Top 10 Mortgage Stress Countdown At December 2017

Following our monthly mortgage stress post, released yesterday, we have updated our video which counts down the most stressed households across the country.

As normal, there are some changes from last month, as conditions vary across the states. But overall, we see relatively more stress in Victoria and New South Wales.  We will count down to the post code with the highest levels of mortgage stress.

We also discuss the causes of mortgage stress and what households might do to mitigate the issues.

 

Mortgage Stress to Trigger Rise in Defaults, says Analyst

From The Adviser.

Defaults are expected to rise this year amid new data which reveals that almost a million Australians are under mortgage stress.

Digital Finance Analytics (DFA) has released its mortgage stress and default analysis for the month of December, revealing that over 921,000 households (29.7 per cent) are under “mortgage stress”, with 24,000 households under “severe mortgage stress”, up by 3,000 from the previous month.

DFA principal Martin North has predicted that more Australians will default on their debts in 2018, with an estimated 54,000 households at risk of 30-day debt defaults in the next 12 months.

“My own view is that we’re going to see default debts rise in 2018,” Mr North told The Adviser. “I can’t see any argument to suggest that it’s going to be different unless income starts to move up in real terms.

“I know that Treasury is forecasting a very positive outlook for wage growth over the next couple of years, [but] I can’t see where that’s coming from at the moment. My own view is that we’re going to see mortgage stress rising and that will actually have a knock-on effect on defaults. So, I’m forecasting defaults will be higher later into the year than they were at the end of last year.”

The data analyst attributed rises in mortgage stress to the “loose” lending standards of previous years.

“Over the last four or five years, lending standards have been a bit too loose,” Mr North said.

“We’ve got a lot of people now who, if they applied for the same mortgage two or three years ago, they wouldn’t now get that mortgage because effectively the affordability criteria has been tightened, the income standards have been tightened, all of the dimensions have been tightened.”

Mr North also urged Australians to keep a budget, and he warned that household accumulation of unsecured debt could further perpetuate mortgage stress.

“There’s an alignment between mortgage stress and rises in other forms of debt,” the principal said.

“What we’re finding is that there’s an accumulation of other debt categories around people with mortgage stress, so it’s part of the problem.”

Despite acknowledging the negative impact that a future rate rise imposed by the Reserve Bank of Australia (RBA) would have on mortgage stress, Mr North believes that the central bank needs to increase its cash rate to ease “systematically structural risk” caused by a high debt ratio.

“The RBA [has] a really tricky situation because we’ve got mortgage lending growing at three times income growth — 6 per cent annual mortgage growth lending and 2 per cent income growth — so, that’s an unsustainable position.

“If they do lift rates, essentially that’s going to put more households under pressure.

“[But] my own view is that the next rate will be up, [and] it won’t be for some months — probably in the second half of 2018 — and I think it’s predicated on what happens to wages.”

Concluding, Mr North said: “I can’t see any logic for driving rates lower, and the challenge is that they should be putting rates higher than they probably will because of the problem with debt overhanging in the system we’ve got at the moment.”

Households Under The Mortgage Stress Gun In December

Digital Finance Analytics has released the December mortgage stress and default analysis update. Across Australia, more than 921,000 households are estimated to be now in mortgage stress (last month 913,000). This equates to 29.7% of households. In addition, more than 24,000 of these in severe stress, up 3,000 from last month. We estimate that more than 52,000 households risk 30-day default in the next 12 months, similar to last month. We expect bank portfolio losses to be around 2.8 basis points, though with losses in WA rising to 4.9 basis points. Households in NSW are showing the most significant rise in stress, thanks to larger mortgages relative to income, while income growth is slow.

Martin North, Principal of Digital Finance Analytics said “the number of households impacted are economically significant, especially as household debt continues to climb to new record levels. Mortgage lending is still growing at three times income. This is not sustainable”. The latest household debt to income ratio is now at a record 199.7.[1]

Risks in the system continue to rise, and while recent strengthening of lending standards will help protect new borrowers, there are many households currently holding loans which would not now be approved. This is a significant sleeping problem and the risks in the system are higher than many recognise.

Our analysis uses the DFA core market model which combines information from our 52,000 household surveys, public data from the RBA, ABS and APRA; and private data from lenders and aggregators. The data is current to end December 2017. We analyse household cash flow based on real incomes, outgoings and mortgage repayments, rather than using an arbitrary 30% of income.

Households are defined as “stressed” when net income (or cash flow) does not cover ongoing costs. Households in mild stress have little leeway in their cash flows, whereas those in severe stress are unable to meet repayments from current income. In both cases, households manage this deficit by cutting back on spending, putting more on credit cards and seeking to refinance, restructure or sell their home.  Those in severe stress are more likely to be seeking hardship assistance and are often forced to sell.

The forces which are lifting mortgage stress levels remain largely the same. In cash flow terms, we see households having to cope with rising living costs whilst real incomes continue to fall and underemployment remains high. Households have larger mortgages, thanks to the strong rise in home prices, especially in the main eastern state centres, but now there are signs prices are slipping. While mortgage rates remain quite low for owner occupied borrowers, those with interest only loans or investment loans have seen significant rises.  We expect some upward pressure on real mortgage rates in the next year as international funding pressures mount, a potential for local rate rises and margin pressure on the banks.

Probability of default extends our mortgage stress analysis by overlaying economic indicators such as employment, future wage growth and cpi changes.  Our Core Market Model also examines the potential of portfolio risk of loss in basis point and value terms. Losses are likely to be higher among more affluent households.

Stress by The Numbers.

Regional analysis shows that NSW has 258,572 households in stress (251,576 last month), VIC 254,485 (253,248 last month), QLD 156,097 (157,019 last month) and WA 121,934 (123,849 last month). The probability of default rose, with around 9,800 in WA, around 9,500 in QLD, 13,000 in VIC and 14,000 in NSW.

The largest financial losses relating to bank write-offs reside in NSW ($1.3 billion) from Owner Occupied borrowers) and VIC ($957 million) from Owner Occupied Borrowers, which equates to 2.1 and 2.7 basis points respectively. Losses are likely to be highest in WA at 4.9 basis points, which equates to $682 million from Owner Occupied borrowers.

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Note that the detailed results from our surveys and analysis are made available to our paying clients.

[1] RBA E2 Household Finances – Selected Ratios September 2017

National Dwelling Values Fall 0.3% In December – CoreLogic

Further evidence of cracks showing in the property market in the major centres.

From CoreLogic.

According to the CoreLogic December Hedonic Home Value Index results, national dwelling values slipped lower over the month, led by falls across Sydney, Darwin, Melbourne and Perth . This sets the scene For softer housing conditions In 2018

The transition towards weaker housing market conditions has been clear but gradual and is likely to continue throughout 2018 according to CoreLogic head of research Tim Lawless.

Commenting on the results, Mr Lawless said, “From a macro perspective, late 2016 marked a peak in the pace of capital gains across Australia with national dwelling values rising at the rolling quarterly pace of 3.7% over the three months to November.”

“In 2017 we saw growth rates and transactional activity gradually lose steam, with national month-on-month capital gains slowing to 0% in October and November before turning negative in December.”

According to CoreLogic, the 0.3% fall in December was the catalyst for dragging the quarterly capital gains result into negative territory for the first time since the three months ending April 2016.  Nationally, dwelling values were 4.2% higher over the 2017 calendar year which is a slower pace of growth relative to 2016 when national dwelling values rose 5.8% and in 2015 when values nationally were 9.2% higher.

Index results as at December 31, 2017

2018-01-02--Indices_results

Preparing Borrowers for the Unknown

From Australian Broker.

Will the current standard serviceability buffer be enough to protect borrowers, or is a domino effect of defaults on the horizon?

Industry regulator APRA tightened lending criteria earlier this year and increased its scrutiny of banks’ lending practices – but with the cash rate likely to rise in the not-so-far-off future, some industry figures are now wondering if the restrictions fall short of what is actually needed to prevent borrowers from defaulting on their home loans.

In March, when the new lending caps were introduced, APRA reiterated the importance of the interest rate buffer, which it had earlier recommended be set at at least two percentage points. The regulator said “a prudent ADI would use a buffer comfortably above this”, but it set no further limits.

Harald Scheule, associate professor of finance at Sydney’s University of Technology, is among those questioning the efficacy of APRA’s buffer.

“I do not think that a 2% buffer is sufficient, as interest rate changes are likely to be greater in the medium term,” Scheule tells Australian Broker. “APRA has acknowledged this by making clear that 2% is only the bare minimum.”

Scheule is an expert in risk management and has undertaken consulting work for a wide range of financial institutions in Asia, Australia, Europe and North America. He says if the cash rate rises, as suggested by the RBA, it’s inevitable that some mortgage holders will be unable to meet their repayments.

“Rising interest rates will impact borrowers with limited free cash flow. This may include leveraged interest-only borrowers and borrowers that have recently purchased a property,” he warns. “Mortgage delinquency rates will increase.”

A recent survey by home loan lender ME asked 2,000 mortgage holders about potential interest rate rises and found the issue was causing major concern among homeowners.

“Rising interest rates will impact borrowers with limited free cash flow … [including] leveraged interest-only borrowers and borrowers who recently purchased a property” – Harald Scheule, UTS

More than half (56%) said that if the RBA were to raise the official cash rate by 1% from its current record low of 1.5%, it would have an “adverse impact”, with 43% indicating they would spend less, and 27% of investors saying they would sell their investment property.

“The prospect of rate rises is probably already impacting consumer sentiment, with 62% of borrowers expecting their lender to increase interest rates on their home loan in the next 12 months,” the survey said.

If a future rate rise does lead to increased mortgage delinquency, Scheule says banks are likely to tighten lending standards even further and drop the loan amounts offered to applicants. That combination could further constrain interest-only borrowers seeking to refinance at the end of their interest-only terms.

“This means more mortgage stress, as many had expected to roll over the interest-only period indefinitely, but now they are forced to make principal repayments next to interest payments,” Scheule says.

As loan supply is increasingly restricted alongside rising delinquency rates, housing prices will begin to tumble, and Scheule says Australia will be well on its way to a burst housing bubble.

“The cycle between delinquencies and tightening bank lending standards continues, and as a result there’s a noticeable drop in loan supply and a fall in house prices,” he explains.

When asked if banks and brokers are doing enough to protect borrowers, Scheule admits it’s a difficult question to answer but says the best thing brokers can do is provide balanced advice and education to their clients.

“High professional standards for both banks and brokers are critical to the resilience of our financial system,” he says. “This includes consumer awareness of risks. The impact of payment shocks via interest rate increases or loss of employment should be discussed.”

Tony MacRae, general manager of third party distribution at Westpac, agrees that high professional standards are a necessity in any market but says the situation isn’t as bleak as it’s sometimes portrayed.

“The number of our customers in arrears on their loans is at historically low levels, and we don’t expect this to increase in the short or medium term,” he says.

MacRae says Westpac remains conservative in its lending and has long included a range of protectionary measures in its processes, such as the addition of buffers and floor rates to account for possible future interest rate increases.

“Our credit policies are informed by our deep experience and understanding of the mortgage market,” he says.

“They include consideration of customers’ specific circumstances, including income and expenditure, previous repayments history and the overall customer relationship.”

MacRae also says the bank has employed a range of measures to help it meet APRA’s benchmark of 30% for new interest-only lending, including adjusting its interest rates and lending policies.

However, what MacRae says Westpac has seen is an increase in the number of customers taking out or switching to principal and interest repayments – something Canberra broker Stephanie Duncan, of Tiffen & Co, has also noticed.

According to Duncan, who has been recognised as one of the most successful female brokers in Australia, the trend suggests clients are fully aware that the interest rates are likely to rise, and they understand the impact this will have on their financial situation.

“The increase in repayments to mortgage holders if rates are to rise is somewhat expected by consumers. It is not going to come as a surprise that rates will be increasing in the short to medium term,” she says.

“Most of my clients are opting for P&I repayments so as to take advantage of the record lows in anticipation of better preparing themselves for the future rates rises,” she adds.

Duncan agrees that the banks are being incredibly cautious with lending in the current climate, which is helping to offset much of the risk that mortgage holders could potentially face.

“There have certainly been some fairly significant changes to policy that have reduced overall lending amounts and, in turn, the risk to consumers,” she says.

However, Duncan says there are some significantly more pressing problems that the industry should be dealing with.

“My biggest issue is not the tightening of policy and reduced lending capacities but the inconsistency of assessment and discrepancies between credit assessors,” she continues.

“With so many changes in such a short space of time, I feel the education on credit is lacking. This results in multiple touches to a file, and when there is no ownership of a file and it is being touched by different assessors this can result in a very slow and frustrating approval process.”

Duncan also suggested that clients are more likely to be adversely impacted by lenders’ mortgage insurance rather than increasing interest rates.

“In my experience there has been an increase in family guarantee lending and gifts from family becoming a new norm for most young people borrowing these days due to the high cost of living,” she says.

Based on this, Duncan says the bigger issue for clients is raising a large enough deposit to avoid LMI when entering the market, rather than the problem of having enough regular income to service the loan.

Our Most Popular Posts of 2017

As we tie the ribbons on 2017, here are the top 10 most popular posts from the DFA Blog throughout the past year.

Mortgage stress and the property market were to most visited, but Fintech innovation and household finances also featured.  The ABC Four Corners programme generated the most traffic to our site in a single day. Our earlier research on consumer debt continued to rate very highly.

The Definitive Guide To Our Latest Mortgage Stress Research

October Mortgage Stress Higher Again – See The Top 10 Post Codes

Tic:Toc launches with 22-minute home loan

Mounting concerns over Australian housing bubble

Safe as Houses? Not if You Live in Australia

ABC Four Corners Does Mortgage Stress

6 astonishing features of Australia’s current house price boom

Where Do Consumers Fit in the Fintech Stack?

Digital Finance Analytics – Quenching The Thirst For Accurate Household Mortgage Data

The Stressed Household Finance Report 2015 is Available

Our Top Reports Released In 2017

As we tie the ribbons on 2017, here are our most popular reports from 2017, all of which are still available free on request.

The Property Imperative Volume 9 Report Released Today

Time For “Digital First” – The Quiet Revolution Report Vol 3 Released

DFA’s SME Report 2017 Released

 

The Shape of 2018 – The Property Imperative Weekly 30th Dec 2017

In the final edition of the Property Imperative Weekly for 2017, we look ahead to 2018 and discuss the future trajectory of the property market, the shape of the mortgage industry, the evolution of banking and the likely state of household finances.

Watch the video, or read the transcript.

We start with the state of household finances. The latest data from the RBA shows that the ratio of debt to income deteriorated again (no surprise given the 6%+ growth in mortgage debt, and the ~2% income growth). The ratio of total debt to income is now an astronomical 199.7, and housing debt 137.5. Both are at all-time records, and underscores the deep problem we have with high debt.

We think that households will remain under significant debt pressure next year, and the latest data shows that mortgage lending is still growing at 3 times income growth. We doubt that incomes will rise any time soon, and so 2018 will be a year of rising debt, and as a result, more households will get into difficulty and mortgage stress will continue to climb.  We think Treasury forecasts of rising household incomes are overblown. On the other hand, the costs of living will rise fast.

As a result, two things will happen. The first is that mortgage default rates are likely to rise (at current rock bottom interest rates, defaults should be lower), and if rates rise then default rates will climb further. The second outcome is that households will spend less and hunker down. As the Fed showed this week, the US economy is highly dependent on continued household spending to sustain economic growth – and the same is true here. We think many households will hold back on consumption, spending less on discretionary items and luxuries, and so this will be a brake on economic activity. This will have a strong negative influence on future economic growth, which we already saw throughout the Christmas shopping season.

Mortgage interest rates are likely to rise as international markets follow the US higher, lifting bank funding costs. This is separate from any change to the cash rate. This year the RBA was able to sit on its hands as the banks did their rate rises for them. We hold the view that the cash rate will remain stuck it its current rut for the next few months, because the regulators are acutely aware of the impact on households if they were to lift. They have little left in the tank if economic indicators weaken, and the bias will be upward, later in the year.

Competition for new loans will be strong, as banks need mortgages to support their shareholder returns. The latest credit data from the RBA showed that total mortgages are now at a record $1.71 trillion, and investor lending has fallen to an annual rate of 6.5%, compared with owner occupied lending at 6.3%, so total housing lending grew at 6.4%. Business lending is lower, at 4.7% and personal lending down 1.2%.

But APRA’s data shows that banks are writing less new business, so total Owner Occupied Balances are $1.041 trillion, up 0.56% in the month (so still well above income growth), while Investment Loans reached $551 billion, up 0.1%. So overall portfolio growth is now at 0.4%, and continues to slow. In fact, comparing the RBA and APRA figures we see the non-bank sector is taking up the slack, and of course they do not have the current regulatory constraints.  The portfolio movements of major lenders show significant variation, with ANZ growing share the most, whilst CBA shrunk their portfolio a little.  Westpac and NAB grew their investment loans more than the others.

We think there will be desperate attempts to attract new borrowers, with deeply discounted rates, yet at the same time mortgage underwriting standards will continue to tighten. We already see the impact of this in our most recent surveys. The analysis of our December 2017 results shows some significant shifts in sentiment –  in summary:

  • First, obtaining finance for a mortgage is getting harder – this is especially the case for some property investors, as well as those seeking to buy for the first time; and those seeking to trade up. Clearly the tightening of lending standards is having a dampening effect. As a result, demand for mortgage finance looks set to ease as we go into 2018 and mortgage growth rates therefore will slide below 6%.
  • Next, overall expectations of future price gains have moderated significantly, and property investors are now less expectant of future capital growth in particular. This is significant, as the main driver for investors now is simply access to tax breaks. As a result, we expect home prices to drift lower as demand weakens.
  • Mortgage rates have moved deferentially for different segments, with first time buyers and low LVR refinance households getting good deals, while investors are paying significantly more. This is causing the market to rotate away from property investors.
  • Net rental returns are narrowing, so more investors are underwater, pre-tax. So the question becomes, at what point will they decide to exit the market?

We see a falling expectation of home price rises in the next 12 months, across all the DFA household segments. Property Investors are clearly re-calibrating their views, and this could have a profound impact on the market. We see a significant slide in the proportion of property investors and portfolio investors who are looking to borrow more. First time buyers remain the most committed to saving for a deposit, helped by new first owner grants, while those who desire to buy, but cannot are saving less. Those seeking to Trade Up are most positive of future capital growth. Foreign buyers will be less active in 2018.

So our view is that demand for property will ease, and the volume of sales will slide through 2018. As a result, the recent price falls will likely continue, and indeed may accelerate. We will be watching for the second order impacts as investors decide to cut their losses and sell, creating more downward pressure. Remember the Bank of England suggested that in a down turn, Investment Property owners are four times more likely to exit compared with owner occupied borrowers.

So risks in the sector will grow, and bank losses may increase.

More broadly, banks will remain in the cross-hairs though 2018 as the Royal Commission picks over results from their notice requiring banks, insurance companies and superannuation funds to detail all cases of misconduct from 2008 onwards. We expect more issues will surface. The new banking code which was floated before Christmas is not bad, but is really still setting a low bar and contains elements which most customers would already expect to see. This is not some radical new plan to improve customer experience, rather more recognition of the gap between bank behaviour and customer expectation. And it does not HAVE to be implemented by the banks anyway.

There is much more work to do. For example, how about proactive suggestions to switch to lower rate loans and better rates on deposits?  What about the preservation of branch and ATM access? What about the full disclosure of all fees relating to potential loans?  And SME’s continue to get a raw deal thanks to lending policy and bank practice (despite the hype).

Then the biggie is mortgage lending policy, where banks current underwriting standards are set to protect the bank from potential loss, rather than customers from over-committing.

We will get to hear about the approach to Open Banking, the Productivity Commission on vertical integration and the ACCC on mortgage pricing, as well as the outcomes from a range of court cases involving poor banking behaviour. APRA will also discuss mortgage risk weights. So 2018 looks like adding more pressure on the banks.

So in summary, we think we will see more of the same, with pressure on households, pressure on banks, and a sliding housing market. Despite this, credit is growing at dangerous levels and regulators will need to tighten further.  We are not sure they will, but then the current issues we face have been created by years of poor policy.

Households can help to manage their financials by building a budget to identify their commitments and cash flows. Prospective mortgage borrowers should run their own numbers at 3% above current rates, and not rely on the banks assessment of their ability to repay – remember banks are primarily concerned with their risk of loss, not household budgets or financial sustainability per se. Regulators have a lot more to do here in our view.

Many will choose to spruke property in 2018 (we are already seeing claims that the Perth market “is turning”), and the construction sector, real estate firms, and banks all have a vested interest in keeping the ball in the air for as long as possible. Governments also do not want to see prices fall on their watch, and many of the states are totally reliant on income from stamp duty.  But we have to look beyond this. If we are very luck, then prices will just drift lower; but it could turn into a rout quite easily, and don’t think the authorities have the ability to calibrate or correct a fall if it goes, they do not.

The bottom line is this. Think of property as a place to live, not an investment play. Do that, and suddenly things can get a whole lot more sensible.

That’s the Property Imperative Weekly to 30th December 2017. We will return in the new year with a fresh weekly set of objective news, analysis and opinion. If you found this useful, do leave a comment, or like the post, and subscribe to receive future updates.  Best wishes for 2018, and many thanks for watching.

More Debt Burdens Households; Again.

The RBA statistical tables were released just before Christmas, and it included E2 – Selected Household Ratios. This chart of the data tells the story – the ratio of debt to income deteriorated again (no surprise given the 6%+ growth in mortgage debt, and the ~2% income growth).  This got hardly any coverage, until now.  Since then mortgage debt is up again, so the ratio will probably cross the 200 point Rubicon next quarter.

The ratio of total debt to income is now an astronomical 199.7, and housing debt 137.5. Both are at all time records, and underscores the deep problem we have with high debt. [Note: the chart scale does not start from zero]

Granted in the current low interest rate environment repayments are just about manageable (for some), thanks to the cash  rate cuts the RBA made but even a small rise will put significant pressure on households. And rates will rise.

Highly relevant given our earlier post about [US] household spending being the critical economic growth driver, Australia is no different.

The current settings will lead to many years of strain for many households. We are backed into a corner, with no easy way to exit.

 

 

Mortgage Lending On The Slide, Perhaps

The RBA data for November 2017 was released today.  The financial aggregates shows that mortgage lending momentum is easing a little, but more slowly than bank lending, suggesting that the non-bank sector is taking up much of the slack. In addition, more loans were reclassified in the month, taking the total to an amazing $61 billion. Total mortgages are now at $1.71 trillion, another record. Overall growth is still much higher than wage growth, so household debt levels will continue to climb.

The monthly trends are pretty clear, if noisy.

The 12 month view irons out the noise and shows that investor lending has fallen to an annual rate of 6.5%, compared with owner occupied lending at 6.3%.   Total housing lending grew at 6.4%. Business lending is lower, at 4.7% and personal lending down 1.2%.

Looking at the values involved, total mortgage lending rose to $1.71 trillion, and investor loans fell to 34.1% of balances, still too high.

Two interesting points to make. First, it is clear mortgage momentum is being support by the non-bank sector, as the RBA aggregate data is significantly higher than the ADI growth from APRA. We have plotted the gap between the two on a 12 month rolling basis.

Second, there is still more “tweakage” in the numbers as loans are re-classified.  Total to date now $61 billion, a large proportion of investor loans!

Following the introduction of an interest rate differential between housing loans to investors and owner-occupiers in mid-2015, a number of borrowers have changed the purpose of their existing loan; the net value of switching of loan purpose from investor to owner-occupier is estimated to have been $61 billion over the period of July 2015 to November 2017, of which $1.2 billion occurred in November 2017. These changes are reflected in the level of owner-occupier and investor credit outstanding. However, growth rates for these series have been adjusted to remove the effect of loan purpose changes.