First Time Buyers Keep The Property Market Afloat – The Property Imperative Weekly – 9th Dec 2017

First Time Buyers are keeping the property ship afloat for now, but what are the consequences?

Welcome to the Property Imperative weekly to 9th December 2017. Watch the video, or read the transcript.

In our weekly digest of property and finance news, we start this week with the latest housing lending finance from the ABS. The monthly flows show that owner occupied lending fell $23m compared with the previous month, down 0.15%, while investment lending flows fell 0.5%, down $60m in trend terms. Refinanced loans slipped 0.13% down $7.5 million. The proportion of loans excluding refinanced loans for investment purposes slipped from a recent high of 53.4% in January 2015, down to 44.6% (so investment property lending is far from dead!)

While overall lending was pretty flat, first time buyers lifted in response to the increased incentives in some states, by 4.5% in original terms to 10,061 new loans nationally. At a state level, FTB’s accounted for a 19% per cent share in Victoria and 13.7% in New South Wales, where in both states, a more favourable stamp duty regime and enhanced grants were introduced this year. But, other states showed a higher FTB share, with NT at 24.8%, WA at 24.6%, ACT at 20.1% and QLD 19.7%. SA stood at 13% and TAS at 13.3%. There was an upward shift in the relative numbers of first time buyers compared with other buyers (17.6% compared with 17.4% last month), still small beer compared with the record 31.4% in 2009. These are original numbers, so they move around each month. The number of first time buyer property investors slipped a little, using data from our household surveys, down 0.8% this past month. Together with the OO lift, total first time buyer participation has helped support the market.

The APRA Quarterly data to September 2017 shows that bank profitability rose 29.5% on 2016 and the return on equity was 12.3% compared with 9.9% last year. Loans grew 4.1%, thanks to mortgage growth, provisions were down although past due items were $14.3 billion as at 30 September 2017. This is an increase of $1.5 billion (11.8 per cent) on 30 September 2016. The major banks remain highly leveraged.

The property statistics showed that third party origination rose with origination to foreign banks sitting at 70% of new loans, mutuals around 20% and other banks around the 50% mark. Investment loan volumes have fallen, though major banks still have the largest relative share, above 30%.  Mutuals are sitting around 10%.  Interest only loans have fallen from around 40% in total value to 35%, but this represents a fall from around 30% of the loan count, to 27%. This reflects the higher average loan values for IO borrowers. The average loan balance for interest only loans currently stands at $347,000 against the average balance of $264,000.  No surprise of course, as these loans do not contain any capital repayments (hence the inherent risks involved, especially in a falling market).

But there has been a spike in loans being approved outside serviceability, with major banks reporting 5% or so in September. This may well reflect a tightening of standard serviceability criteria and the wish to continue to grow their loan books. We discussed this on Perth 6PR Radio.  So overall, we see the impact of regulatory intervention. The net impact is to slow lending momentum. As lenders tighten their lending standards, new borrowers will find their ability to access larger loans will diminish. But the loose standards we have had for several years will take up to a decade to work through, and with low income growth, high living costs and the risk of an interest rate rise, the risks in the system remain.

On the economic front, GDP from the ABS National Accounts was 0.6%. This was below the 0.7% expected. This gives an annual read of 2.3%, in trend terms, well short of the hoped for 3%+. Seasonally adjusted, growth was 2.8%. Business investment apart, this is a weak and concerning result.  The terms of trade fell. GDP per capita and net disposable income per capita both fell, which highlights the basic problem the economy faces.  The dollar fell on the news. Households savings also fell. No surprise then that according to the ABS, retail turnover remained stagnant in October. The trend estimate for Australian retail turnover fell 0.1 per cent in October 2017 following a relatively unchanged estimate (0.0 per cent) in September 2017. Compared to October 2016 the trend estimate rose 1.8 per cent. Trend estimates smooth the statistical noise.

So no surprise the RBA held the cash rate once again for the 16th month in a row.

The latest BIS data on Debt Servicing ratios shows Australia is second highest after the Netherlands. We are above Norway and Denmark, and the trajectory continues higher. Further evidence that current regulatory settings in Australia are not correct. As the BIS said, such high debt is a significant structural risk to future prosperity. They published a special feature on household debt, in the December 2017 Quarterly Review. They call out the risks from high mortgage lending, high debt servicing ratios, and the risks to financial stability and economic growth.  All themes we have already explored on the DFA Blog, but it is a well-argued summary. Also note Australia figures as a higher risk case study.  They say Central banks are increasingly concerned that high household debt may pose a threat to macroeconomic and financial stability and highlighted some of the mechanisms through which household debt may threaten both. Australia is put in the “high and rising” category.  The debt ratio now exceeds 120% in both Australia and Switzerland.  Mortgages make up the lion’s share of debt.  In Australia mortgage debt has risen from 86% of household debt in 2007 to 92% in 2017.

Basel III was finally agreed this week by the Central Bankers Banker – the Bank for International Settlements – many months later than expected and somewhat watered down. Banks will have to 2022 to adopt the new more complex framework, though APRA said that in Australia, they will be releasing a paper in the new year, and banks here should be planning to become “unquestionably strong” by 1 January 2020.  We note that banks using standard capital weights will need to add different risk weights for loans depending on their loan to value ratio, advanced banks will have some floors raised, and investor category mortgages (now redefined as loans secured again income generating property) will need higher weights. Net, net, there will be two effects. Overall capital will probably lift a little, and the gap between banks on the standard and internal methods narrowed. Those caught transitioning from standard to advanced will need to think carefully about the impact. This if anything will put some upwards pressure on mortgage rates.

The Treasury issues a report “Analysis of Wages Growth” which paints a gloomy story. Wage growth, they say, is low, across all regions and sectors of the economy, subdued wage growth has been experienced by the majority of employees, regardless of income or occupation, and this mirrors similar developments in other developed western economies. Whilst the underlying causes are far from clear, it looks like a set of structural issues are driving this outcome, which means we probably cannot expect a return to “more normal” conditions anytime some. This despite Treasury forecasts of higher wage growth later (in line with many other countries). We think this has profound implications for economic growth, tax take, household finances and even mortgage underwriting standards, which all need to be adjusted to this low income growth world.

Mortgage Underwriting standards are very much in focus, and rightly, given flat income growth.  There was a good piece on this from Sam Richardson at Mortgage Professional Australia which featured DFA. He said that over four days in late September two major banks added extra checks to an already-extensive application process. ANZ introduced a Customer Interview Guide requiring brokers to ask questions about everything from a customer’s Netflix subscription to whether they were planning to start a family. Three days later CBA introduced a simulator that would show interest-only borrowers how their repayments would change and affect their lifestyle. Customers would be required to fill in an ‘acknowledgement form’ to proceed with an interest-only application.

Getting good information from customers is hard work, not least because as we point out, only half of households have formal budgeting. So, when complete the mortgage application, households may be stating their financial position to the best of their ability, or they may be elaborating to help get the loan. It is hard to know. Certainly banks are looking for more evidence now, which is a good thing, but this may make the loan underwriting processes longer and harder. Improvements in technology could improve underwriting standards for banks while pre-populating interactive application forms for consumers and offering time-saving solutions to brokers and Open Banking may help, but while Applications can be made easier, this does not necessarily mean shorter.

More data this week on households, with a survey showing Australians have become more cautious of interest only loans with online panel research revealing that 46 per cent of Australians are Adamant Decliners of interest-only home loans according to research from the  Gateway Credit Union. In addition, a further quarter of respondents are Resistant Approvers, acknowledging the benefits of interest-only loans yet choosing not to utilise them. Of the generations, Baby Boomers are most likely to be Adamant Decliners and therefore, less likely to use interest-only products. While Gen Y are most likely to be Enthusiastic Users.

Banks continue to offer attractive rates for new home loans, seeking to pull borrows from competitors. Westpac for example, announced a series of mortgage rate cuts to attract new borrowers, as it seeks to continue to grow its portfolio, leveraging lower funding costs, and the war chest it accumulated earlier in the year from back book repricing, following APRA’s tightening of underwriting standards and restrictions on interest only loans. Rates for both new fixed rate loans and variable rate loans were reduced.  For example, the bank has also increased the two-year offer discount on its flexi first option home for principal and interest repayments from 0.84% p.a. to 1.00% p.a. putting the current two-year introductory rate at 3.59% p.a.

The RBA released their latest Bulletin  and it contained an interesting section on Housing Accessibility For First Time Buyers.  They suggest that in many centers, new buyers are able to access the market, thanks to the current low interest rates. But the barriers are significantly higher in Melbourne, Sydney and Perth. They also highlight that FHBs (generally being the most financially constrained buyers) are not always able to increase their loan size in response to lower interest rates because of lenders’ policies. Indeed, the average FHB loan size has been little changed over recent years while the gap between repeat buyers and FHBs’ average loan sizes has widened. They also showed that in aggregate, rents have grown broadly in line with household incomes, although rent-to-income ratios suggest housing costs for lower-income households have increased over the past decade.

Housing affordability has improved somewhat  across all states and territories, allowing for a large increase in the number of loans to first-home buyers, according to the September quarter edition of the Adelaide Bank/REIA Housing Affordability Report. The report showed the proportion of median family income required to meet average loan repayments decreased by 1.2 percentage points over the quarter to 30.3 per cent. The result was decrease of 0.6 percentage points compared with the same quarter in 2016. However, Housing affordability is still a major issue in Sydney and Melbourne they said.  In addition, over the quarter, the proportion of median family income required to meet rent payments increased by 0.3 percentage points to 24.6 per cent.

Our own Financial Confidence Index for November fell to 96.1, which is below the 100 neutral metric, down from 96.9 in October 2017. This is the sixth month in succession the index has been below the neutral point. Owner Occupied households are the most positive, scoring 102, whilst those with investment property are at 94.3, as they react to higher mortgage repayments (rate rises and switching from interest only mortgages), while rental yields fall, and capital growth is stalling – especially in Sydney.  Households who are not holding property – our Property Inactive segment – will be renting or living with friends or family, and they scored 81.2. So those with property are still more positive overall. Looking at the FCI score card, job security is on the improve, reflecting rising employment participation, and the lower unemployment rate.  Around 20% of households feel less secure, especially those with multiple part time jobs. Savings are being depleted to fill the gap between income and expenditure – as we see in the falling savings ratio. As a result, nearly 40% of households are less comfortable with the amount they are saving. This is reinforced by the lower returns on deposit accounts as banks seek to protect margins. More households are uncomfortable with the amount of debt they hold with 40% of households concerned. The pressure of higher interest rates on loans, tighter lending conditions, and low income growth all adds to the discomfort. More households reported their real incomes had fallen in the past year, with 50% seeing a fall, while 40% see no change.  Only those on very high incomes reported real income growth.

Finally, we also released the November mortgage stress and default analysis update. You can watch our video counting down the most stressed postcodes in the country. But in summary, across Australia, more than 913,000 households are estimated to be now in mortgage stress (last month 910,000) and more than 21,000 of these in severe stress, the same as last month. Stress is sitting on a high plateau. This equates to 29.4% of households. We see continued default pressure building in Western Australia, as well as among more affluent household, beyond the traditional mortgage belts across the country. Stress eased a little in Queensland, thanks to better employment prospects. 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.

So, the housing market is being supported by first time buyers seeking to gain a foothold in the market, but despite record low interest rates, and special offer attractor rates, many will be committing a large share of their income to repay the mortgage, at a time when income growth looks like it will remain static, costs of living are rising, and mortgage rates will rise at some point. All the recent data suggests that underwriting standards are still pretty loose, and household debt overall is still climbing. This still looks like a high risk recipe, and we think households should do their own financial assessments if they are considering buying at the moment – for home prices are likely to slide, and the affordability equation may well be worse than expected. Just because a lender is willing to offer a large mortgage, do not take this a confirmation of your ability to repay. The reality is much more complex than that. Getting mortgage underwriting standards calibrated right has perhaps never been more important than in the current environment!

And that’s the Property Imperative to 9th December 2017. If you found this useful, do leave a comment, sign up to receive future research and check back next week for the latest update. Many thanks for taking the time to watch.

What The Royal Commission Means For Home Prices – The Property Imperative Weekly 2nd December 2017

The Banking Royal Commission is on, Housing credit is still growing strongly, and home prices in Sydney are slipping. So plenty to discuss in this week’s Property Imperative weekly to 2nd December 2017.

Watch the video, or read the transcript.

In this week’s review of finance and property news we start with the announced $75 million Royal Commission into Financial Services, which after lots of wrangling was announced this week. I will leave the politics alone, but as Fitch Ratings said, the inquiry into alleged misconduct adds challenges to the financial system and the findings could weaken the reputation of individual players, or possibly expose wider structural weaknesses.

So we think uncertainty about whether there will be an inquiry, and what scope it would cover, has been replaced by potential uncertainty of outcome. OK, the scope has been crafted to include a wide gamut of players, from banks, insurers and superannuation funds, but it is narrow because it will only look at misconduct against community expectations. It will touch on culture and governance (and this poses the question of the relationship between misconduct and culture) and it is tasked to make recommendations (but steering around other parallel work including the vertical integration which the Productivity Commission is looking at, and ACCC’s work on pricing).  So it will likely focus on the well-trod paths of poor financial advice, bad insurance policy outcomes and inappropriate handling of SME’s when they get into financial difficulty. We hope the inquiry will specifically look at the various conflicts of interest which currently exist across the sector.

Credit and lending policies appear to be in scope, but we will have to wait and see whether they are explored, along with the role of financial advisers and mortgage brokers.  The scope does not touch on broader policy or regulatory issues (such as macroprudential) but could conceivably cover lending standards and “liar loans”. One potential outcome could be to lift the lid on “not unsuitable” lending.  It will not consider the disruptive intrusion from digital or Fintech.

What we can say is the banks and the Government clearly decided to cut their losses in the light of a potentially broader and more detailed scope which was being discussed on the back bench. This way they are controlling the agenda, at least to some extent. An interim report is expected next September.

Lots of economic news came out this week. The ABS Dwelling approvals for October were stronger than expected, reaching more than 19,000, the highest since August 2016. Growth in Victoria drove approvals higher up 3.8% – whilst there was a fall in New South Wales, down 0.3%.  We are still seeing the strongest demand for property in VIC, thanks to strong migration, though supply and demand is patchy as the recent ANU study highlighted. Overall this suggest more property will continue to come on the market for sale, putting further downward pressure on prices.

The RBA’s Credit Data for October showed that lending for housing rose 0.5% in the month, and 6.5% for the past year (three times inflation!).  Lending to business rose 0.3% to 4% over the past year and personal credit was flat, and fell 0.9% over the past year. Another $1.2 billion of housing loans were reclassified in the month, making $60 billion in total, this is more than 10% of the total investment loan book! The proportion of investor loans fell slightly again, down to 34.2% of portfolio. Total mortgage lending is now above $1.7 trillion, with owner occupied loans up 0.6% or $6.6 billion to $1.12 trillion, and investor loans up 0.2% or $1.2 billion to $584 billion. Comparing this with the APRA data, we see continued relative growth in the non-bank sector.

The parallel ADI data from APRA to end October 2017 shows that banks continue to lend strongly to households. The overall value of their mortgage portfolios grew 0.5% in the month to $1.57 trillion, up $7.3 billion. Owner occupied loans grew 0.6% to $1.03 trillion, up $6.4 billion and investment loans rose 0.15% to $816 million. The proportion of investment loans continues to drift lower, but is still at 34.8% of all lending (too high!!). CBA reduced their investment portfolio this month, whilst Westpac grew theirs. Investor lending market growth is sitting at around 3% over the past year, though some smaller lenders are well above the APRA 10% speed limit.

There is simply no excuse to allow home lending to be running at more than three times inflation or wage growth at the current dizzy price and leverage levels. There is still too much focus on home lending and not enough on productive growth enabling business lending. This is something which the Royal Commission is unlikely to touch, as it is a policy, not a behavioural issue.

The OECD report on Australia said things are looking better. As a result, they recommend rate hikes next year to help cool the housing market. But they call out a number of risks to economic growth and says macro-prudential measures should be maintained. Also their growth rates are lower than latest from the RBA! They also said Australia is vulnerable to “too big to fail” risks, due to its highly concentrated banking sector.

The Reserve Bank NZ has been more proactive on managing risks in the housing sector. They announced a slight reduction in tight loan to value lending controls, in response to slowing housing demand and new Government policies.  The loan-to-value ratio (LVR) policy was first introduced in October 2013, with progressively tighter restrictions for investors introduced in November 2015 and October 2016. From 1 January 2018, the LVR restrictions will require that:

  • No more than 15 percent (currently 10 percent) of each bank’s new mortgage lending to owner occupiers can be at LVRs of more than 80 percent.
  • No more than 5 percent of each bank’s new mortgage lending to residential property investors can be at LVRs of more than 65 percent (currently 60 percent).

They had previously parked their Loan to Income initiative, in the light of easing momentum.

The Gratton Institute published a report which showed rising housing costs are hurting low-income Australians the most. Those at the bottom end of the income spectrum are much less likely to own their own home than in the past, are often spending more of their income on rent, and are more likely to be living a long way from where most jobs are being created. in 1981 home ownership rates were pretty similar among 25-34 year old’s no matter what their income. Since then, home ownership rates for the poorest 20% have fallen from 63% to 23%. Home ownership rates also declined more for poorer households among older age groups. Home ownership now depends on income much more than in the past.

They say that reducing demand – such as by cutting the capital gains tax discount and abolishing negative gearing – would reduce prices a little. But in the long term, boosting the supply of housing will have the biggest impact on affordability. To achieve this, state governments need to change planning rules to allow more housing to be built in inner and middle-ring suburbs.

So now to home prices. According to ME Bank, in a study of 1500 Australian adults, 43% of respondents said they were reliant on future house prices to achieve future life / financial goals, with 10% completely reliant. But it’s a tug-of-war as to which way we want prices to go: 38% want prices to increase while 37% want them to fall. Where you sit largely comes down to your property ownership status: 39% of those who own the home they live in and 47% who own an investment property indicated they are ‘reliant’ on future prices, presumably increasing, while 48% of those who don’t own a property also say they are reliant, presumably wanting prices to fall. Most tellingly, the survey indicates more Australians would benefit from property prices falling than rising, with only 28% indicating they’d benefit by selling if prices continued to rise compared to 47% who said they’d benefit by buying in if property prices fell.

But then again, according to CANSTAR nearly four out of five Australians don’t see house prices falling in their state over the next two years. CANSTAR surveyed 2,026 consumers on their views on property prices and home buying. Nationally, 47% of respondents expected steady growth in house prices, with a further 8% predicting prices would ‘skyrocket at some point’. Just 11% of respondents thought prices could fall in the next two years. Sydney was the most pessimistic city, with 16% predicting values would fall.

CoreLogic’s home price index reported a 0.1% fall nationally in November, with Sydney recording a 0.7% falls, along with falls across Darwin and regional Northern Territory, down 0.4% over the month. For the remaining broad regions of Australia, dwelling values were relatively steady, or experienced a subtle rise, over the month. However, the averages hide significant variations, with for example more expensive homes sliding further relative to cheaper ones.  National dwelling values tracked 0.2% higher over the past three months and have increased 5.2% over the twelve months ending November. The national annual growth rate has now halved since reaching a recent peak in May 2017, when dwelling values rose 10.4%.

CoreLogic also says there were 3,409 homes taken to auction across the combined capital cities last week, returning a preliminary auction clearance rate of 66.9 per cent, overtaking the previous week as the third busiest for auctions so far this year. Last week, based on final results, 60.9 per cent of the 3,390 auctions held recorded a successful result, the lowest clearance rate since late 2015/early 2016.

But auction clearance rates may be lower than the CoreLogic figures suggest according to John Cunningham, president of the REINSW. Cunningham said that 40 per cent of results have not been reported, and if those results represent a no sale, then the clearance rate for Sydney could be a lot lower than the 66 per cent being reported by CoreLogic. With an initial clearance rate again in the mid 60 per cent range, the lack of clear data from the 40 per cent of unreported results fails to provide us with the real picture of the market,” he said.

More evidence of tighter lending standards, with CBA revealing a raft of changes including LVR caps and restrictions to rental income for serviceability that will impact mortgage brokers and their clients from next week. CBA will be introducing a new Home Loan Written Assessment document called the Credit Assessment Summary (CAS) for all owner occupied and investment home loan and line of credit applications solely involving personal borrowers. Meanwhile, CBA confirmed that it will introduce credit policy changes for certain property types in selected postcodes from Monday 4 December. They will reduce the maximum LVR without LMI from 80 per cent to 70 per cent, reducing the amount of rental income and negative gearing eligible for servicing and changing eligibility for LMI waivers including all Professional Packages and LMI offers for customers financing security types in some postcodes. “We continue to lend in all postcodes across Australia,” CBA said.

More rate cuts were announced this week, with Heritage Bank cutting the rate on new owner occupied loans by up to 50 basis points, and 30 basis points on new investment loans.  They want to build and keep attracting new customers to the bank as part of a nationwide growth strategy. This will put more pressure on margins.

KPMG released their 2017 Mutuals Industry Review. Under the hood, the sector is under pressure, despite asset growth. COBA said they welcome the backing from KPMG, which highlighted strong financial performance. We are not so sure.  Sure, assets are growing, but at what cost? KPMG says: profits before tax declined by 4.3 percent to $605.7 million. This compares to the major banks which saw profits grow by 7.6 percent. The net interest margin (NIM) continued to tighten and decreased to 2.03 percent, down 11 basis points.  The increasing pressures on net interest margin is a result of historically low interest rates and increasing competition in the marketplace. Mutuals have sacrificed margins to maintain and grow the membership base. The average capital adequacy ratio dropped 30 basis points to 17.2 percent in 2017, representing a decline in capital levels for the fourth consecutive year. This reflects the increasing prioritisation of effective capital use by mutuals. As limited equity funding is inherent within the mutuals’ current business model and capital growth through new profits have been constrained this year, mutuals have looked to existing capital bases to fund balance sheet growth.

We think the Royal Commission will tend to drive international funding costs higher (they were already going higher), and as banks have around 30% of their books funded offshore, this will put more pressure on margins and local mortgage rates. In addition, we are still forecasting a cash rate hike next year, so more pressure on mortgage rates there. At the same time lending standards continue to be tightened, so borrowers will need a larger deposit especially in some higher risk areas. Mortgages are set to become more expensive and harder to get. Also, more new property is set to come onto the market, and as home price momentum eases, this will tend to push prices lower.  So we can suggest several reasons why prices will go lower, but non to make them rise. So on that basis, the 80% of households expecting prices to keep rising are in for a rude awakening.

And that’s the Property Imperative weekly to 2nd December 2017. If you found this useful, do leave a comment or subscribe to receive future updates. Check back next week for our latest update, which will include November Mortgage Stress results. Many thanks for taking the time to watch.

Walking The Tightrope – The Property Imperative Weekly 18 Nov 2017

A really mixed bag of news this week, with stronger business and employment data, lower mortgage defaults and yet weak wage growth, and more evidence of the pressure on households. We pick over the coals and try to make sense of what’s going on.

 Welcome to the Property Imperative Weekly to 18 November 2017. Watch the video or read the transcript.

We start with some good news.

The latest National Australia Business (NAB) survey — a composite indicator that measures trading activity, profitability and employment — surged by a massive 7 points to +21, leaving it at the highest level since the survey began in 1997. On this measure, Australian businesses have not had it so good in at least two decades. There were enormous increases recorded in trading and profitability, suggesting that demand was rampant during October. However, beware, this included a massive unexplained jump in manufacturing and the survey’s lead indicators softened over the month, which, along with an unchanged reading on business confidence, raises questions as to whether the bounce in the conditions index can be sustained.

Deputy Governor Guy Debelle spoke at the UBS Australasia Conference on “Business Investment in Australia“. He argued that investment has been strong over the last decade, thanks to the mining sector. This is now easing back, and the question is will the non-mining sector start firing or not? Even if it does, they have huge boots to fill!

Luci Ellis RBA Assistant Governor (Economic) delivered the Stan Kelly Lecture on “Where is the Growth Going to Come From?“. An excellent question given the fading mining boom, and geared up households! But we really got few answers. Australia’s population is growing faster than in almost any other OECD economy. That has remained true over the past couple of years. The rate of natural increase is higher than many other countries, but most of the difference is the large contribution from immigration. Of course, just adding more people and growing the economy to keep pace wouldn’t boost our living standards. Next, employment participation has been rising recently. The increase has been concentrated amongst women and older workers and is linked with the increase in health and education employment. Finally, productivity can improve, especially if innovation can be leveraged, although she noted the rate of technology adoption has slowed down since the turn of the century. We wonder if this has something to do with the sluggish and underpowered NBN rollout currently underway.

The monthly trend unemployment rate remained at 5.5 per cent in October 2017, according to figures released by the Australian Bureau of Statistics. While the trend is down, it was not as strong as some analysts were expecting.  The seasonally adjusted unemployment rate decreased by 0.1 percentage points to 5.4 per cent and the labour force participation rate decreased to 65.1 per cent.

The ABS released their analysis of individual state accounts to Jun 2017. This includes an estimate of average gross household disposable income per capita. The variations across states are significant and interesting. Of note is the astronomical value, and trajectory of individuals in the ACT, at more than $90,000. We saw a decline in gross incomes in WA (one reason why mortgage defaults are rising there) at around $50,000. NSW was also around $50,000 while VIC was around $45,000 and TAS was $40,000.

Wages rose 0.5 per cent in the September quarter 2017 and 2.0 per cent over the year, according to the ABS. This was below consensus expectation, and continues the slow grind in household income, for many falling below the costs of living.  Those in the public sector continue to do better than those in the private sector. In original terms, wage growth to the September quarter 2017 ranged from 1.2 per cent for the Mining industry to 2.7 per cent for Health Care and Arts and recreation services. Western Australia recorded the lowest growth through the year of 1.3 per cent and Victoria, Queensland and Tasmania the highest of 2.2 per cent.

The legislation to tighten some aspects of investment property, and levy a charge on vacant foreign owned property has been passed in the Senate. The legislation prevents property investors from claiming travel expenses when travelling between properties, as well as tightening depreciation on plant and equipment tax deductions. Foreign owners will be charged a fee if they leave their properties vacant for at least six months in a 12-month period, in an attempt to release more property to ease supply. The latest Census showed that there are 200,000 more vacant homes across Australia than there were ten years ago.

Turning to the mortgage industry, Fitch Ratings says Australia’s RBMS mortgage arrears fell to 1.02% in 3Q17, a 15bp decrease from the previous quarter; consistent with the nine-year long seasonal trend where 30+ days arrears have eased in the third quarter. They say the curing of third-quarter arrears was helped by borrowers using tax return receipts to make repayments. The 30+ days arrears were 4bp lower than in 3Q16, reflecting Australia’s improved economic environment and lower standard variable interest rates for owner-occupied lending. They said the gap between investor lending and owner-occupied rates has widened, as banks respond to regulatory investment and interest-only limits on new loan origination. Historically, investors paid a 25bp-30bp premium over owner-occupied loans, but this widened to 60bp in September 2017.

S&P Global Ratings said RMBS Mortgage arrears fell to 1.08% in September across Australian down from 1.10% in August 2017. They say mortgage arrears rose in both the Northern Territory and the ACT during September but fell elsewhere. The ACT mortgage arrears it is only at a low 0.64%, compared with Western Australia who has the highest arrears of 2.21%. However, while outstanding loan repayments on 30-to-60-day arrears also declined in most states between January and September, 90-day+ arrears rose in Western Australia and Queensland. This is the same as we saw recently in the bank reporting season. S&P expects arrears to rise over the coming months, as they “traditionally start to increase in November and continue through to March.”

There was more evidence of poor mortgage lending practice this week, following the recent UBS “Liar Loans” research study. A liar loan is a loan that is approved on the basis of unverified and possibly false information about income, assets or capacity to repay. This is important because mortgage delinquency and default may rise due to excessive risk taking in mortgage lending combined with deteriorating economic conditions; or due to falling income and rising unemployment during a housing downturn.

Connective remained brokers of their obligations, and pointed to findings from the 2016 Veda Cybercrime and Fraud Report, which recorded a 27 per cent year-on-year increase in falsifying personal information. “Falsified documentation — particularly documents that verify a customer’s income — is the most common type of fraud that a mortgage broker is likely to encounter,” the aggregator said. Back in June, Equifax informed brokers at a Pepper Money roadshow that 13 per cent of frauds reported were targeting home loans and there has been a 25 per cent year-on-year increase in frauds originating from the broker channel.

In the same vein, NAB has said it has commenced a remediation program for some of its customers, after a review identified their home loan may not have been established in accordance with NAB’s policies. NAB identified around 2,300 home loans since 2013 that may have been submitted without accurate customer information and/or documentation, or correct information in relation to NAB’s Introducer Program. As a result of NAB’s review, 20 bankers in New South Wales and Victoria had their employments terminated, or are no longer employed by NAB, and an additional 32 bankers had consequences applied including the reduction of remuneration. NAB has commenced writing to these customers – many of whom live overseas – asking them to participate in a detailed review of their loan, which may include verification of documents submitted at the time of their home loan application. Affected customers may be offered compensation as appropriate.

More evidence of the risks in the system came when The Reserve Bank in New Zealand said that Westpac New Zealand has had its minimum regulatory capital requirements increased after it failed to comply with regulatory obligations relating to its status as an internal models bank. Internal models banks are accredited by the Reserve Bank to use approved risk models to calculate how much regulatory capital they need to hold. Westpac used a number of models that had not been approved by the Reserve Bank, and materially failed to meet requirements around model governance, processes and documentation.

Still talking of risks, there was an interesting paper from the Federal Reserve Bank of Cleveland “Three Myths about Peer-to-Peer Loans” which suggested these platforms, which have experienced phenomenal growth in the past decade, resemble predatory loans in terms of the segment of the consumer market they serve and their impact on consumers’ finances and have a negative effect on individual borrowers’ financial stability. This is of course what triggered the 2007 financial crisis. There is no specific regulation in the US on the borrower side.  Given that P2P lenders are not regulated or supervised for antipredatory laws, lawmakers and regulators may need to revisit their position on online lending marketplaces.

We published two research reports this week. First our Quiet Revolution Banking Channel and Innovation Report, which is available for free download. And second the impact of rising interest rates on households.

It seems that eventually mortgage rates will rise in Australia, as global forces exert external pressure on the RBA, and as the RBA tries to normalise rates (at say 2% higher than today). Timing is, of course, not certain. But it is worth considering the potential impact. While our mortgage stress analysis takes a cash flow view of household finances, our modelling can look at the problem another way. One algorithm we have developed is a rate sensitivity calculation, which takes a household’s mortgage outstanding, at current rates, and increments the interest rate to the point where household affordability “breaks”.  We use data from our household survey to drive the analysis.

So we start with the average across the country. We find that around 10% of households would run into affordability issues with less a 0.5% hike in mortgage rates, and around another 8% would be hit if rates rose 0.5%, and a larger number would be added to the “in pain” pile, giving us a total of around 25% of households across the country in difficulty if rates went 1% higher. [Note that the calculation does not phase the rate increases in]. Around 40% of households would be fine even if rates when more than 7% higher. At a state level we found that around 40% of households in NSW would have a problem, compared with 27% in VIC and 24% in WA. We can also take the analysis further, to a regional view across the states. This reveals that the worst impacted areas would be, in order, Greater Sydney, Central Coast, Curtain and Greater Melbourne. These are all areas where home prices relative to income are significantly extended, thus households are highly leveraged.

CoreLogic said Mortgage clearance rates have continued to track below 70 per cent since June the year; this is a considerably softer trend than what was seen over the same period last year when clearance rates were tracking around the mid 70 per cent range for most of the second half 2016.  Results across each of the individual markets were varied this week, with Canberra recording the highest preliminary auction clearance rate of 72.9 per cent, while in Brisbane only 45.7 per cent of auctions cleared.

So to, two important reports.

According to the eighth edition of the Credit Suisse Research Institute’s Global Wealth Report, in the year to mid-2017, total global wealth rose at a rate of 6.4%, the fastest pace since 2012 and reached USD 280 trillion. But wealth distribution has become more uneven. This reflected widespread gains in equity markets matched by similar rises in non-financial assets (home prices), which moved above the pre-crisis year 2007’s level. Household wealth in Australia grew at an average annual growth rate of  12%, with about half the rise due to exchange-rate appreciation against the US dollar. Australia’s wealth per adult in 2017 is USD 402,600, the second highest in the world after Switzerland.

However, the composition of household wealth in Australia is heavily skewed towards non-financial assets, which average USD 303,200, and form 60% of gross assets. The high level of real assets partly reflects a large endowment of land and natural resources relative to population, but also results from high property prices in the largest cities.

Finally, Industry Super Australia, published an excellent discussion paper on “Assisting Housing Affordability” which endeavours to identify the underlying causes of affordability issues, and  considers some useful policy responses in the current and historical context. They rightly consider both supply and demand related issues.

They call out specifically the impact of incoming migration, especially around university suburbs in the major centres as one major factor.

More broadly, they articulate the problem facing many, in that access to affordable housing – a basic need – is now more difficult than ever and the issue is affecting household spending decisions:

  • Key workers like police officers, teachers and nurses can’t afford to live near the communities they serve.
  • Children are staying at home for longer, marrying later and taking longer to save for a home deposit.
  • Many older Australians are locked into big houses that no longer suit their needs while a greater number of near retirees are renting or paying off a mortgage.
  • Commuters spend too much time on congested roads and trains which are now the norm in certain Australian cities.
  • More Australians are renting.

The report is worth reading because it knits together the complex web of issues, and confirms the complexity which is housing affordability, and that there are no simple single point solutions.

And that’s the point. Sure, employment looks strong, but the nature of that employment is favouring lower wage occupations. Business confidence is strong, because business profits are up, but this is not translating into higher wages. As a result, wealth distribution is becoming more skewed, as home prices and stock prices rise. But the risks remain. Property is overvalued, and we lack joined up thinking to address the fundamental structural issues which exist. So meantime we muddle on, hoping that wage growth will start to rise before home prices fall too far and mortgage rates rise. Don’t look down, we are walking a tightrope!

So that’s the Property Imperative weekly to 18th November 2017. If you found this useful, do leave a comment below, subscribe to receive future updates, and check back next time.  Thanks for watching.

Crunch Time In Australian Banking – The Property Imperative Weekly – 04 Nov 2017

Its crunch time in Australian banking, as property momentum slows, households feel the pinch and mortgage risks rise. Welcome to the Property Imperative Weekly to 4th November 2017.

Watch the video or read the transcript.

We start this week’s review by looking at interest rates. The Bank of England lifted their cash rate by 25 basis points, the first hike since July 2007. The move  highlights how shrinking output gaps and tighter labour markets are pushing central banks towards interest rate normalisation. The FED kept US rates on hold at their November meeting, but signalled its intent to lift rates further, and Trump’s nomination for the FED Chair, Jay Powell to replace Yelland will probably not change this.  The US economy is certainly outpacing Australia’s at the moment. Rates are indeed on the rise and policy makers are of the view that if there is the need to lift rates, the tightening should be gradual as to not destabilize the economy. The question is though whether this will neutralise the impact, or simply prolong the pain as we adjust to more normal rates.  The boom brought about by the banks’ policy of extending credit must necessarily end sooner or later. RBA please note!

Turning to this week’s Australian economic data, Retail turnover was flat in September according to the Australian Bureau of Statistics. More evidence that many households are under financial pressure. In trend terms, there were falls in WA, NT and ACT. NSW had a 0.1% rise compared to last month. On the other hand, Dwelling approvals were stronger than expected, up 1.8 per cent in September 2017, in trend terms, the eighth rise in a row. Approvals for private sector houses rose 0.7 per cent.

The latest credit data from the RBA showed housing lending grew the most, with overall lending for housing up 0.5% in September or 6.6% for the year, which is higher than the 6.4% the previous year. Looking at the adjusted RBA percentage changes we see that over the 12 months’ investor lending is still stronger than owner occupied lending, though both showed a slowing growth trend. They said $59 billion of loans have been switched from investment to owner occupied loans over the period of July 2015 to September 2017, of which $1.4 billion occurred in September 2017. So more noise in the numbers!

Unusually, personal credit rose slightly in the month though down 1.0 % in the past year.  Lending to business rose just 0.1% to 4.3% for the year, which is down from 4.8% the previous year. Business investment (or the lack of it), is a real problem. As John Fraser, Secretary to the Treasury said the bottom line is as the mining investment boom ended, Australia has struggled with weak investment in the non-mining sectors, weighing on the labour market, productivity and ultimately economic growth.

And data from APRA showed that the banks are still doubling down on mortgages, in September. Owner occupied loan portfolios grew 0.48% to $1.03 trillion, after last month’s fall thanks to the CBA loan re-classifications. Investment lending grew just a little to $550 billion, and comprise 34.8% of all loans. Overall the loan books grew by 0.3% in the month. We saw some significant variations in portfolio flows, with CBA, Suncorp, Macquarie and Members Equity bank all reducing their investment loan balances, either from reclassification or refinanced away. The majors focussed on owner occupied lending – which explains all the attractor rates for new business. Westpac continues to drive investor loans hard. Comparing the RBA and APRA figures, it does appear the non-banks are lifting their share of business, as the banks are forced to lift their lending standards. But they are still fighting hard to gain market share, which is not surprising seeing it is the only game in town!

Corelogic’s October property price trends showed that Sydney’s deflating house prices have dragged the property market down across the entire country, the most conclusive sign yet that the boom is over. October is traditionally a bumper month for property sales but average house prices across Australia’s capital cities posted no growth at all. Sydney house prices fell by 0.5 per cent, bringing quarterly losses to 0.6 per cent. Prices in Canberra and Darwin also fell (by 0.1 per cent and 1.6 per cent respectively), while Adelaide and Perth each posted zero growth. Of the capital cities, only Melbourne, Brisbane and Hobart saw property prices increase, at 0.5 per cent, 0.2 per cent and 0.9 per cent respectively. The Australian Property boom is “Officially Over”, despite stronger auction clearance results this past week, which underscored the gap between the momentum in Sydney and Melbourne. Total listings and clearance rates were significantly higher down south.

The HIA reported a further decline in New Home Sales. The results are contained in the latest edition of the HIA New Home Sales Report. During September 2017, new detached house sales fell by 4.5 with a reduction of 16.7 per cent on the multi-unit side of the market.

Lender Mortgage Insurer, Genworth a bellwether for the broader mortgage industry, reported their Q3 performance. While the volume of new business written was down 9.8% on 3Q16, the gross written premium was only down 3.9%. Underlying NPAT was down 14.5% to $40.5 million. The total portfolio of delinquencies rose 4.4% to 7,146, and the loss rate overall was 3 basis points. The regional variations are stark, the performance in Queensland and Western Australia remains challenging and delinquencies are elevated they said. WA was 0.88%, up 19 basis points and QLD was 0.72% up 5 basis points.  According to the Australian Financial Security Authority, insolvencies are also rising in WA and QLD, which is mirroring the rise in mortgage delinquency.

We released our October 2017 Mortgage Stress and Default Analysis. Across Australia, more than 910,000 households are estimated to be now in mortgage stress up 5,000 from last month. This equates to 29.2% of households. More than 21,000 of these are in severe stress, up by 3,000. We see continued default pressure building in Western Australia, as well as among more affluent household, beyond the traditional mortgage belts across the country. We estimate that more than 52,000 households risk 30-day default in the next 12 months, up 3,000 from last month. We expect bank portfolio losses to be around 2.8 basis points ahead, though with WA losses rising to 4.9 basis points.

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. As continued pressure from low wage growth and rising costs bites, those with larger mortgages are having more difficulty balancing the family budget. These stressed households are less likely to spend at the shops, which will act as a further drag anchor on future growth, one reason why retail spending is muted.

The post code with the highest count of stressed households, and up from fourth place last month is NSW post code 2170, the area around Liverpool, Warwick Farm and Chipping Norton, which is around 27 kilometers west of Sydney. There are 6,380 households in mortgage stress here. The average home price is $803,000 compared with $385,000 in 2010. There are around 27,000 families in the area, with an average age of 34. The average income is $5,950. 36% have a mortgage and the average repayment is about $2,000 each month.

Mortgage stress is still strongly associated with fast growing suburbs, where households have bought property relatively recently, often on the urban fringe. The ranges of incomes and property prices vary, but strikingly it is not necessarily those on the lowest incomes who are most stretched. The leverage effect of larger mortgages has a significant impact.

The latest Household Debt Trends from the ABS also showed first, more households are in debt today, compared with 2005-6, and second more households have debts at more than three times their income. Those on lower incomes have borrowed harder, with 50% in the bottom income range borrowing, compared with 44.6% in 2003-4.

Many banks are cutting their mortgage rates to try to attract new borrowers, desperate to write business in a slowing market, because mortgage lending remains the only growth engine in town. We saw announcements from ANZ, and Virgin Money, the Bank of Queensland-owned lender who cut rates by up to 21 basis points and also lifted the maximum LVR to 80%.  On the other hand, mirroring other lenders, Westpac is the latest to bring in a number of responsible lending changes affecting how brokers enter in requirements and objectives (R&O) questions for clients. In a note to brokers the bank said: “This will ensure that the correct R&O are captured accurately for all applications submitted and resubmitted and there is a central location that incorporates all the R&O information that has been discussed between yourself and the client with documented evidence of any loan changes,”.

More evidence of the impact of regulation on the mortgage sector came when Bengido and Adelaide Bank’s CEO provided a brief trading update as part of the FY17 AGM. There are some interesting comments on the FY18 outlook. First they have been forced to “slam on the breaks” on mortgage lending to ensure they comply with APRA’s limits on interest only loans and investor loans. As a result, their balance sheet will not grow as fast as previously expected. On the other hand, this should help them maintain their net interest margins, their previous results had shown a steady improvement and strong exit margin.  They are forecasting 2.34%.

NAB reported their FY17 results and cash earnings were up 2.5% to $6,642 million, which was below expectations. NAB now has its main footprint in Australia, (and New Zealand). Of the $565 billion in loans, 84% of gross loans are in Australia, and 13% in New Zealand. 58% of the business is mortgages, and 10.9% of gross loans, or $62bn are commercial real estate loans, mainly in Australia. So you can see how reliant NAB is on the property sector. NIM improved a bit, although the long term trend is down. Wealth performance was soft, and expenses were higher than expected, but lending, both mortgages and to businesses, supported the results.  They made a provision for potential risks in the retail and the mortgage portfolio, with a BDD charge of 15 basis points but new at risk assets were down significantly this last half. The key risk, or opportunity, depending on your point of view, is the property sector. Currently portfolio losses are low at 2 basis points but WA past 90-day mortgages were up. If property prices start to fall away seriously, new mortgage flows taper down, or households get into more difficulty (especially if rates rise), NAB will find it hard to sustain its current levels of business performance. Ahead, they flagged considerable investment in driving digital, and major cost savings later into FY20 with a net reduction of 4,000 staff.

It is worth saying that back in the year 2000, NAB’s net interest margin was 2.88% compared with 1.85% today, which is lower than ANZ’s 1.99% recently reported. This should be compared with US banks who are achieving 3.21% on average according to Moody’s. It shows that considerable reform of banks in Australia are required. The biggest expense by far is the people they employ. The future of banking is digital! As the mortgage lending tide recedes, the underlying business models of Australian banks are firmly exposed. They have to find a different economic model for their business. Just pulling back to Australia and New Zealand and flogging more mortgages will not solve their problem.

And that’s the Property Imperative Weekly to the 4th November 2017. If you found this useful, as always, do leave a comment below, subscribe to receive future updates, and check back next week for our latest weekly digest

Asleep At The Wheel? – The Property Imperative Weekly 28 Oct 2017

Another big week of finance and property news, so we pick over the bones and try to make sense of what’s going on. And we ask were the Regulators asleep at the wheel?

Welcome to the Property Imperative weekly to 28th October 2017. Watch the video or read the transcript.

We start this week’s review with a look at the latest economic data. The latest GDP read from the US, at 3.1% annualised, in Q2 and 3.0% in Q3, provides more support to the view the FED will lift their benchmark rate again before the end of the year. This is likely to have a flow on effect by rising rates in the international capital markets, which will mean higher bank funding costs here, as well as putting downward pressure on the toppy stock market. To confirm this view, we saw the benchmark 10-year Treasury Bond Yield in the USA rose to its highest rate in several months.

In Australia, the ABS said the CPI was 0.6 per cent in the September quarter 2017 following a rise of 0.2 per cent in June. The most significant price rises were electricity (+8.9%), tobacco (+4.1%), international holiday travel and accommodation (+4.1%) and new dwelling purchase by owner-occupiers (+0.8%). These rises were partially offset by falls in vegetables (-10.9%), automotive fuel (-2.3%) and telecommunication equipment and services (-1.5%). The CPI rose 1.8 per cent through the year to September quarter 2017 having increased to 1.9 per cent in the June quarter 2017, below the RBA’s 2-3% target band.

The RBA’s Guy Debelle spoke about some of the uncertainties in taking the economic temperature in Australia. He homed in on the CPI data from the ABS, making the point that our belated quarterly CPI reports are out of kilter with the monthly data now provided in many other western countries. In addition, the ABS will be revising their expenditure weightings in the CPI series, which means that CPI may currently be over stated by perhaps a quarter of a percent. These revisions are made every 5 or 6 years, although there are plans afoot to make them more frequently. The ABS is under tremendous funding pressure, and there are risks their critical data series may be compromised.

The National Accounts data from the ABS for the year 2016-17 really brought home how much of the growth in the economy was thanks to household consumption, as opposed on business or government investment. This helps to explain why the RBA was willing to let household debt escalate to their current astronomical levels, why rates are so low, and why the property sector is so important.  In summary, overall growth was 2%, the lowest since 2008-9; wages rose 2.1%, the weakest since 1991-2; growth in household expenditure as measured in current price terms was 3.0%, the lowest on record; the household saving ratio was at its lowest point (4.6%) in nine years and yet household consumption was the strongest growth driver at 1.22 percentage points.

This was because households borrowed an additional $990 billion over the 10 year period from 2006-07, mainly in mortgages. The value of land and dwellings owned by households increased by $2.9 trillion over the same period and increased by $621 billion through 2016-17 and despite slow wage growth, household gross disposable income plus other changes in real net wealth increased $456.6 billion, or 32.6%, in 2016-17, largely due to a $306.5 billion appreciation in the value of land held by households.

But of course, such high debt and high property prices are now creating fault lines in the property market and household finances.

We are seeing more risks in the property investment sector. Traditionally, in the Australian context, loans to property investors have tended to perform better than loans to owner occupiers. This is because investors receive rental income streams to help pay for the mortgage costs, they are willing to carry the costs of the property against future capital gains, and many will be able to offset costs against tax, especially when negatively geared. In addition, occupancy rates in most states have been stellar.

But things are changing, as the costs of borrowing for investment purposes have risen (thanks to the banks’ out of cycle rises), while rental returns are flat, or falling and the costs of managing the property are rising. In addition, the supply of investment property is rising, and occupancy rates are declining in a number of key markets. As a result, more investors are seeing net rental yields – after mortgage payments and other costs drifting into negative territory, especially in VIC and NSW.  Our Core Market Model, and recent data from ANZ suggests defaults from the property investment sector are now running at similar levels to owner occupied borrowers, and are set to rise further.

In fact, the ANZ full year result, which superficially looked strong – up 18% on the prior comparable period – contained a number of negative trends, as they focus more on the retail business in Australia and New Zealand.  Yes, they have a strong balance sheet, as capital is released from their assets sales, and provisions were down; but the underlying net interest margin fell, down 8 basis points on last year to 1.99%, with a fall of 2 basis points in 2H, despite the mortgage book repricing and loan switching. In addition, 90-Day mortgage defaults overall remained similar to last year, but with a spike in WA and a fall in VIC/TAS. Investment loan delinquencies are rising, whereas they have traditionally been lower than OO loans. They have recently tightened underwriting standards, but of course loans already on their books have looser standards. They warn “household debt and savings have both increased, however the ability for households to withstand economic shocks has diminished a little”. “In 2018 we expect the revenue growth environment for banking will continue to be constrained as a result of intense competition and the effect of regulation including a full year of impact of the Australian bank tax.”

Our own analysis of default probability, from our Core Market Model, now includes 90-day default risk modelling.  We measure mortgage stress on a cash flow basis – the October data will be out next week – and we also overlay economic data at a post code level to estimate the 30-day risk of default (PD30). But now we have added in 90-day default estimates (PD90) and the potential value which might be written off, measured in basis points against the mortgage portfolio. We also calibrated these measures against lender portfolios. Granular analysis can provide a rich understanding of the real risks in the portfolio. Risks though are not where you may expect them! If we look at the results by state, WA leads the way with the highest measurement, then followed by VIC, SA and QLD. The ACT is the least risky area. In WA, we estimate the 30-day probability of default in the next 12 months will be 2.5%, 90-day default will be 0.75% and the risk of loss will be around 4 basis points. This is about twice the current national portfolio loss, which is sitting circa 2 basis points.

Banks are cracking down on loans to borrowers buying into Brisbane’s over-supplied apartment market, with a number of risky postcodes identified, which require bigger deposits. The four major banks – Westpac, Suncorp, Australia and New Zealand Banking Group (ANZ), and National Australia Bank (NAB) – are restricting lending for certain Brisbane postcodes, where apartment buyers will now be required to have a deposit of up to 20% to qualify for a home loan. Suncorp has blacklisted nearly 40 postcodes in the Queensland capital, including Inner Brisbane, Teneriffe, Fortitude Valley, Bowen Hills, and Herston. The banks are refusing to loan more than 80% of the cost of a unit due to “[weaknesses] in the investment market” as well as the current oversupply in inner-city apartments. Prices for apartments in Inner-Brisbane have dropped to their lowest level in three years.

QBE’s Housing Outlook, published this week, suggests home price growth will slow further in the years ahead. We continue to see appetite from property investors easing, as property price growth stalls or in some states reverse. Banks on the other hand are chasing new business with deep discounts on new loans. For example, Teachers Mutual cut their rate for new loans by 30 basis point, to 3.84%.  Westpac, St George, BankSA and Bank of Melbourne all introduced promotional discount rates, with rates down by up to 20 basis points. Bank West also offered discounts to both new owner occupied and investor borrowers. So, the war chests created by the back book repricing earlier in the year – especially investor and interest loans are being used to target new business. As a result, we expect to see a hike in refinancing, especially in the lower LVR owner-occupied sector, as borrowers seek to reduce their monthly outgoings.

We also showed that more households seeking a mortgage are generating multiple applications, sometimes direct to a bank, and sometimes via mortgage brokers, as they seek to find the best deals. More applications are made via online systems, which make the process easier, but the net result of all this is that mortgage conversation rates have fallen from around 80% to 50%, creating more noise, and costs in the system. We think this is a direct results of the banks’ so called omni-channel approach to distribution, which will turn out to be quite costly.

Following the concerns expressed recently by RBA and ASIC on the risks to household finances, finally, we got an admission from APRA that mortgage lending standards have decayed over the last decade, and that they needed to take action to reverse the trend. And now they are looking at debt-to-income. Poor lending standards, they say are systemic, driven by completion, and poor bank practices. They recently intervened (a little). And late to the piece (now) debt-to-income is important. Did you hear the door slamming after the horse has bolted?

The Treasury added their voice this week, when John Fraser, Secretary to the Treasury, gave an update on household finances and housing as part of his opening statement to the October 2017 Senate Estimates.  He expressed the view that debt is born by those with the greater capacity to repay but this belies the leverage effect of larger loans in a rising interest rate environment. He said that “while banks’ progress against these measures has been positive, regulators will need to think carefully about whether future efforts to maintain financial stability should lean against cyclical excesses or address structural risks within the financial system”.

So, we have the full Monty, with all four members of the shadowy “Council of Financial Regulators” expressing concerns about household debt and home price risks. A completed change of tune from the declarations of 2015 when everything was said to be just dandy!

Now those following this blog over the past few years will know we have been flagging these concerns, especially as the cash rate was brought to its all-time low.  We said DTI was critical, that standards should be tightened, and the growth of debt to income was unsustainable.

All members of the “Council of Financial Regulators” which is chaired by the RBA are culpable.  This body, which works behind the scenes, is referred to when hard decisions need to be take. If you look back at recent APRA and RBA statements, the Council gets a Guernsey! The problem is there has been group-think for year, driven by the need to use households as a growth proxy for the failing mining and resource sector. And no clear accountability. But too little has been done, too late.  And it is poor old households who, one way or the other will pick up the pieces – not the banks who have enjoyed massive profit and balance sheet growth. Even now, lending for housing is growing three time faster than incomes or cpi. Regulators are now lining up to call out the problems. Managing the risk going forwards is a real challenge. It’s time to review the regulatory structure and remember that the Financial System Inquiry recommended the creation of a new Financial Regulator Assessment Board to assess the performance of the regulatory framework, but this was rejected by the Government! That could prove to be a costly mistake.

And that’s the Property Imperative Weekly to 28th October 2017. If you found this useful, do leave a comment below, subscribe to receive future updates and check back next week for the next installment.

Pulling In Two Directions – The Property Imperative Weekly 21 Oct 2017

The latest economic and finance data appears to be pulling in two directions, so we discuss the trends.

Welcome to the Property Imperative Weekly to 21st October 2017. Watch the video, or read the transcript!

In this week’s review of the latest finance and property news, we start with data from the Australian Institute of Health and Welfare in their newly released report Australian Welfare 2017. This is a distillation of data from various public sources, rather than offering new research.

In the housing chapter, they reinforce the well-known fact that home ownership is falling in Australia, while rates have been rising in a number of other comparable countries. Contributing to this trend overseas, at least in part, they say, are changes in the characteristics of households (including population ageing, household structure, and income and education) and policy influences, such as mortgage market innovations (including the relaxation of deposit constraints, increasing home ownership rates among lower income households, and tax reliefs on mortgage debt financing). In Australia, the steepest decline in home ownership rates across the 25 years to 2013–14 has been for people aged 25–34. This is typically the age at which first transitions into home ownership are made. But, fewer and fewer people in this age group are entering home ownership, with a 21 percentage point decline to just 39% in 2013–14 (compared with 60% in 1988–89). Home ownership rates for people aged 35–44 also fell, but not so much (12 percentage points).

Also, the proportion of home owners without a mortgage has continued to fall, while the proportion of renters has increased. Now more home owners have a mortgage, compared with those who own their property outright. Another fact is the startling gap between the rise in home prices, relative to disposable incomes, creating a barrier to home ownership for many. This gap has been fuelled by rapid house price growth (up 250% since the 1990’s), after the financial system was deregulated, with the total value of Australian housing estimated to be more than $6.5 trillion. Of course, the impact of higher house prices has been partially offset by lower mortgage interest rates, increased credit availability and changes in financial agency practices. These favourable lending conditions and low interest rates have encouraged buyers into the market, despite the growth in house prices themselves. This could all got wrong should mortgage rates rise.

The final piece of data shows that households are getting a mortgage later in life, and holding it longer, often well into retirement. In 2013, 71% of people born between 1957 and 1966 (mainly baby boomers), were financing a mortgage when aged 45–54. This trend is of particular concern as these households’ approach retirement without their home and asset base being paid off. For people looking to retire in the next 10 years, 45% of 55–64-year-olds in 2013 were still servicing a mortgage, compared with just 26% in 1982.

As the recent Citi report emphasises, and using our Core Market Data, the large level of debt outstanding by borrowers aged in their 50s and 60s means many investors will need to sell property to discharge their debts, especially those holding interest only loans. Given that the average age of wealthy seniors is 63 and the average IO debt is $236,400, Citi expressed concern that this cohort will not have enough time to repay the principal “without a significant hit to household cash flows”.

We still think the mortgage underwriting standards are too lose in Australia, as regulators try to balance slowing the market, but not killing the goose which is laying the golden economic egg.  So we found the Canadian regulators intervention in their mortgage market this week significant. There the index of house prices to disposable income has increased 25%, from 2000,  raising the prospect that real estate overvaluation is driving up overall household debt and overextending borrowers. So they tightened serviceability requirements and imposed loan to value limits on lenders.

Good news on housing affordability this week from the HIA, at least for some. Their Housing Affordability index for Australia improved by 0.5 per cent in the September 2017 quarter but still remains 4.4 per cent below the level recorded a year ago. It also showed that while some owner occupied borrowers had seen their mortgage rates drop, many property investors, has seen their rates rise. Sydney remains the least affordable market they say.

Our friends at Mozo wrote a blog post for us on the impact of the APRA changes to mortgage rates, which underscored the movements by type of loan.

More good news from the ABS. The monthly trend unemployment rate decreased by 0.2 per cent over the past year to 5.5 per cent in September, the lowest rate seen since March 2013. The participation rate remained steady at 65.2 per cent, within that male participation rate was 70.8 per cent, while the female participation rate reached a record high of 59.9 per cent. Over the past year, the states with the strongest annual growth in employment were Queensland (4.1 per cent), Tasmania (3.9 per cent), Victoria (3.1 per cent) and Western Australia (2.9 per cent). However, the underemployment trend rate still does not look that flash, especially in TAS, SA and WA, and we have a very high unemployment rate among younger workers as well as a rise in more casual, part-time work. All of this translates to lower wages.

The latest data from S&P showed a small decline in mortgage defaults in August. S&P said arrears decreased in all states and territories except the Australian Capital Territory (ACT) over the month, with noticeable improvements in Australia’s mining states and territories. The Northern Territory recorded the largest improvement, with arrears declining to 1.63% from 1.98% a month earlier. In Western Australia, arrears fell to 2.22% in August from a historic high of 2.38% in July. They still warned of potential risks in the system, especially from higher LVR IO loans written before 2015. And of course, this is looking a selection of securitised loans which may not be typical, and in any case, in most places home price rises mean struggling borrowers should have the capacity to sell and repay the bank. That would change if prices started to fall seriously.

Talking of risks, there were interesting comments from ASIC this week, suggesting that whilst brokers may be having appropriate conversations with their interest only mortgage customers, there was evidence of poor record keeping. This follows the regulator’s announcement they would commence a loan file review, to ensure that consumers are not paying for more expensive products that are unsuitable. Without good documentation brokers and lenders leave themselves open to the charge of making unsuitable loans, which can have significant consequences.

Another indicator of potential risks in the system is the rise in the number of households seeking short term loans from pay day lenders and other providers. Our surveys show that more than 1.4 million of the 9.5 million households in Australia are looking for finance (and it is rising fast as cash flows are stressed). Not all will successfully obtain a loan. We think more than $1 billion in loans are out there, and our research shows that such short term loans really do not solve household financial issues. However, when people are desperate, they will tend to grasp at any straw in the wind, regardless of cost or consequences. We also find these households are within certain household segments, who tend to be less affluent, and less well educated.

The RBA minutes, release this week, did not tell us much more, but contained this morsel. “Members noted that housing loans as a share of banks’ domestic credit had increased markedly over the preceding two decades. APRA intended to publish a discussion paper later in 2017 addressing the concentration of banks’ exposures to housing.  Members also noted that APRA had intensified its focus on Australian banks strengthening their risk culture”.  We can barely contain our excitement at the prospect! A discussion paper later in the year!

CoreLogic’s latest auction clearance results showed there is still demand for property, with a preliminary clearance rate of 70.6 per cent, and increase from last week when the final clearance rate slipped to 64.4 per cent, the lowest clearance rate since January 2016.

Finally, we released our latest flagship report – The Property Imperative, Volume 9. This is available free on request from our web site and is a distillation of our research into the finance and property market, using data from our household surveys and other public data. Whilst we provide these weekly updates via our blog, twice a year we publish a full report. Volume 9 offers, in one place, a unique summary of the finance and property markets, from a household perspective, over more than 70 pages.

What really struck us as we wrote the report was the amount of change in the property and finance sector, with significant regulatory tightening, changes in mortgage pricing and a rotation in mortgage lending. But the underlying facts of high prices, mortgage stress and rising risks in the system appear unchanged. The number of reports highlighting the risks have risen substantially.

Standing back, sure the data is pulling to two directions, with employment higher, auction clearance rates firm and affordability for some manageable. But the bigger picture contains a number of risks, stemming from the divergence of incomes and home prices, the lose lending standards over the past few years, and the risks from the more recent tightening of the rules, at a time when interest rates are more likely to rise than fall. Without a significant rise in incomes in real terms – and we cannot see where this will come from – the risks to growth and financial stability are still not fully understood.

And that’s the Property Imperative to 21st October 2017. Follow this link to request the Volume 9 Property Imperative Report.

The Property Imperative Volume 9 Report Released Today

The latest and updated edition of our flagship report “The Property Imperative” is now available on request with data to mid October 2017.

This Property Imperative Report is a distillation of our research into the finance and property market, using data from our household surveys and other public data. Whilst we provide weekly updates via our blog, twice a year we publish this report. This is volume 9. It offers, in one place, a unique summary of the finance and property markets, from a household perspective.

Residential property, and the mortgage industry is currently under the microscope, as never before. Around two thirds of all households have interests in residential property, and about half of these have mortgages. More households are excluded completely and are forced to rent, or live with family or friends.

We believe we are at a significant inflection point and the market risks are rising. Many recent studies appear to support this view. There are a number of concerning trends. While household incomes are flat in real terms, the size of the average mortgage has grown significantly in the past few year, thanks to rising home prices (in some states), changed lending standards, and consumer appetite for debt. In fact, consumer debt has never been higher in Australia. As a result, households are getting loans later, holding mortgages for longer, even in to retirement, so household finances are being severely impacted, and more recent changes in underwriting standards are making finance less available to many.

Property Investors still make up a significant share of total borrowing, and experience around the world shows it is these households who are more fickle in a downturn. Many use interest only loans, which create risks downstream, and regulators have recently been applying pressure to lenders to curtail their growth.

Mortgage rates are now higher for Investors and those holding Interest Only loans, while low-risk customers with a Principal and Interest loan should be able to find some amazingly low rates. While mortgage underwriting standards are now tighter, there is an overhang of existing loans which would now fall outside existing underwriting standards. Interest Only loans are especially at risk, not least because rental incomes are being compressed.

We hold the view that home prices are set to ease in coming months, as already foreshadowed in Sydney. We think mortgage rates are more likely to rise than fall as we move on into 2018.

Finally, lenders have been able to repair their margins, under the umbrella of supervisory intervention, and their back book repricing has created a war chest to fund attractor offers.

We will continue to track market developments in our weekly Property Imperative weekly video blogs, and publish a further consolidated update in about six months’ time.

Here is the table of contents.

 3.1 Current Property Prices
 4.1 Total Housing Credit Is Up
 4.2 ADI Lending Trends Are Suspect
 4.3 Housing Finance Flows
 4.4 The Rise of the Bank of Mum and Dad
 5.1 RBA Financial Stability at Risk
 5.2 IMF Warnings On Growth and Debt
 5.3 Household Ratios Under Pressure
 5.4 Housing Occupancy Costs Are High
 5.5 Households Are Spending More On Basics
 5.6 Savings Are Shrinking
 5.7 DFA Mortgage Stress Rises Again
 5.8 Top Ten Stressed Post Codes
 5.9 More Households Have No Equity
 5.10 Greater Risks from Interest Only Loans
 5.11 The Consumption Crunch
 5.12 A Fall in Household Financial Security
 5.13 Mortgage Rates Will Rise – Sometime
 5.14 Defaults Are Down a Little, But Risks Remain
 5.15 Observations
 6.1 Property Active and Inactive Households
 6.2 Cross Segment Comparisons
 6.3 Property Investors
 6.4 How Many Properties Do Investors Have?
 6.5 SMSF Property Investors
 6.6 First Time Buyers.
 6.7 Up Traders and Down Traders
 6.8 Auction Clearances Remain Quite Strong
 7.1 ASIC Looks at Interest Only Loans
 7.2 APRA Lifts Capital
 7.3 APRA Lifts Underwriting Standards
 7.4 APRA to Regulate Non-Bank Lenders
 7.5 APRA Delays Mortgage Reporting Standards
 7.6 The Impact On Interest Only Loans
 7.7 Standards Are Tighter Now
 7.8 Risks Are Increasing; Standards Still Too Lose
 8.1 It Pays to Haggle

Request the free report [72 pages] using the form below. You should get confirmation your message was sent immediately and you will receive an email with the report attached after a short delay.

Note this will NOT automatically send you our ongoing research updates, for that register here.

Too Little Too Late? – The Property Imperative Weekly 14th October 2017

Another massive week of finance and property news, much of it centred on households and their finances, as the regulators home in on the risks in the mortgage market. But is it too little too late?

Welcome to the Property Imperative weekly to the 14th October 2017. Watch the video, or read the transcript.

We start our review of this week’s finance and property news with the RBA’s Financial Stability report.  This quarterly report, which ran to 62 pages said that International economic conditions, and local business confidence are on the improve while banks now hold more capital, have tightened lending standards, and shadow banking is under control. But, they say, Australian household balance sheets and the housing market remain a core area of interest, and from a financial stability perspective, this is the key risk. They showed that one third of mortgage holders have less than one months’ buffer, and their key concern is the negative impact on future growth as households hunker down;  so nothing new really, apart from some new “Top Down” stress testing.

And nothing to answer the IMF’s downgraded Australian growth forecast. Given the first half result in 2017 was 1.2% a second half forecast at circa 1% is hardly stellar; and the sudden rebound to 3% next year, some might say, appears courageous. The IMF also revised up the unemployment rate, suggesting it will remain at 5.6%, rather than falling to 5.3% as estimated last time. This plus slow wage growth highlights the issues underlying the economy. They also warned about risks from high debt saying growth in household debt relative to GDP is associated with a greater probability of a banking crisis. And Australia is right up there!

On the same day, the ABS released their latest Housing and Occupancy Costs data. The average household with an owner occupied mortgage is paying around $450 a week, slightly lower than the peak a couple of years ago.  This equates to around 16% of gross household income. But of course, the true story is interest rates have fallen to all-time lows, allowing people to borrow more, as prices rise. As a result, should interest rates start to bite, this will cause real pain. Plus, we have recent flat wage growth, in real terms, in the past couple of years. Finally, households have a bigger mortgage held for longer, which is great for the banks, but not helpful from a household perspective, as it erodes savings into retirement and means that more older Australians are still borrowing as they transition from the work force.

Earlier in the week, the ABS also released their latest housing finance data which showed that ADI lending rose 0.6% in trend terms in August, or 2.1% seasonally adjusted. Within that, lending for owner occupied housing rose 0.9%, or 2.1% seasonally adjusted and investor loans rose 0.2% in trend terms, or a massive 4.3% in seasonally adjusted terms. So lending growth is apparent, and signals more household debt ahead. First time buyers continue to extend their reach, despite the fact we are seeing “Peak Price” for property at the moment. In original terms, the number of first home buyer commitments as a percentage of total owner occupied housing finance commitments rose to 17.2% in August 2017 from 16.6% in July.

AFG’s latest mortgage index, shows that property investor appetite is falling, while first time buyers, and property upgraders are more active. First time buyers are reacting to the recent incentives put in place in VIC and NSW, they said.

Citi published a 54-page report on the highly topical subject of interest only (IO) loans, and we provided data from our Core Market Model to assist their research. Even after recent regulatory tightening, they say that underwriting standards in Australia are still more generous than some other countries, at 5.3 times income, compared with 3.7 times in the UK, 4.4 times in Canada and 4.9 times in New Zealand. They conclude that there are vulnerabilities in the IO sector, both from property investors and owner occupied IO loan holders. Overall this is, we estimate, more than $680 billion of the $1.6 trillion mortgage book. They say that tighter lending criteria and rising house prices has meant investors increasingly face net negative cash flows and investors face a growing household cash flow gap and reducing capital gains expectations. The large levels of debt outstanding by borrowers aged in their 50’s and 60’s means many investors will need to sell property to discharge their debts. Owner Occupied IO borrowers are more susceptible to interest rate rises given higher average borrowing levels and higher average loan to value ratios. They concluded “Given the widespread use of IO finance and the reduced prospects of discharging debt via means other than liquidation of portfolio holdings, banks must face an increased risk of mis-selling claims in future years. Mining towns serve as a microcosm of this threat”.

ASIC updated their work on IO loans finding that Australia’s major banks have cut back their interest-only lending by $4.5 billion over the past year. However, other lenders have partially offset this decline by increasing their share of interest-only lending. They say that borrowers who used brokers were more likely to obtain an interest-only loan compared to those who went directly to a lender and borrowers approaching retirement age continue to be provided with a significant number of interest-only owner-occupier loans. Now ASIC will examine individual loan files to ensure that lenders are providing interest-only home loans in appropriate circumstances, to ensure that consumers are not paying for more expensive products that are unsuitable, under the responsible lending provisions.

In this light, it was interesting to listen to some of the Big Bank’s CEO’s in front of the House of Representatives Standing Committee on Economics. Westpac CEO said half of his $400 billion mortgage portfolio was interest only. The other banks were closer to 40%. While both Westpac and ANZ said “we don’t lend to people who can’t pay it back. It doesn’t make sense for us to do so”, the underwriting standards are, we think, way too lose, as the recent regulatory tightening highlights, but it’s probably too late, especially for IO loans which now would fail even the current still generous standards. In an excellent The Conversation article, Richard Holden, Professor of Economics, UNSW rightly highlighted the “Spooky” parallels between our current situation, and the US mortgage market prior to the GFC.  “Australia’s large proportion of five-year interest-only loans – turbocharged by an out-of-control negative-gearing regime – looks spookily similar. It’s one thing for borrowers to do silly things. When it becomes dangerous is when lenders not only facilitate that stupidity, but encourage it. That seems to be what has happened in Australia”.

Smaller lenders are still feeling the pressure, as illustrated by the Bank of Queensland results, which came out this week. While the headline profit was up, underlying growth was lower, and mortgage lending was the key. Net interest margin fell to 1.87%, but was better in 2H. Interest only loans were 40% in 2H16, and 39% in 1H17, but trending down, they say! 8% of loans are higher than 90% LVR on a portfolio basis, and 19% in the 81-90% band.

During their hearing, the big banks also confirmed they had repriced their mortgage back book, especially for interest only and investment loans, but weirdly denied this was to increase profitability.  The quote of the week for me was one CEO saying that people should switch from IO loans to P&I loans “because they were cheaper” – which may be true from a headline interest rate perspective, but the monthly repayments when switching are significantly higher, so in reality, it is not cheaper in cash flow terms!

There was conflicting data relating to Foreign Property Investors, especially from China, with Credit Suisse saying they estimate, based on stamp duty records, that foreign buyers are acquiring the equivalent of 25% of new housing supply in NSW, 17% in Victoria and 8% in Queensland.  If they are correct, this may put a floor on home prices, and they suggest that crackdowns on capital outflows by Chinese authorities appear not have slowed China’s appetite for Australian property.

On the other hand, while the NAB Residential Property Index rose 6 points in Q3, they highlighted lower foreign buying activity in new property markets, VIC saw the share fall to 14.4% (from 20.8% in Q2) and NSW down to 7.8% from 12% in Q2. In contrast, QLD saw a rise to 11.4%, up from 8.6% last quarter. NAB also revised its national house price forecasts, predicting an increase of 3.4% in 2018 (previously 4.3%) and easing to 2.5% in 2019. Unit prices are forecast to rise 0.5% in 2018 (-0.3% previously), with a modest fall expected in 2019.

Our data suggests that Chinese buyers are indeed still active, with a focus on certain postcodes where high-rise units are being built, and often offered direct to overseas buyers. We also see evidence of some high rollers buying larger houses. But overall this is not enough to support home prices into next year.

We published the September update of the Digital Finance Analytics Household Finance Security Index, which underscored the growing gap between employment, which remains relatively strong, and the Financial Security of households. The Index fell from 98.6 in August to 97.5 in September. The state by state view highlights a fall in NSW, while VIC holds higher, and there was a rise in WA from February 2017 lows. This highlights the fact the households across the national are under different levels of pressure. Tracking by age bands we find younger households are significantly less confident, compared with those aged 50-60 years.  But across the board, the general trend is lower.

Similar findings were contained in the latest AlphaWise survey conducted by Morgan Stanley. Income growth has not recovered, ‘cost of living’ inflation is re-accelerating and ‘macro-prudential’-related tightening of credit conditions is extending from housing into consumer finance. They say Australian households are in a vulnerable financial position, especially those who have taken out a mortgage. And in an era of weak incomes growth, soaring energy prices and high levels of indebtedness, with the prospect of higher interest rates on the way, many intend to cut discretionary spending in anticipation of even tighter household budgets. That’s bad news, not only Australia’s retail sector, but also the broader economy. They forecast discretionary consumption volumes will slow to just 0.2% in 2018, dragging overall consumption growth down to 1.1% and well below consensus of 2.5%.

So, in summary the evidence is building that we are entering a concerning episode where growth is likely to be lower, households will remain under pressure, and risks in the system are considerably higher than the RBA is willing to concede. The mystery though is why the regulators are still allowing mortgage lending to grow way faster than inflation, and wages. This surely must be slowed, and soon. Once again, too little too late.

So that’s the Property Imperative Weekly to 14th October. If you found this useful, do leave a comment below, subscribe to receive future updates and check back next week.

Households Get Crushed – The Property Imperative Weekly 07 Oct 2017

Mixed economic news this week, which makes the call on the next cash rate move more complex, but even at current levels, more households are getting crunched as wages tall, debt rises and property prices turn.

Welcome to the Property Imperative weekly to 7th October 2017, the latest digest of finance and property news. Watch the video, or read the transcript.

The big shock this week was the horrible retail spending data from the ABS.  Retail turnover in August declined for a second month in a row, down 0.6 per cent, the worst monthly performance in more than four years, which puts economic growth at risk. In seasonally adjusted terms, there were falls in all states and territories but Victoria (-0.8 per cent) and Queensland (-0.8 per cent) led the way.  The full impact of the August slump will be seen when the September quarter GDP figures are released. Last time, the share of economic growth flowing to wage earners fell to 51.3 per cent in trend terms, the lowest since 1964.

Commonwealth Bank economist Gareth Aird said mortgage interest payments are taking up a larger proportion of household income, and were acting as “a handbrake on consumer spending and the retail sector in general”. All too true – as followers of our blog will know, poor wage growth is the problem.

Even the PM highlighted the impact of slow or no wage growth. “While we’re seeing strong growth in employment, we’re yet to see stronger growth in wages so people feel as though they’re not getting ahead,” Mr Turnbull told Neil Mitchell on 3AW radio. But its more than a feeling, it’s an economic reality.

To underscore the pressure on households, we released our mortgage stress data to end September, which confirmed the uptrend by crossing the 900,000 household rubicon for the first time.  Across the nation, more than 905,000 households are now in mortgage stress (last month 860,000) and more than 18,000 of these are in severe stress. This equates to 28.9% of households. A rising number of more affluent households are being impacted as the contagion of mortgage stress continues to spread beyond the traditional mortgage belts. We estimate that more than 49,000 households risk default in the next 12 months, up 3,000 from last month. You can watch our video summary to see which post codes are most impacted.

New research commissioned by mortgage brokers iSelect through Galaxy Research which polled over 1,000 Australian households also found that 25% were experiencing difficulty covering their mortgage repayments and 33% have had their interest rates increased in the past year. Almost 40% of households making their payments have no surplus left over and if interest rates were to rise by 1%, more than 780,000 mortgage holders would struggle to make repayments. This includes 632,000 households which would have to cut back to cover repayments and 150,000 which would be forced into further debt.

Roy Morgan Research mortgage stress data also confirmed the rising pressure, with a rise, to 17.3%, despite a decline in loan rates.  Those they identified as ‘Extremely at Risk’ also increased from 12.4% to 12.8%. They define stress on a different basis to the DFA cash-flow method, but the trend is still clear.

We also found, in joint research with HashChing a massive discrepancy in home loan interest rates across NSW, with vast differences in rates even within the same suburbs. The data shows that in some cases, neighbours are paying up to $87,027 more for new owner occupied loans (105 basis point disparity), and $201,704 more for refinanced owner occupied loans (235 basis point disparity). The calculation is based on an average home loan of $500,000 over 25 years. Those borrowers paying higher rates are essentially adding an extra three years of mortgage repayments compared to those on a lower rate.

More bad news from banking analysts at UBS who said a third of borrowers with interest-only (IO) loans “do not know or understand that they have taken out an IO mortgage”. According to the results, 23.9 per cent (by value) of respondents stated that they were on an IO mortgage, well below APRA’s figure of 35.3 per cent. UBS said “While we initially suspected that this was a sample error… We believe a more plausible explanation is that around one-third of IO customers do not know or understand that they have taken out an IO mortgage. We are concerned that it is likely that approximately one-third of borrowers who have taken out an IO mortgage have little understanding of the product or that their repayments will jump by between 30-60 per cent at the end of the IO period”.

Whilst FBAA executive director Peter White said that the conclusion was “the biggest load of nonsense on the planet” and that there was no analytical data to support what they’re saying; DFA analysis shows that over the next few years a considerable number of interest only loans (IO) due for review, will fail current underwriting standards.  So households will be forced to switch to more expensive P&I loans, assuming they find a lender, or even sell. The same drama played out in the UK a couple of years ago when they brought in tighter restrictions on IO loans.  We conservatively estimate $7 billion will fall due this year, $9 billion in 2018 and rise to $20 billion in 2020. So the value of the loans is significant and if UBS is right, may be understated.

The IMF released their Global Financial Stability Report, and Australia got a mention for all the wrong reasons. With household debt now 100% of GDP, we are at the top end of the risk curve.  Whilst increased household debt gives an economy a boost in the short term, the IMF has found it creates greater risk 3-5 years later, lifting the potential for a financial crisis, as household struggle to repay.  Given the ultra-high debt levels in Australia, this is an important observation, and we are entering the danger zone now.

Data from the RBA showed that overall household debt rose again with the household debt ratio now at a new record of 193.7.  They left the cash rate unchanged for the 14th consecutive month. But the real problem is that with the current economic settings, mortgage debt is growing at more than three-time income and cpi. There can be no excuse for this, and the settings need to be changed, now.

Even the property news was mixed. ABS data showed overall Building approvals were up 0.4% in August but had fallen 1.2% (on revised figures) in July. This was driven by apartment approvals, which were up 4.8%, while approvals for houses fell 0.6%. Year-on-year the news is still bleak. Approvals are down 15.5% on that basis – the 12th consecutive month they have fallen. The HIA home sales for August lifted but whilst the increase in sales offset larger declines in sales in recent months, it was not sufficient to reverse the decline in sales that is evident since early 2016. The auction volumes were down last week, thanks to the Grand Finals and Long Weekend. But clearance rates in Melbourne remained firm.  And CoreLogic’s September home price series showed slippage in Sydney, down 0.1% in the month, although the national average was up just 0.2%, with Hobart and Melbourne leading the way.

The bottom line is this. We are certainly at a tipping point, and more evidence is amassing on the risks to households, to the housing sector and to the the broader economic outlook. Worryingly, we think there are strong echoes of the pre-GFC conditions which existed in the USA. High debt, extended home prices, suspect mortgage underwriting standards, and the risk of rates rising. There is now a very limited window for regulators to get their act together, and head off the potential crash at the pass. The problem is, intervention also risks creating the crisis they are trying to prevent, so regulators are in a bind, and politicians would prefer to kick the can down the road. The signs are there for those who what to see them, but many prefer to look away.

And that’s the Property Imperative Weekly to 7th October 2017. If you found this useful, do leave a comment below, subscribe to receive future updates and check back next week.

Mortgage Tightening – The Property Imperative Weekly 30 Sept 2017

Mortgage Lending is slowing and banks are tightening their underwriting standards still further, so what does this tell us about the trajectory of home prices, and the risks currently in the system?

Welcome to the Property Imperative weekly to 30th September 2017. Watch the video, or read the transcript.

We start our review of the week’s finance and property news with the latest lending data from the regulators.

According to the RBA, overall housing credit rose 0.5% in August, and 6.6% for the year. Personal credit fell again, down 0.2%, and 1.1% on a 12-month basis. Business credit also rose 0.5%, or 4.5% on annual basis. Owner occupied lending was up $17.5 billion (0.68%) and investment lending was up $0.8 billion (0.14%). Credit for housing (owner occupied and investor) still grew as a proportion of all lending. The RBA said the switching between owner-occupier and investment lending is now $58 billion from July 2015, of which $1.7 billion occurred last month. These changes are incorporated in their growth rates.

On the other hand, data on the banks from APRA tells a different story. Overall the value of their mortgage portfolio fell 0.11% to $1.57 trillion. Within that owner occupied lending rose 0.1% to $1.02 trillion while investment lending fell 0.54% to $550 billion. As a result, the proportion of loans for investment purposes fell to 34.9%.

This explains all the discounts and special offers we have been tracking in the past few weeks, as banks become more desperate to grow their books in a falling market. Portfolio movements across the banks were quite marked, with Westpac and NAB growing their investment lending, while CBA and ANZ cutting theirs, but this may include loans switched between category. Remember that if banks are able to switch loans to owner occupied categories, they create more capacity to lend for investment purposes.  Putting the two data-sets together, we also conclude that the non-bank sector is also taking up some of the slack.

Our mortgage stress data got a good run this week, with the AFR featuring our analysis of Affluent Stress. More than 30,000 households in the nation’s wealthiest suburbs are facing financial stress, with hundreds risking default over the next 12 months because of soaring debts and static incomes. This includes blue ribbon post codes like Brighton and Glen Iris in Victoria, Mosman and Vaucluse in NSW and Nedlands and Claremont in WA.

The RBA is worrying about household debt, from a financial stability perspective, according to Assistant Governor Michele Bullock.  She said households have really high debt – mainly mortgages, as a result of low interest rates and rising house prices, and especially interest only loans. “High levels of debt does leave households vulnerable to shocks.” She said. The debt to income ratio is rising (150%), but for some it is much higher. We will release our September Stress update this coming week.

Debt continues to remain an issue. For example, new data from the Australian Financial Security Authority shows that in 2016–17, the most common non-business related causes of debtors entering personal insolvencies was the excessive use of credit (8,870 debtors), followed by unemployment or loss of income (8,035 debtors) and then domestic discord or relationship breakdown (3,222 debtors). However, employment related issues figured first in WA and SA.

It is also worth saying the Bank of England has now signalled that the UK cash rate will rise, and this follows recent statements from the FED in the same vein. It is increasingly clear these moves to lift rates will raise international funding costs to banks and put more pressure on the RBA to follow suit.

Meantime, lenders continue to tighten their underwriting standards.

ANZ announced that it will be implementing new restrictions on some loans for residential apartments, units and flats in Brisbane and Perth. Now there will be a maximum 80 per cent loan-to-value ratio for owner-occupier and investment loans for all apartments in certain inner-city post codes. We think these changes reflect concerns about elevated risks, due to oversupply and price falls. ANZ’s policy changes apply to all apartments in affected postcodes, including off-the-plan and non-standard small residential properties valued at less than $3 million. Granny flats though are excluded.

More generally, ANZ also issued a Customer Interview Guide with specific which topics brokers should discuss with home and investment loan borrowers. “We expect brokers to use a customer interview guide (CIG) to record customer conversations as a minimum moving forward,” noted ANZ “while it is not required to submit the CIG with the application, it should be made available when requested as a part of the qualitative file reviews.”

CBA launched an interest-only simulator to help brokers show customers the differences between IO and P&I repayments and a new compulsory Customer Acknowledgement form to be submitted with all home loan applications that have interest-only payments to ensure that IO payments meet customer needs. CBA said that brokers must complete the simulator for all customers who are considering IO payments irrespective of whether the customer chooses to proceed with them. These requirements will be mandatory for all brokers and will become effective on Monday, 9 October.

Suncorp announced it is introducing new pricing methodology for interest only home lending. Variable interest rates on existing owner-occupier interest only rates will increase by 0.10% p.a and variable interest rates on all investor interest only rates will increase 0.38% p.a., effective 1 November, 2017.

But what about property demand and supply?

The ABS said Australia’s population grew by 1.6% during the year ended 31 March 2017. Natural increase and Net Overseas contributed 36.6% and 59.6% respectively. In fact, all states and territories recorded positive population growth in the year ended 31 March 2017, but Victoria recorded the highest growth rate at 2.4%. and The Northern Territory recorded the lowest growth rate at 0.1%. Significantly, Victoria, the state with the highest growth rate is currently seeing the strongest auction clearance rates, strong demand, and home price growth. This is not a surprise, given the high migration and this may put a floor on potential property price falls.

On the other hand, we also see an imbalance between those seeking to Trade up and those looking to Trade down, according to our research. Those trading up are driven by expectations of greater capital growth (42%), for more space (27%), life-style change (14%) and job change (11%). Those seeking to trade down are driven by the desire to release capital for retirement (37%), to move to a place which is more convenient (either location, or for easier maintenance) (31%), or a desire to switch to, or invest in an investment property (18%).  In the past we saw a relative balance between those seeking to trade up and those seeking to trade down, but this is now changing.

Intention to transact, highlights that relatively more down traders are expecting to transact in the next year, compared with up traders. Given that there around 1.2 million Down Traders and around 800,000 Up Traders, we think there will be more seeking to sell, than buyers able to buy. As a result, this will provide a further drag on future price growth, especially in the middle and upper segments of the markets, where first time buyers are less likely to transact. This simple demand/supply curve provides another reason why prices may soon pass their peaks. Up Traders have more reason to delay, while Down Traders are seeking to extract capital, and as a result they have more of a burning platform.

Finally, auction clearance rates were still quite firm, despite the fact that property price growth continues to ease and time on market indicators suggest a shift in the supply and demand drivers, especially in Sydney.

So, overall, banks are on one hand still wanting to grow their home loan portfolios (as it remains the main profit driver), but lending momentum is slowing, and underwriting standards are being tightened further, at a time when home price growth is slowing.

This leaves many households with loans now outside current lending criteria, households who are already feeling the pain of low income growth as costs rise. More households are falling into mortgage stress, and this will put further downward pressure on prices and demand.

So we think the risks in the mortgage market are extending further, and the problem is that recent moves to ease momentum have come too late to assist those with large loans relative to income. As a result, when rates rise, as they will, the pain will only increase further.

And that’s the Property Imperative weekly to 30th September 2017.