a total of USD 400 billion of US goods imports from China in the simulations in light of recent statements from the US administration.  The tariffs under this new scenario would cover 90% of total Chinese goods exports to the US when added to tariffs on USD 50 billion of exports already announced. They suggest that the global drop of 0.4%.

The tariffs would initially feed through to higher import prices, raising firms’ costs and reducing real wages. Business confidence and equity prices would also be dampened, further weighing on business investment and reducing consumption through a wealth effect. Over the long run, the model factors in productivity being affected as local firms are less exposed to international competition and so would face fewer incentives to seek efficiency gains. Export competitiveness in the countries subject to tariffs would decline, resulting in lower export volumes. The negative growth effects would be magnified by trade multipliers and feed through to other trading partners not directly targeted by the tariffs. Import substitution would offset some of the growth shock in the countries imposing import tariffs. The US, Canada and Mexico would be the most affected countries. GDP growth would be 0.7% below the baseline forecast in 2019 in the US and Canada and 1.5% in Mexico. The level of GDP would remain significantly below its baseline in 2020. China would be less severely impacted, with GDP growth around 0.3% below the baseline forecast. China would only be affected directly by US protectionist measures in this scenario, whereas the US would be imposing tariffs on a large proportion of its imports while being hit simultaneously by retaliatory measures from four countries or trading blocs.  US tariffs would hit Chinese imports like mobile phones, laptops, clothing and footwear, all of which may mean consumers will spend less. Meantime, Australia and other countries would likely be caught in the cross-fire, so some extent.

But perhaps the market’s trade-war worries may have hit an inflection point this past week. Trump proclaimed the United States and the European Union had launched a “new phase” in their relationship following a meeting with European Commission President Jean-Claude Juncker on Wednesday. The leaders pledged to expand European imports of U.S. liquefied natural gas and soybeans and both vowed to lower industrial tariffs. They also agreed to refrain from imposing car tariffs while the two sides launch negotiations to cut other trade barriers, as well as re-examine U.S. steel and aluminum tariffs and retaliatory duties imposed by the EU “in due course.” The upbeat remarks helped ease some of the fears of a transatlantic trade war. But there is still China to consider. China said Thursday it was ready to retaliate against any increase in U.S. tariffs on Chinese imports — be it $16 billion or $200 billion — an official in Beijing said, according to Bloomberg.

And just remember the US is funding its growth by running higher deficits, and the tax cuts for corporates has led to a cut in taxes from that sector, a skewed the tax take significantly towards individuals.  More pressure on US households.

Looking across the markets, the ASX 100 ended the week higher, up 0.95% to 5,180.  Bank stocks helped lift the index, with the largest owner occupied mortgage lender, Commonwealth Bank up 0.71% to $75.36, Westpac, the largest investor mortgage lender up 1.10% to 29.47, National Australian Bank up 0.96% to 28.40 and ANZ Banking Group up 1.62% to 29.48.

But AMP took a bath, following the release of their “recovery plan”.  AMP has a massive hole to dig itself out of, given the evidence revealed during the Royal Commission. They charged fees for no services (which by the way other organisations also did), but then appeared to deflect and mislead the regulators pointing to a concerning set of cultural and behavioural issues across the organisation, and to the highest levels in the company.  They have destroyed significant shareholder value, and worse have milked some of their customers for years. The reputational damage is excruciating. They announced a series of measures designed to give the investment market some comfort that action is in hand, although the specifics remain vague, and it is unlikely to placate the potential class action horses circling the AMP wagons. It is hard to judge whether these measures will ever fully compensate customers of AMP for their blatant acts of deceit, and whether shareholders will view the announcements as necessary and sufficient to get to the root causes of the systemic poor practice. The 4% fall in the share price following the announcement suggests probably not and in fact the total potential liabilities facing the company are also probably unknowable at this time. So, my reaction was too little too late. The repair job has only just started and will take years to complete, if indeed this is possible at all. Other investors seem to agree, with the price falling 5.17% to $3.30, a price not seen since the early 2000’s. Takeover target anyone?

In the US markets, Facebook sent a huge tremor through tech stocks this week with a worrying warning about revenue that sent the stock spiralling to a record-setting market-cap loss. Shares of Facebook sank nearly 19% on Thursday, slashing the company’s value by about $120 billion. That was the largest single-day loss in market cap in Wall Street history. Revenue missed expectations, but it was the conference call that really spooked investors. “Looking beyond 2018, we anticipate the total expense growth will exceed revenue growth in 2019,” CFO Dave Wehner said on the conference call. “Over the next several years, we would anticipate that our operating margins will trend toward the mid-30s on a percentage basis.” Facebook also predicted its total revenue growth rate would continue to decelerate in the third and fourth quarters. But it’s worth putting this in context of its long term price growth, from around $50 a share in 2014, to $175 a share now, after the drop.

Just a day after Facebook’s drop, Twitter caused its own shockwaves in the social media space. The stock tumbled more than 20% on Friday after the company reported a surprise drop in average monthly users. Average monthly users dropped to 335 million from 336 million in the first quarter, due to deletion of fake accounts and bots, or, as the company put it, “prioritizing the health of the platform.” Shares of Twitter had wavered earlier in the week after President Donald Trump accused the company of shadow banning Republicans (effectively making the user impossible to find). The company responded that it does not shadow ban in any cases. The longer term trend is starkly different from Facebook, back in 2014 it was priced at well over $50, today, after its 20% fall it was sitting at $34.

The broader markets were down on Friday, despite the GDP numbers, with the S&P 500 falling 0.66% to 2,818, the Dow Jones Industrial average down 0.3% to 25,451 and the NASDAQ, where many of the tech stocks hang out down 1.46% to 7,737. The Volatility Index was higher, up 7.33% to 13.03, suggesting more risks than last year, but still well the panic peak in the earlier part of the year.

Crude oil prices ended the week slightly lower after a selloff Friday ending at 69.02, down 0.85%. But supply concerns remained front of mind for traders. Data released this past week showed that US crude oil inventories fell to their lowest level since 2015 as exports jumped and imports fell sharply. Also, Saudi Arabia temporarily paused shipments through the Bab el-Mandeb strait, which joins the Red Sea to the Gulf of Aden, after two of its oil tankers were reportedly attacked by Houthi rebels. The disruptions in the Middle East come as market participants continue to bet on further disruptions in oil flows underpinning oil prices. “The potential for further disruptions remains high in Libya, Venezuela and Nigeria with last week seeing new disruptions in Norway and Iraq, and Saudi has little incentive to let inventories rise,” Goldman Sachs said in a note to clients Thursday.

Gold fell to 1,222, down 0.29% suggesting that investors are still preferring the US dollar and Copper was down 0.78% on Friday to 2.796. Bitcoin rose to 8,160 up 2.51%. This week we discussed the potential for Bitcoin and compared it with other forms of money. The bottom line is; it may have a place. See our post “Some Myths Around Bitcoin”.

And so finally, back to the property market. CoreLogic reported that last Saturday the combined capital cities returned a final auction clearance rate of 57 per cent last week, improving on the 52 per cent over the week prior across a similar volume of auctions.  There were 1,257 homes taken to auction last week, increasing slightly on the 1,178 held the previous week.  While one year ago, a higher 1,748 auctions were held with a 69.9 per cent success rate.  And the number listed for auction, but not taken to auction rose again.

Melbourne returned a final auction clearance rate of 59.9 per cent across 613 auctions last week, increasing on the 56.2 per cent over the week prior when fewer auctions were held (559). Sydney’s final auction clearance rate came in at 55.2 per cent last week, rising on the week prior when the city returned the lowest reading since Dec-2012 with only 46.9 per cent of auctions successful. Auction volumes were virtually unchanged over the week with a total of 407 held.  As usual the performance across the smaller auction markets was mixed last week, with clearance rates improving in Adelaide and Brisbane, while Canberra, Perth and Tasmania saw clearances rates fall week-on-week.

The Gold Coast region was the busiest non-capital city region last week with 49 homes taken to auction, although only 33.3 per cent sold. Geelong was the best performing in terms of clearance rate with 61.5 per cent of the 32 auctions successful.

This week, the final week of July will see a total of 1,430 homes taken to auction; a slight increase on the 1,257 auctions held last week as at final figures, although lower than the 1,987 auctions held on the same week last year. They say that while it is not unusual to see auction activity cool off throughout the winter period, this year has seen weekly volumes trend lower when compared to the equivalent June- July period last year. With clearance rates at their lowest levels since 2012 there is some clear reluctance in the auction market as capital city dwelling values soften. Melbourne is set to be the busiest auction market this week, with 746 homes scheduled for auction, while in Sydney, 443 homes are scheduled for auction this week. Across the smaller auction markets, Brisbane and Perth will see a higher volume of homes taken to auction this week, while Canberra and Tasmania have fewer scheduled auctions and activity across Adelaide will remain steady.

Prices are still weaker in most markets, and this trend is likely to continue. And the averages mask significant differences across individual locations. For example, at the Sydney SA4 level, units in the Baulkam Hills and Hawkesbury areas have fallen 19% from their peaks, while houses in the City and Inner South have fallen 13.6%, and 10.5% in the Inner West.  Prices fell by 10.6% in Ryde, 8.7% in North Sydney and Hornsby and 6.8% in Blacktown. Once again this underlines the importance of getting granular when it comes to the property market.

And remember that the household debt to GDP ratio in Australia is very high, on an international basis, at 121.7%, just behind Switzerland. Canada in at 100%, the UK at 86.7% and the USA 78.7%. We are full of debt. And our baseline modelling and household surveys signal more weakness in the months ahead, and those spruiking a soft landing and an imminent recovery seems to be missing the obviously tighter credit tightening, selective discounting for some lower LVR refinances, and the impending issue of Interest Only refinancing. Combined these forces will remain potent.

The Treasury’s Mugwump Submission To The Royal Commission

For those who do not know, a mugwump is “a bird who sits with its mug on one side of the fence and its wump on the other.”

That came to mind as I read the Treasury submission to the Royal Commission into Financial Services misconduct which was released recently on three matters:

  • the culture and governance of financial (and other) firms and the related regulatory framework;
  • the capability and effectiveness of the financial system regulators to identify and address misconduct; and
  • conflicts of interest arising from conflicted remuneration and integrated business models.

They say these three issues were drawn from the case studies to date that point to: numerous failures by firms to adhere to existing regulatory obligations and deal openly and honestly with the regulators; an indifference by a number of firms to delivering good consumer outcomes, as well as a lack of investment by some firms in systems and processes to monitor product performance and staff conduct; and at times an unsatisfactory attitude and approach to remediation where issues have been identified.

These outcomes reflect instances of failures of leadership, governance and accountability at an industry, firm and business unit level. Where misaligned incentives and conflicts of interest have been present, the underlying failings and the poor outcomes have been exacerbated.

Competitive forces have been unable to fully temper these problems and hold firms to account. In part this is due to the advantages of incumbency and continuing barriers to entry for new firms. It also reflects a lack of effective demand-side pressure. Consumers, when interacting with the financial system, face products and services that are inherently (or by design) complex, opaque and typically have long durations; conflicted advice can worsen the problem. With ineffective competition, profitability can remain high for financial firms even if consumer outcomes are poor. Their shareholders (both retail and institutional) can remain largely complacent about governance and culture, and consequently poor conduct can persist.

The evidence suggests that while financial system regulators have been alert to the problems and have taken action, they have not yet been able to change the underlying behaviours of many of the firms and industries involved.

In our view, the financial system and the regulatory framework cannot perform efficiently when there is a disregard by financial firms to adherence to the law and broader community standards and expectations regarding their trustworthiness. Fundamentally, responsibility for complying with the law rests with those to whom the obligations apply.

Turning the the Mugwump in Action.

They say that ASIC and APRA are world class regulators, and they were across the issues.  The problem lies within the culture of the firms. And, by the way, the Council of Financial Regulators (of which Treasury is a member) is acting just fine. “At a structural level, Australia’s ‘twin peaks’ model of financial regulation – where responsibility for conduct and disclosure regulation lies with ASIC and responsibility for prudential regulation with APRA – has clearly served the financial system and economy well and remains appropriate. Similar architecture has been adopted in other jurisdictions and ASIC and APRA are well-regarded by peer-regulators in other countries and by international standard setting
bodies and organisations.

They do say it is clear that the current regulatory framework and its enforcement are not delivering satisfactory outcomes and that shareholders’ interests do not necessarily coincide with customers’ interests, particularly in the short-term; indeed much of the misconduct has generated significant returns to the firms that have flowed through to healthy dividends. But the problem is accountability in firms and the complexity of the law. Extending the BEAR, or a like regime, to a wider range of entities may be one way to lift standards of behaviour and conduct across the financial sector. But the fundamental limitation of such reform is that it relies on shareholders to agitate when remuneration policies do not serve consumer interests — and they may not do so.

But they also warn that over time, a financial system that is overburdened by regulation will fail to deliver on its objectives of meeting the financial needs of the community and facilitating a dynamic, stable and growing economy. Thus reforms to ensure consumer confidence through strong respected regulators must balance the efficiency and ability of the financial system as a whole to succeed.

With regards to conflicted remuneration, again they acknowledge that wrong incentives can lead to bad customer outcomes, yet fall short of supporting the idea of, for example, removing broker commissions and trails, warning darkly of unintended consequences.

All remuneration structures and business models can give rise to conflicts of interest, even if its form differs or the parties concerned vary. When markets function well, commercial practices evolve to best manage the multiplicity of interests and potential conflicts. Hence, overly prescriptive interventions —not taking account of all the trade-offs involved — can give rise to costs and unintended consequences.

Our judgment — subject to evidence in future hearings — is that recent structural changes in the industry, recently introduced or soon to be introduced reforms, other potential reforms the Commission could recommend, and heightened attention by firms and ASIC, should be sufficient to mitigate the systemic risks involved — subject to further ongoing scrutiny by regulators. Structural separation would also be complex and disruptive, and could have unintended consequences.

That said, There is clear evidence from the hearings and ASIC that vertically integrated firms have often not appropriately managed these conflicts, despite general legal obligations to do so.

Brokers are currently paid by lenders (via aggregators) using a standard commission model. This model includes upfront and trailing commissions which are proportional to the size of the loan, and subject to clawback arrangements which allow lenders to recover some or all of upfront commissions if a loan goes into significant arrears or is terminated within a specified period. These commissions have also been supplemented by volume and campaign-based bonuses, as well as non-monetary benefits that are predominately determined by volume targets. These features of the standard model give rise to conflicts of interest for brokers that could lead directly to poor consumer outcomes and reduce competition.

There is a risk that brokers working under vertically integrated aggregators may recommend specific in-house loan products that may not provide the best outcome for a consumer. Again, they are also suggestive of a potential negative effect on competition in the mortgage market at the expense of customers more generally.

Proposals for upfront, flat fees can involve up to three distinct changes to current industry practices:

  • a move away from remuneration set by reference to loan size, to one of a fixed dollar amount per loan (possibly still varying with loan or lender type or characteristics);
  • ending the practice of trail commissions; and
  • requiring the payment to be made by the consumer and not the lender.

The first of these would directly target the incentive to encourage customers to take out larger loans, though in practice the consequence of this incentive may be quite limited. It would create some other misaligned incentives that would also need to be managed, such as the need to limit the splitting of a loan into multiple loans to generate additional broker fees.

The industry argues that a larger loan size correlates with greater complexity and hence effort on the part of the broker. If this is correct, brokers could have an incentive under a flat fee to service only those customers with straightforward needs, disadvantaging those with more complex needs such as first home buyers. The correlation between loan size and broker effort is, however, not obvious and commissions can already vary according to product and lender characteristics and flat fees could also do so.

The second change, of removing trail commissions, would have the potential advantage of removing incentives for brokers to inappropriately recommend larger loans that take longer to pay back (though, again, how significant this incentive is in practice is unclear), and brokers would have greater incentives to assist customers to refinance.

The removal of trails would, however, also reduce incentives for brokers to guard against arranging non-performing loans and to not unnecessarily switch consumers to alternative loans that do not provide for a better deal. Refinancing is not a costless exercise, with real costs for both lenders and borrowers. In the United Kingdom, where trails are not used, concern over churn has led lenders to pay retention fees to brokers to encourage consumers not to switch lenders but refinance at a different rate.

Services provided by brokers to customers after a loan has been arranged could also be affected if trailing commissions were removed.

The third change, of requiring consumers rather than lenders to pay the broker, would be the most radical. Without any significant remuneration from lenders, brokers’ loan products and lender recommendations are more likely to align with the consumers’ best interests or be more transparent if they do not. Some specific payments from lenders to brokers may, however, need to be retained if they were to continue to provide specific services to the lender.

The standard commission structure represents a balancing of commercial interests and responsibilities between lenders, aggregators and brokers, as well as the interests of consumers. Too prescriptive and fixed a model risks being commercially inefficient, particularly as the market develops over time and technological and other innovations arise, and negatively affecting competition. While the online and technology based mortgage broker start-ups remain nascent, they are also innovating with remuneration structures (such as rebating commissions to customers) as a point of competitive advantage.

As brokers act as trusted advisers for customers with respect to housing finance, there is an in-principle case for introducing a positive duty on brokers to act in the interests of their customers. While responsible lending obligations provide protection against customers being recommended loans that are too large or otherwise not suitable for them, the purpose of a positive duty would be to counteract incentives to, for example, recommend a particular lender and loan type because the commission available to the broker is higher or because the loan is an in-house or white label product.

Applying a positive duty to brokers would not, however, necessarily be best achieved by attempting to replicate the financial advice best interests duty given differences between brokers and financial advisers, and the existence of responsible lending and other obligations. If it was to be introduced, careful consideration would again need to be given to an approach that mitigates conflicts of interest risks while avoiding unnecessary compliance costs, and to what extent it can rely on industry efforts or providing ASIC with some discretion or rule-making power.

Finally, with regard to employee incentives, the Treasury paper says that given the impending introduction of new powers for ASIC and the efforts of the banking industry to undertake significant reform itself, it is not clear that further regulatory interventions are merited at this stage. While the policy focus has traditionally been around remuneration, it is also relatively easy for firms to reward staff that are high-sellers (or to penalise poor-sellers) without resorting to a direct link to remuneration. As general obligations already exist to manage such conflicts, the broader issue raised is that of firm culture and governance.

S0, reading the submission, I felt the Treasury was firmly sitting on the fence, acknowledging the issues raised (they could do no other), but falling back to incremental changes, warning of unintended consequences, and pointing the figure at cultural bad practice in financial firms. The regulators escaped scot-free.

Frankly I found the submission all rather embarrassing…  and rather missed the point!

I expect the Royal Commission will do better.

Reasons to Get a Mortgage Refinance

There are some amazing mortgage refinance deals out in the market at the moment as lenders seek out lower risk mortgage borrowers, so it is worth considering whether a refinance is appropriate for your financial situation.

There are both benefits and risks, as this guest post from NSW Mortgage Corp highlights.

First let’s be clear what a refinance is. Essentially it means transferring your current mortgage to another lender, (or a different loan with the same lender), and it may be for the same amount, or if there is sufficient equity, you might be able to get a bigger loan. But there might be fees to do this, and not all lenders have the same deals, so it is important to shop around.

There are a range of scenarios where a refinance makes sense.

Reducing Monthly Payments and Avoiding Default

Many households are finding their monthly mortgage repayments a strain, yet they are not necessarily on the lowest available rate. Depending on your current rate it might be possible to reduce the real monthly payments. In some cases, this make the difference between keeping the mortgage up to date and missing payments, which might lead to default.

Helping with Home Renovations

With home prices on the slide in some areas, more home owners are looking towards home renovations as a way to increase the equity in their home. But, home renovation is costly. Renewing or restoring your home to its former conditions may require expensive materials and skilled labor. You need money to finance house renovations like fixing of old walls and ceilings, repainting and plumbing works. Things could get more costly if you would include roof repair or replacement, fixing of sewer line problems, and fixing pest problems.

But if there is sufficient equity in your property (value of the property less current mortgage) it is feasible to refinance and drawn down money for renovation. Often this is a more cost effective route than looking to fund renovations on a credit card, or even a personal loan, because secured interest rates tend to be significantly lower.

Invest in Education

Some households use equity from their property to pay for or to complete a college education, but this is getting more costly with time. For those thinking of going back to school while working, taking a break to complete the course funded from equity might work for you (provided the mortgage repayments can still be met from the household budget). Applying for refinance mortgage could spell the difference between a good and stable career and failure. Sometimes, you just have to make the decision and move forward with your career goals. In the same way, parents who are willing to send their children to a good school can take advantage of mortgage refinance. They can use the money to pay off the old mortgage and get some extra cash for their child’s education. This way, you don’t have to get another short-term loan or charge your credit card with a high interest date for your child’s tuition fees.

Pay outstanding bills

This is more tricky, but in some cases a refinance can be used to pay outstanding bills and so avoiding missing payments, save money on late fees and avoid getting a bad credit score. Think of this as a one-time opportunity to revamp your finances, as it’s not something which can be repeated often, the equity in the property is not an ATM.

Also, some loans have pre-payment penalties, while others don’t. So before you make any advanced payment, clear this up with your creditor. You can also pay overdue bills and save yourself from collectors and court suits.

The Small Print

But, you have to face one big truth – not all refinance mortgages are the same. There are lenders who have lenient standards and those that are very strict especially in terms of your income requirement. Others have strict credit score requirements and financial documents. So, before you sign up for the next refinance mortgage, ask everything you need to know about the requirement and the loan agreement.

While there are many benefits to mortgage and home refinance loans, there are risks to keep in mind as well.

Before choosing a refinance product:

  • Shop around and ensure you choose a refinance product best suited to your needs. Criteria includes what your loan to value ratio (LVR) is, and which home loan features you need or which features you no longer want
  • Make sure that the new mortgage is cheaper than your original mortgage
  • Be aware there may be high exit fees for leaving your fixed rate home loan early, and upfront fees from your new lender. Ask about additional costs such as private mortgage insurance, application of valuation fees, and the possibility of getting a third mortgage
  • Know the modes of payment. Some lenders offer interest only payment, which may sound so good because of low monthly dues, but it can actually draw more money from you because you are simply paying the interest and not the principal. Make sure that the payment terms allow you to pay the principal, plus the interest each month
  • Consider the housing market. Don’t get refinancing when the market is not doing well. You may end up paying very high fees in exchange of a loan. Why don’t you wait till it gets better? Or, you can opt for a more practical solution. Look for a lender that gives you an interest rate and loan costs which is similar to loan terms when the market is favorable. Remember that volatility has a high impact in the pricing of the real estate properties and the mortgage fees as well
  • Check whether making multiple refinance applications are damaging your credit file. Only make soft enquiries which do not affect your credit score

There are many reasons to get a mortgage refinance, but it ultimately depends on your situation. Always shop around and take your time to do research before making a decision. While shopping around, avoid making hard inquiries as this will lower your credit score which will result in getting higher interest rates. By considering all the advice given in this article, you will be able to determine which refinance product is best for you.

The Savings Market Is Not Working

One of the critical issues which is hardly discussed in the media is that fact that many savers have funds in accounts which are paying very low rates of interest, when in fact there are better deals available. This little guilty secret allows banks to pump up their margins, offer highly attractive rates to capture new customers then milk them down stream.

Paying lower interest rates to longstanding customers is a long-running pricing strategy used by firms around the world, and gets almost NO coverage.  Its a blatant example of “price discrimination” which occurs when providers offer different prices to different customers that have the same costs to serve but different willingness to pay.

But now the UK’s Financial Conduct Authority has released a discussion paper on the problem, which we also see here in Australia. They believe this is unlikely to change without further intervention. They propose a solution which we think might be worth looking at here too.  So today I am going to look through their report, and discuss the issue in depth.

Many savers (yes there are still some with money in the bank despite the debt bomb), have their hard earned funds sitting in low interest paying accounts.  Their research shows that 33% of the £354bn easy access savings account balances in savings accounts in the UK have been in accounts for more than 5 years, and that on average longstanding customers received on average 0.82% less than accounts opened more recently. A similar trend is also reported in the £108bn investment savings account, where again longstanding customers received on average 0.87% lower.

They call out the high level of consumer inertia in the cash savings market, with only 9% of consumers switching in the last 3 years. Their research also highlights that providers have multiple easy access products, leading to confusion for consumers, and large personal account providers have a competitive advantage over smaller providers.

So they has initiated a discussion about what should be done in the UK to improve outcomes for customers.

They say that consumers are put off switching by the expected hassle; large, well-established personal current account providers are able to attract most savings balances despite offering lower rates; and there is a lack of product transparency.

In fact this is the latest in a series of interventions which the FCA has been look at since 2015. They initially trialed

  • A switching box: provided to customers periodically, setting out the potential financial gains from switching. This would prompt customers to consider their choice of account and provider.
  • RSF: a simple ‘tear-off’ form and pre-paid envelope which would enable a customer to switch to a better paying account offered by their existing provider more easily (internal switching).

Neither worked that well, though the second, a simple tear-off form was a little more effective.

They also tried what they called a sunlight remedy for 18 months in 2015-16. In this trial, they asked firms to provide data on the lowest possible rate that customers could earn across all their easy access savings accounts and easy access cash ISAs. This was split into on-sale and off-sale accounts and branch and non-branch accounts. They released the data over 12 months, via publications. However, they found that the trial did not have a clear, measurable impact on providers’ rate setting strategies. There may be several reasons for this, including that the rates published did not always accurately reflect the rate being paid to most customers.

In the current paper they describe some of the other options they considered, including a complete price discrimination ban on easy access cash savings products. This would involve firms being required to offer single interest rates for all easy access cash savings accounts and easy access cash ISAs, irrespective of the length of time the account has been open.

Banning price discrimination would address the harm against longstanding customers. Under this approach, providers would be unable to offer different interest rates based on age of account. Longstanding customers would have the most to gain from this approach as they are likely to see an increase to their interest rates. Furthermore, customers would not have to take any action to be put on to the same rate as new customers.

It would also increase transparency as providers would be unable to obfuscate prices by making interest rates for all customers clear. This would make it easier for customers to understand and compare their interest rate. It would therefore be beneficial for competition as it would make it easier for customers to shop around for a potentially better value product with an alternative provider.

It may be beneficial for smaller providers with smaller back-books as it would not affect them as much as providers with larger back-books. Smaller providers would therefore be able to continue to offer higher rates than large providers, attracting customers.

This would make it easier for small firms to attract new balances and thus expand. The increased transparency adds to this effect as customers would be able to compare rates more easily and understand how different providers treat their customers.

However, the FCA says that although they have not performed any detailed modelling of this potential remedy, they believe that the unintended consequences of this approach could be significant and may outweigh the intended benefits. First, retail deposits make up a vital part of providers’ funding strategies, with 87% of funding generated by customer deposits (either current accounts or savings accounts).

This approach is, therefore, likely to have an adverse impact on funding models. It would significantly decrease flexibility and reduce providers’ ability to alter their pricing strategies to manage their funding  requirements, ie by either shedding or attracting deposits. They
consider that this could lead to significant unintended consequences. They, therefore, believe that a less restrictive option would be more proportionate relative to the harm. Secondly, the impacts may be offset by significantly reducing front-book interest rates across the board, particularly for larger providers. This is because providers may find it too costly to increase interest rates on all back-book accounts. This may reduce the benefits of shopping around for more active customers who wish to remain with a larger provider.If the customer knows they are getting the best internal rate, there may be less of an incentive to shop around at all. If fewer customers shopped around, this may have the effect of further entrenching the power of the incumbents.

So, instead, they suggesting the introduction of a basic-savings-rate (BSR).
The BSR would involve providers applying single interest rates (BSRs), respectively, to all easy access cash savings accounts and to all easy access cash ISAs which have been open for a set period of time (for example, 12 months). Individual providers could decide the level of their BSR, and would be able to vary it. Providers would remain able to offer different interest rates to customers in the period before the BSR applies (the front-book).

The BSR option that they have modelled is based on providers having broadly 3 groups of customers:

  • front-book customers who opened their accounts less than 1 year earlier
  • mid-book customers who opened their accounts between 1 and 2.5 years earlier
  • back-book customers who opened their accounts over 2.5 years earlier

They suggest that consumers could gain £300m per year –  (actually a range of £150m – £480m)

This is a net transfer from firms to customers, taking into account the ‘waterbed effect’ between the different customer groups. They envisage that a BSR could apply to an account after it has been open for a specified length of time. Providers would retain the freedom to offer a full range of easy access products to front-book customers (ie on accounts before the BSR applies) and would also be free to offer the BSR to front-book customers.

They envisage that a BSR could apply to all banks and building societies that offer easy access cash savings accounts and easy access cash ISAs. Credit unions were excluded from the scope of the CSMS as most products they offer could not be substituted for others. Most credit unions offer a dividend rather than an advertised interest rate on their savings. This dividend can depend on how much profit the credit union has made in the year.

They say it would be important for the BSR to be communicated effectively to consumers. This would ensure that consumers are aware of the changes to their interest rate on their savings account and prompt them to consider their choice of savings account and firm; in doing so, they may increase competitive pressure. In addition to providers’ current obligations on the communication of interest rate changes, to provide clarity to consumers before they open their account, providers could:

  • display their BSR prominently on their webpage, clearly stating that this is their ‘Basic Savings Rate’ and that it is comparable
  • include the BSR in summary boxes for easy access accounts; they could make the interest rate that would apply after 12 months clear and include a projection of the balance of the account when the BSR applies based on a £1,000 account balance.If a BSR were to be proposed, the FCA’s current view is that providers should communicate the change to existing customers when they first implement the BSR. Sunlight remedy linked to a BSRAs a development of the sunlight remedy trialled in 2015-16, they could introduce a sunlight remedy linked to the BSR. They could ask providers to report their BSRs to the FCA to be published on the FCA website biannually. The aim of this would be to bring to light firms’ strategies towards their longstanding customers. They would expect this to:
  • be reported by the media as an indicator of how firms treat longstanding customers, exerting reputational pressure on firms to change their behaviour
  • increase back-book rate transparency, removing a switching barrier by making it easier for customers to understand if they are getting a good dealThey believe that publishing BSRs on the FCA webpage would be more successful than the sunlight trial, given that the BSRs would be directly comparable across firms. they, therefore, believe this would be more likely to have an effect on providers’ rate-setting strategy.

I think its time we had a debate in Australia about the same issue, because data from my surveys highlights that many savers are not getting the best returns they could.  So far as I can see ASIC has not even looked at the problem, more shame on them. Another case where regulators here are asleep, and customers are being ripped off as a result – does that sound familiar?

Higher home loan rates in Australia are positive for small and midsize lenders

According to Moody’s , Australian regional banks Bendigo and Adelaide Bank  and Teachers Mutual Bank Limited increased their home loan rates.

This follows a number of other small and midsize banks that have recently raised their home loan rates, taking the total to 16. The increase in rates is credit positive for these banks because it will help preserve their net interest margins amid higher wholesale funding costs and slower loan growth.

In contrast, Australia’s four-largest banks – Australia and New Zealand Banking Group Corporation, Commonwealth Bank of Australia, National Australia Bank Limited and Westpac Banking Corporation – have yet to raise their lending rates amid intense political scrutiny and against the backdrop of a probe by Australia’s Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry. Given that the four major banks have traditionally been the first-movers on headline home loan rates, we see smaller lenders’ willingness and ability
to increase rates as credit-positive evidence that they retain pricing power independent of the current challenges confronting the major banks.

To date, the rate increases have been concentrated in variable-rate home loan products, which are more popular in Australia than fixed-rate loans, at about 10 basis points for owner-occupier principal and interest loans, and higher for riskier products such as investor and interest-only loans.

Higher home loan rates will offset higher wholesale funding costs, with short-term funding costs being particularly affected.

 

Long-term debt issuance costs have increased proportionally less and, importantly, remain low by historical comparison. As such, the effect on banks’ weighted-average cost of long-term debt has thus far been muted. Positively, blended average deposit costs are marginally lower because banks have been paying lower rates on short-term deposits. The net effect varies by bank, according to various factors including their loan mix and funding profile. For instance, midsize listed banks have a moderately lower proportion of home loans and more short-term wholesale funding than smaller, predominantly mutual banks, which tend to have a higher concentration in home loans and are principally retail deposit-funded. As a consequence, the smaller banks may gain a little more profitability benefits from the latest round of rate increases. Following the rate increases, smaller banks still offer more favourable headline home loan rates than the major banks. However, the majors continue to offer significant discounts to attract the highest-quality borrowers at a time when system loan growth has slowed.

Despite the very high level of household leverage in Australia, we do not expect the current round of home loan rate moves to cause a sharp increase in loan delinquencies or credit costs. That is because labour market conditions, which are a strong indicator of mortgage performance, are likely to remain favourable, underpinned by solid economic growth forecasts. Additionally, the increases in home loan rates are small compared with the buffer built into home loan serviceability assessments. Australian lenders commonly assess borrowers’ repayment ability based on an interest rate floor of 7.25%, which is well above the average home loan rate of around 5.25% posted by Australian banks over the past three years. Moreover, collateral quality will remain strong, despite ongoing house price corrections in Sydney and Melbourne. The average loan-to value ratio for Australian bank home loan portfolios remains around 50%.

The Two Sides Of The Household Debt Issue

Michael Pascoe has penned an article in the New Daily, which attempts to bring some balance to the discussion of the severity of household debt in Australia.

“there are no guarantees and household debt levels do indeed need watching, but it’s not as simple an Armageddon as the scaremongers would like you to think”.

Good on him, for not just following the herd on this one. Because the debt footprint is more complex than some would like to admit.

Averaging data tells us very little. For example the RBA chart showing 190 debt to income includes all households, including those without debt, so the ratio is higher for those with big debts.

Second,  you have to look at individual households and their finances. This is of course what our surveys do, alongside details of their overall assets, and net worth.

And yes, many are doing just fine (even if much of those assets are in inflated housing, or superannuation which is locked away).

But it is the marginal borrower who is under the gun now, even at rock bottom interest rates, and banking lending standards are a lot tighter so around 40% of households are having trouble getting a refinance.  Plus we do have problems with some interest only loans, especially where the borrower is a serial leveraged investor with a significant number of properties.

Then of course there is the question of whether employment rates will rise or fall, and the quality of new jobs on offer. As a piece in The Conversation today shows:

many jobs are Job creation in the female-dominated health and education service sectors is driving both full-time and part-time employment growth in Australia.

And some of these will be less well paid.

Here is a plot for all households of TOTAL debt repayments as a ratio to income at the current time. This includes households with a mortgage, those who own property outright and those renting. Many have no debt.

For those borrowing, debt can include mortgages (both owner occupied and investor), personal loans, credit cards, and other consumer finance.  This does not include business lending.

Many more have commitments which require less than 20% of household incomes (from all sources). But others have much higher debt servicing requirements, and a few are through the 100% barrier – meaning ALL income is going to repay debt. Not pretty. In some cases this is triggered by changes in personal circumstances.

If you boil it back to owner occupied mortgage borrowers, then our data suggests around 30% have little wiggle room at current levels. Even small rises would be concerning.

And at the end of the day it will be the marginal borrower who has the potential to trigger issues down the track – as happened in the USA post the GFC.

It is certainly not an all or nothing picture. Granularity is your friend.

 

US Bank Supervision Gets The Hump

From The St. Louis Feds On The Economy Blog.

The health of banks is important to everyone, whether a borrower or a saver, an individual or a business. Subject to certain restrictions, bank deposits up to $250,000 are insured by the Federal Deposit Insurance Corp. The agency’s deposit insurance fund is financed by banks through fees. For catastrophic events, the fund is further supported by a $100 billion line of credit at the Treasury Department, meaning that taxpayers serve as the ultimate backstop in the event of a crisis.1

Because of the government safety net and in support of financial stability, bank supervisors monitor the health of banks through periodic examinations. At the conclusion of its exam, each bank is assigned a rating—called CAMELS—that allows comparisons of bank health over time and with peers.

CAMELS as a Health Monitor

CAMELS is an acronym representing its six components:

  • Capital adequacy
  • Asset quality
  • Management
  • Earnings
  • Liquidity
  • Sensitivity to market risk

Banks are rated on each component, and a composite rating is also computed. Ratings range from one to five:

  • 1 is “strong.”
  • 2 is “satisfactory.”
  • 3 is “less than satisfactory.”
  • 4 is “deficient.”
  • 5 is “critically deficient.”

To earn a 1 on any component, a bank must show the strongest performance and risk management practices in that area. Alternatively, a rating of 5 indicates weak performance, inadequate risk management practices and the highest degree of supervisory concern.

The overall, or composite, rating for each bank is based on the six components. However, it is not an arithmetic average of the individual component ratings. Rather, some components are weighed more heavily than others based on examiner judgment of risk.

For community banks, the asset quality rating is critical because of the size of the loan portfolio at small banks. We’ll take a deeper dive into asset quality and the other individual components of CAMELS in upcoming posts.

Who Sees the Rating?

At the conclusion of each examination, the bank’s rating is revealed to senior bank management and the board of directors. If the rating is 3, 4 or 5, the board is typically required to enter into an agreement with bank supervisors to correct the issues. The most serious deficiencies can result in formal supervisory actions that can be enforced in court.

Each bank’s CAMELS ratings and examination report are confidential and may not be shared with the public, even on a lagged basis. In fact, it is a violation of federal law to disclose CAMELS ratings to unauthorized individuals.2 Outsiders may monitor bank health through private-sector firms that use publicly available financial data to produce their own analysis of bank health, sometimes even using their own rating system.

Notes and References

1 The FDIC may borrow money from the U.S. Treasury, the Federal Financing Bank and individual banks to replenish the fund on a temporary basis. See the FDIC’s Federal Deposit Insurance Act page for more information.

2 Violators may be assessed criminal penalties under 18 USC §641.

Majors will move rates “sooner or later”

From Australian Broker.

The big banks are under increasing pressure to move interest rates as more lenders make changes in response to increased costs.

Over the last week ten institutions have changed their interest rates to home loan products, with a total of 53 product level changes recorded.

While we have seen a number of rate increases over the last few weeks, despite the Reserve Bank of Australia (RBA) holding the cash rate, not all of the changes have been increases.

According to the information from comparison site Canstar, Yellow Brick Road made changes to all home loan types.

Mortgage House dropped its fixed rate investment products by 61 to 72 bps. It also made some changes to its owner occupier fixed rate products with interest rate decreases of 8 to 26bps.

Westpac also made changes this week. It increased its owner occupier fixed rate interest only home loans by 5 to 15bp.

Suncorp also made changes to its fixed rate products, decreasing the rates of its investment loans by 10 to 40bps.

Explaining the changes in interest rates, Steve Mickenbecker, group executive, financial services, at Canstar, said, “We are seeing a classic bit of churn that tends to happen at the top or bottom of a market.

“It has only just started in the last month or two, and we’re quite a while from seeing the end of it. The upward pressure is mounting, and at the same time the banks want to hold some competitive rates in the market.

“With LIBOR and BBSW up 40 basis points in a month, it’s not surprising that we are seeing rate increases.

“The cost of wholesale funding is rising, which ultimately has to find its way through to home loan rates. At this stage it is the second-tier banks that have increased their variable rates by 8 to 10 basis points, not the big banks.

“The funding pressure sees some fixed rates rising, while other banks have moved down to maintain a competitive rate in the market for new business as they have increased their variable rates across the book for both the existing and new.”

While so far it has been the ‘second-tier’ banks changing variable rates, Mickenbecker said “big banks are under even more pressure”.

He added, “With around 80% of existing loans provided by the big four and the bulk in variable rates, any move in variable rates is going to flow through to most Australian borrowers.

“In the political world of banks through this Royal Commission, an increase is going to only increase the opprobrium. Westpac has moved interest only fixed rates up, reflecting that even the big lenders are feeling the funding pressure.

“But in terms of margin across the Westpac portfolio, the increase will hardly make a difference.  With most big banks funding around 60 to 65% of their loan book through retail deposits, they have some buffer from wholesale funding increases.

“However, sooner or later they will have to move variable rates up. The timing might come down to when they feel they can face down the community.”