The Mortgage Industry Omnishambles – The Property Imperative 17 March 2018

Today we examine the Mortgage Industry Omnishambles. And it’s more than just a flesh wound!

Welcome to the Property Imperative Weekly to 17th March 2018. Watch the video, or read the transcript.

In this week’s review of property and finance news we start with the latest January data from the ABS which shows lending for secured housing rose 0.14% or 28.8 million to $21.1 billion. Secured alterations fell 1%, down $3.9 million to $391 million.  Fixed personal loans fell 0.1%, down $1.2 million to $4.0 billion, while revolving loans fell 0.06%, down $1.3 million to $2.2 billion.

Investment lending for construction of dwellings for rent rose 0.86% or $10 million to $1.2 billion. Investment lending for purchase by individuals fell 1.34%, down $127.7 million to $9.4 billion, while investment lending by others rose 7.7% up $87.2 million to $1.2 billion.

Fixed commercial lending, other than for property investment rose 1.25% of $260.5 million to $21.1 billion, while revolving commercial lending rose 2.5% or $250 million to $10.2 billion.

The proportion of lending for commercial purposes, other than for investment housing was 45% of all commercial lending, up from 44.5% last month.

The proportion of lending for property investment purposes of all lending fell 0.1% to 16.6%.

So, we are seeing a rotation, if a small one, towards commercial lending for more productive purposes. However, lending for property and for investment purposes remains quite strong. No reason to reduce lending underwriting standards at this stage or weaken other controls.

But this also explains the deep rate cuts the banks are now offering – even to investors – ANZ Bank and the National Australia Bank were the last of the big four to announce cuts to their fixed rates, following similar announcements from the Commonwealth Bank and Westpac. NAB has dropped its five-year fixed rate for owner-occupied, principal and interest home loans by 50 basis points, from 4.59 per cent to 4.09 per cent. The bank has also reduced its fixed rates on investor loans by up to 35 basis points, with rates starting from 4.09 per cent. And last week ANZ also dropped fixed rates on its “interest in advance”, interest-only home loans by up to 40 basis points, with rates starting from 4.11 per cent. Further, fixed rates on its owner-occupied, principal and interest home loans have fallen by 10 basis points, with rates now starting from 3.99 per cent.  This fixed rate war shows our big banks are not pricing in a rate hike anytime soon.

But we think these offers will likely encourage churn among existing borrowers, rather than bring new buyers to the market.  For example, the ABS housing finance data showed that in original terms, the number of first home buyer commitments as a percentage of total owner occupied housing finance commitments rose to 18.0% in January 2018 from 17.9% in December 2017 – and this got the headline from the real estate sector, but the absolute number of first time buyers fell, thanks mainly to falls of 22.3% in NSW and of 13.3% in VIC. More broadly, there were small rises in refinancing and investment loans for entities other than individuals.

The latest data from CoreLogic shows home prices fell again this week, with Sydney down for the 27th consecutive week, and their index registering another 0.09% drop, whilst auction volumes were down on last week. They say that last week, the combined capital city final auction clearance rate fell to 63.3 per cent across a lower volume of auctions with 1,764 held, down from the 3,026 auctions over the week prior when a slightly higher 63.6 per cent cleared.  The weighted average clearance rate has continued to track lower than results from last year; when over the corresponding week 75.1 per cent of the 1,473 auctions sold.

But the strategic issues this week relate to the findings from the Royal Commission and from the ACCC on mortgage pricing. I did a separate video on the key findings, but overall it was clear that there are significant procedural, ethical and even legal issue being raised by the Commission, despite their relatively narrow terms of reference. They cannot comment on bank regulation, or macroprudential, but the Inquiries approach is to examine a series of case studies, from the various submissions they have received, and then apply forensic analysis to dig into the root causes examining misconduct. The question of course is, do the specific examples speak to wider structural questions as we move from the specific instances. We discussed this on ABC Radio this week.

From NAB we heard about referrer’s providing leads to the Bank, outside normal lending practices and processes, and some receiving large commissions, despite not being in the ambit of the responsible lending code. From CBA we heard that the bank was aware of the conflict brokers have especially when recommending an interest only loan, because the trail commission will be higher as the principal amount is not repaid. And from Aussie, we heard about their reliance on lenders to trap fraud, as their own processes were not adequate. And we also heard of examples of individual borrowers receiving loans thanks to poor conduct, or even fraud. We also heard about how income and expenses are sometimes misrepresented. So, the question is, do these various practices show up more widely, and what does this say about liar loans, and mortgage systemic risk?

We always struggled to match the data from our independent household surveys with regards to loan to income, and loan to value, compare with loan portfolios we looked at from the banks. Now we know why. In some cases, income is over stated, expenses are understated, and so loan serviceability is a potentially more significant issue than the banks believe – especially if interest rates rise. In fact, we saw very similar behaviours to the finance industry in the USA before the GFC, suggesting again we may see the same outcomes here. One other point, every lender is now on notice that they need to look at their current processes and back book, to test affordability, serviceability and risk. This is a big deal.

I will also be interested to see if the Commission turns to look at foreclosure activity, because this is the other sleeper. Mortgage delinquency in Australia appears very low, but we suspect this is associated with heavy handed forced sales. Something again which was apparent around the GFC.

More specifically, as we said in a recent blog, the role and remuneration models for brokers are set for a significant shakedown.

Turning to the ACCC report on mortgage pricing, this was also damming. Back in June 2017, the banks indicated that rate increases were primarily due to APRA’s regulatory requirements, but now under further scrutiny they admitted that other factors contributed to the decision, including profitability. Last December, the ACCC was called on by the House of Representatives Standing Committee on Economics to examine the banks’ decisions to increase rates for existing customers despite APRA’s speed limit only targeting new borrowers. The investigation falls under the ACCC’s present enquiry into residential mortgage products, which was established to monitor price decisions following the introduction of the bank levy. Here are the main points.

  1. Banks raised rates to reach internal performance targets: concern about a shortfall relative to performance targets was a key factor in the rate hikes which were applied across the board. Even small increases can have a significant impact on revenue, the report found. And the majority of existing borrowers would likely not be aware of small changes in rates and would therefore be unlikely to switch.
  2. A shared interest in avoiding disruption: Instead of trying to increase market share by offering the lowest interest rates, the big four banks were mainly preoccupied and concerned with each other when making pricing decisions. It shows a failure in competition (my words).
  3. Reputation is everything: The banks it seems were very conscious of how they should explain changes. As it happens, blaming the regulators provides a nice alibi/
  4. For Profit: Internal memos also spoke of the margin enhancement equating to millions of dollars which flowed from lifting investment loans.
  5. New Loans are cheaper, legacy rates are not. Banks of course are offering deep discounts to attract new customers, funded by the back book repricing. The same, by the way, is true for deposits too.

The Australian Bankers Association “silver lining” statement on the report said they welcomed the interim report into residential mortgages, which clearly shows very high levels of discounting in the Australian home loan market. It’s clear that competition is delivering better deals for customers, shopping around works and Australians should continue to do so to get the best discounts on the advertised rate. But they are really missing the point!

We will see if the final report changes, but if not these are damming, but not surprising, and again shows the pricing power the major lenders have.

So to the question of future rate rises. The FED meets this week, and the expectation is they will lift rates again, especially as the TRUMP tax cuts are inflationary, at a time when the US economy is already firing. In a recent report Fitch Ratings said that Central banks are becoming less cautious about normalising monetary policy in the face of strong growth and diminishing spare capacity. They expect the Fed to raise rates no less than seven times before the end of next year. And while still sounding tentative, the European Central Bank is clearly laying firm groundwork for phasing out QE completely later this year. They now also expect the Bank of England to raise rates by 25bp this year.

Guy Debelle, RBA Deputy Governor spoke on “Risk and Return in a Low Rate Environment“.  He explored the consequences of low rates, on asset prices, and asks what happens when rates rise. He suggested that we need to be alert for the effect the rise in the interest rate structure has on financial market functioning, and that investors were potentially too complacent.  There are large institutional positions that are predicated on a continuation of the low volatility regime remaining in place. He had expected that volatility would move higher structurally in the past and this has turned out to be wrong. But He thinks there is a higher probability of being proven correct this time. In other words, rising rates will reduce asset prices, and the question is – have investors and other holders of assets – including property – been lulled into a false sense of security?

All the indicators are that rates will rise – you can watch our blog on this. Rising rates of course are bad news for households with large mortgages, exacerbated by the possibility of weaker ability to service loans thanks to fraud, and poor lending practice. We discussed this, especially in the context of interest only loans, and the problems of loan resets on the ABC’s 7:30 programme on Monday.  We expect mortgage stress to continue to rise.

There was more discussion this week on Housing Affordability. The Conversation ran a piece showed that zoning is not the cause of poor affordability, and neither is supply of property. Indeed planning reform they say is not a housing affordability strategy.  Australia needs a more realistic assessment of the housing problem. We can clearly generate significant dwelling approvals and dwellings in the right economic circumstances. Yet there is little evidence this new supply improves affordability for lower-income households. Three years after the peak of the WA housing boom, these households are no better off in terms of affordability. In part, this may reflect that fact that significant numbers of new homes appear not to house anyone at all. A recent CBA report estimated that 17% of dwellings built in the four years to 2016 remained unoccupied. If we are serious about delivering greater affordability for lower-income Australians, then policy needs to deliver housing supply directly to such households. This will include more affordable supply in the private rental sector, ideally through investment driven by large institutions such as super funds. And for those who cannot afford to rent in this sector, investment in the community housing sector is needed. In capital city markets, new housing built for sale to either home buyers or landlords is simply not going to deliver affordable housing options unless a portion is reserved for those on low or moderate incomes.

But they did not discuss the elephant in the room – booming credit. We discussed the relative strength of different drivers associated with home price rises in a separate, and well visited blog post, Popping The Housing Affordability Myth. But in summary, the truth is banks have pretty unlimited capacity to create more loans from thin air – FIAT – let it be. It is not linked to deposits, as claimed in classic economic theory.  The only limit on the amount of credit is people’s ability to service the loans – eventually. With that in mind, we built a scenario model, based on our core market model, which allows us to test the relationship between home prices, and a series of drivers, including population, migration, planning restrictions, the cash rate, income, tax incentives and credit.

We found the greatest of these is credit policy, which has for years allowed banks to magic money from thin air, to lend to borrowers, to drive up home prices, to inflate the banks’ balance sheet, to lend more to drive prices higher – repeat ad nauseam! Totally unproductive, and in fact it sucks the air out of the real economy and money directly out of punters wages, but make bankers and their shareholders richer. One final point, the GDP calculation we use in Australia is flattered by housing growth (triggered by credit growth). The second driver of GDP growth is population growth.  But in real terms neither of these are really creating true economic growth. To solve the property equation, and the economic future of the country, we have to address credit. But then again, I refer to the fact that most economists still think credit is unimportant in macroeconomic terms! The alternative is to continue to let credit grow well above wages, and lift the already heavy debt burden even higher. Current settings are doing just that, as more households have come to believe the only way is to borrow ever more. But, that is, ultimately unsustainable, and this why there will be an economic correction in Australia, and quite soon. At that point the poor mortgage underwriting chickens will come home to roost. And next time we will discuss in more detail how these scenarios are likely to play out. But already we know enough to show it will not end well.

The Impossible Property Equation – The Property Imperative Weekly – 10 Mar 2018

Today we discuss the Impossible Property Equation.

Welcome to the Property Imperative Weekly to 10th March 2018. Watch the video or read the transcript.

In this week’s review of property and finance news we start with CoreLogic who reported that last week, the combined capital cities returned a 63.6 per cent final auction clearance rate across 3,026 auctions, down from the 66.8 per cent across 3,313 auctions the week prior.  Last year the clearance rate last year was a significantly higher at 74.6 per cent. Last week, Melbourne returned a final auction clearance rate of 66.5 per cent across 1,524 auctions, down from the 70.6 per cent over the week prior.  In Sydney, both volumes and clearance rate also fell last week across the city, when 1,088 properties went to market and a 62.4 per cent success rate was recorded, down from 65.1 per cent across 1,259 auctions the week prior. Across the remaining auction markets clearance rates improved in Canberra and Perth, while Adelaide, Brisbane and Tasmania’s clearance rate fell over the week. Auction activity is expected to be somewhat sedate this week, with a long weekend in Melbourne, Canberra, Adelaide and Tasmania. Just 1,526 homes are scheduled for auction, down 50 per cent on last week’s final results.

In terms of prices, Sydney, Australia’s largest market is a bellwether. There, CoreLogic’s dwelling values index fell another 0.13% this week, so values are down 4.0% over the past 26-weeks.  Also, Sydney’s annual dwelling value is down 1.04%, the first annual negative number since August 2012. Within that, the monthly tiered index showed that the top third of properties by value in Sydney have fallen hardest – down 3.2% over the February quarter – whereas the lowest third of properties have held up relatively well (i.e. down 0.9% over the quarter), thanks to a 68% rise in first time buyers.  My theory is Melbourne is following, but 9-12 months behind.

The RBA published a paper on the Effects of Zoning on Housing Prices. Based on detailed analysis they suggest that development restrictions (interacting with increasing demand) have contributed materially to the significant rise in housing prices in Australia’s largest cities since the late 1990s, pushing prices substantially above the supply costs of their physical inputs. They estimate that zoning restrictions raise detached house prices by 73 per cent of marginal costs in Sydney, 69 per cent in Melbourne, 42 per cent in Brisbane and 54 per cent in Perth. There is also a large gap opening up between apartment sale prices and construction costs over recent years, especially in Sydney. This suggests that zoning constraints are also important in the market for high-density dwellings. They say that policy changes that make zoning restrictions less binding, whether directly (e.g. increasing building height limits) or indirectly, via reducing underlying demand for land in areas where restrictions are binding (e.g. improving transport infrastructure), could reduce this upward pressure on housing prices.

At its February meeting, the RBA Board decided to leave the cash rate unchanged at 1.50 per cent. Their statement was quite positive on employment, but not on wages growth. They are expecting inflation to rise a little ahead, above 2%. They said that the housing markets in Sydney and Melbourne have slowed and that in the eastern capital cities, a considerable additional supply of apartments is scheduled to come on stream over the next couple of years.

The RBA quietly revised down the household debt to income ratio stats contained in E2 statistical releases and their chart pack. It has dropped by 6% from 199.7 down to 188.4, attributing the change to revised data from the ABS. But it is still very high. By the way, Norway, one of the countries mirroring the Australian mortgage debt bubble, at 223 has just taken steps to tighten mortgage lending further. This includes a limit of 5x gross annual income and a 5% interest rate buffer.

We released our February Mortgage Stress data, which showed across Australia, more than 924,500 households are estimated to be now in mortgage stress, up 500 from last month. This equates to 29.8% of households. In addition, more than 21,000 of these are in severe stress, up 1,000 from last month. We estimate that more than 55,000 households risk 30-day default in the next 12 months, up 5,000 from last month. You can watch our separate video on this.  Our surveys showed significant refinancing is in train, to try to reduce monthly repayments. We publish our Financial Confidence Indices next week.

The retail sector is still under pressure, as shown in the ABS trend estimates for Australian retail turnover which rose just 0.3 per cent in January 2018 following a similar rise in December. Many households just do not have money to spend.  Separately, the number of dwellings approved rose 0.1 per cent in January, driven by a lift in approvals for apartments.  Dwelling approvals increased in Victoria, Tasmania, Queensland and Western Australia, but decreased in the Australian Capital Territory, the Northern Territory, South Australia and importantly New South Wales.

The ABS also released the account aggregates to December 2017.  Overall the trend data is still pretty weak. GDP has moved up just a tad, but GDP per capita is growing at just 0.9% per annum, and continues to fall. Much of the upside is to do just with population growth. But net per capita disposable income rose at just 0.4% over the past year. Housing business investment and trade were all brakes on the economy. Real remuneration is still growing at below inflation, so incomes remains stalled. More than two in three households have seen no increase. It rose by 0.3% in the December quarter and was up just 1.3% over the year to December 2017, compared with inflation of 1.9%. In fact, households continue to raid their savings to support a small increase in consumption, but this is not sustainable.  The household savings ratio recovered slightly to 2.7% from 2.5% in seasonally adjusted terms. Debt remains very high. These are not indicators of an economy in prime health!

Another crack appeared in the property market wall this week when Deposit Power, which provided interim finance to property buyers, closed its doors leaving an estimated 10,000 residential, commercial and property investors in the lurch about the fate of nearly $300 million worth of deposits. This is after the collapse of New Zealand’s CBL’s insurance, which was an issuer and guarantor of deposit bonds. You can watch my separate video on this important and concerning event.

The public hearings which the Productivity Commission has been running in relationship to Competition in Financial Services covered a wide range of issues. One which has surfaced is the Lenders Mortgage Insurance (LMI) sector. With 20% of borrowing households required to take LMI, and just two external providers (Genworth and QBE LMI), the Commission has explored the dynamics of the industry. They called it “an unusual market”, where there is little competitive pricing  nor competition in its traditional form.  Is the market for LMI functioning they asked?  Could consumers effectively be paying twice? On one hand, potential borrowers are required to pay a premium for insurance which protects the bank above a certain loan to value hurdle. That cost is often added to the loan taken, and the prospective borrower has no ability to seek alternatives from a pricing point of view. Banks who use external LMI’s appear not to tender competitively. On the other hand, ANZ, for example has an internal LMI equivalent, and said it would be concerned about the concentration risk of placing insurance with just one of the two external players, as the bank has more ability to spread the risks. The Commission probed into whether pricing of loans might be better in this case, but the bank said there were many other factors driving pricing. All highly relevant given the recent APRA suggestion that IRB banks might get benefit from lower capital for LMI’s loans, whereas today there is little capital benefit. This will be an interesting discussion to watch as it develops towards the release of the final report. They had already noted that consumers should expect to receive a refund on their LMI premium if they repay the loan.

ASIC told the Productivity Commission that there is now “an industry of referrers” who are often being paid the same amount as mortgage brokers despite doing less work. They said – in our work on [broker] commissions, there were a separate category of people who are paid commission who don’t arrange the loan but just refer the borrower to the lender. It seems to be that professionals — lawyers, accountants, financial advisers — are reasonably prominent among people who are acting as referrers and that strangely  the commissions they were paid for just a referral was almost as large as that [for a] mortgage broker doing all the extra [work]. More evidence of the complexity of the market, and of the multiple parties clipping the ticket.

The role of mortgage brokers remains in the spotlight, with both the Productivity Commission sessions this week, and the Royal Commission next week focussing in on this area. In draft recommendation 8.1 of its report, the Productivity Commission called for the ASIC to impose a “clear legal duty” on lender-owned aggregators, which should also “apply to mortgage brokers working under them”.  ANZ CEO Shayne Elliott said applying best interest obligations to brokers could help preserve the integrity of the third-party channel and that despite the absence of a legal duty of care, consumers may be under the impression that such obligations already exist. He also said there was merit in considering a fixed fee model as opposed to a volume-based commission paid to brokers. The ANZ chief said that there is “absolute merit” in exploring such a model, and he pointed to the use of a fixed fee structure in Europe.

Industry insiders on the other hand argue that a push to argue a switch from mortgage broker commission payments, which normally includes an upfront fee and a trailing payment for the life of the loan paid by the lender to the broker, to a fixed fee for advice would be “anti-competitive. The discussion of trailing commissions centered on whether there was downstream value being added to mortgage broker clients, for example, annual financial reviews, or being the first port of call when the borrower has a mortgage related question. The interesting question is how many broker transactions truly include these services, or is the loan a set and forget, whilst the commissions keep flowing?  There is very little data on this. In the UK, mortgage brokers work within a range of payment models. Many mortgage brokers are paid a commission by lenders of around 0.38% of the total transaction and some mortgage brokers also charge a fee to their customers.

Still on, Mortgage Brokers they say they expect to write more non-conforming loans over the next 12 months according to non-Bank Pepper Money. They commissioned a survey of 948 mortgage brokers which showed that 70 per cent expect to write more non-conforming loans in the coming year, while 66 per cent predict a decline in the number of prime loans written. Surveyed respondents expect the demand for non-conforming loans to rise as a result of tighter prime lending criteria (22 per cent), changing customer needs (21 per cent) and changing legislation/regulations (13 per cent). The survey also found that the number of brokers who have yet to write a non-conforming loan has also reduced, falling by 6 per cent from 18 per cent in 2016 to 12 per cent in 2018.

Another non-Bank, Bluestone Mortgages cut its interest rates by 75 to 105 basis points across its Crystal Blue products. The Crystal Blue portfolio includes a range of full and alt doc products that provide lending solutions to established self-employed borrowers (with greater than 24 months trading history), and PAYG borrowers with a clear credit history. The lender expects the rate reduction, coupled with the 85% low doc option, to drive the uptake of the portfolio. The rate cuts come shortly after the company was acquired by private equity firm Cerberus Capital Management. Parent company Bluestone Group UK is fully divesting its interest in Bluestone Mortgages Asia Pacific as part of the acquisition deal.

The ABS released their latest data on the Assets and Liabilities of Australian Securitisers. At 31 December 2017, total assets of Australian securitisers were $132.5b, up $7.3b (5.9%) on 30 September 2017. During the December quarter 2017, the rise in total assets was primarily due to an increase in residential mortgage assets (up $6.0b, 6.0%) and by an increase in other loans assets (up $0.9b, 6.1%). You can see the annual growth rates accelerating towards 13%. This is explained by a rise in securitisation from both the non-bank sector, which is going gangbusters at the moment, and also some mainstream lenders returning to the securitised funding channels, as costs have fallen. There is also a shift towards longer term funding, and a growth is securitised assets held by Australian investors.  Asset backed securities issued overseas as a proportion of total liabilities decreased to 2.6%. Finally, at 31 December 2017, asset backed securities issued in Australia as a proportion of total liabilities increased to 89.8%. The non-banks are loosely being supervised by APRA (under their new powers), but are much freer to lend compared with ADI’s.  A significant proportion of business will be investment loans.

It’s not just the non-banks cutting mortgage rates to attract new business.  The story so far. Banks were lending up to 40%+ of mortgages with interest only loans, some even more. The regulator eventually put a 30% cap on these loans and the volume has fallen well below the limit. Some banks almost stopped writing IO loans. They also repriced their IO book by up to 100 basis points, so creating a windfall profit. This is subject to an ACCC investigation to report soon. The RBA and APRA both warn of the higher risks on IO loans, especially on investment properties, in a down turn. APRA has confirmed the “temporary” 30% cap will stay for now, although the 10% growth cap in investment loans is now redundant, thanks to better underwriting standards. Banks have now started to ramp up their selling of new IO loans, to customers who fit within current underwriting standards and are offering significant discounts.  Borrowers will be encouraged to churn to this lower rate.  For example, CBA will cut fixed interest rates for property investors across one-, two-, three-, and four-year terms. The cuts, which range from 5 basis points to 50 basis points, apply to both interest-only investor loans and principal-and-interest investor loans. CBA is also cutting some of its fixed rates for owner-occupiers, including a reduction on owner-occupied principal-and-interest fixed-rate loans by 10 basis points over terms of one to two years, landing at 3.89% for borrowers on package deals. Key rival Westpac also unveiled a suite of fixed-rate changes, including some cuts to fixed-rate interest-only mortgages, another area where banks have been forced to apply the brakes. They also hiked rates across various fixed terms for owner-occupiers. So the chase is on for investor loans now, with a focus on acquiring good credit customers from other banks. Other smaller lenders, such as ING, Mortgage House, and Virgin Money have also dropped some interest-only rates.

Finally, The Grattan Institute released some important research on the migration and housing affordability saying Australia’s migration policy is its de-facto population policy. The population is growing by about 350,000 a year. More than half of this is due to immigration. The pick-up in immigration coincides with Australia’s most recent housing price boom. Sydney and Melbourne are taking more migrants than ever. Australian house prices have increased 50% in the past five years, and by 70% in Sydney. Housing demand from immigration shouldn’t lead to higher prices if enough dwellings are built quickly and at low cost. In post-war Australia, record rates of home building matched rapid population growth. House prices barely moved. But over the last decade, home building did not keep pace with increases in demand, and prices rose. Through the 1990s, Australian cities built about 800 new homes for every extra 1,000 people. They built half as many over the past eight years. So there is no point denying that housing affordability is worse because of a combination of rapid immigration and poor planning policy. Rather than tackling these issues, much of the debate has focused on policies that are unlikely to make a real difference. Unless governments own up to the real problems, and start explaining the policy changes that will make a real difference, Australia’s housing affordability woes are likely to get worse.

So the complex equation of supply and demand, loan availability and home prices, will remain unsolved until the focus moves from tactical near term issues to strategy. Meantime, my expectation is that prices will continue south for some time yet, despite all the industry hype.

Going Down, Down, Down – The Property Imperative Weekly 03 Mar 2018

How far will home prices fall? Welcome to the Property Imperative weekly to 3rd March 2018.

Yet another big big week in property and finance for us to review today. Watch the video or read the transcript.

We start with the latest home price data from CoreLogic.  Prices continue to soften. On an annual basis, prices are down 0.5% in Sydney, 2.7% in Perth and 7.4% in Darwin. They were higher over the year in Melbourne, up 6.9%, Brisbane 1.8%, Adelaide 2.2% and Hobart a massive 13.1%. But be beware, these are average figures, and there are considerable variations across locations within regions and across property types. The bigger falls are being seen at the top end of the market.

Over the three months to February, Adelaide was up 0.1% and Hobart 3.2%. These were the only capital cities in which values rose.  Sydney, which has been the strongest market for value growth over recent years, saw the largest fall in values over the three-month period, down -2.4%. Sydney was followed by Darwin, which has been persistently weak over recent years, and saw values fall by a further -2.0% over the quarter.

Finally, CoreLogic says month-on-month falls were generally mild but broad based. Over the month, values fell across every capital city except Hobart (+0.7%) and Adelaide (steady), with the largest monthly decline recorded across Darwin (-0.9%) and Sydney (-0.6%).  Values were lower in Melbourne (-0.1%), Brisbane (-0.1%), Perth (-0.2%), and Canberra (-0.3%).

The reason for the falls are pretty plain to see. Demand is substantially off, especially from investors, as mortgage underwriting standards are tightening. So it was interesting to hear APRA chairman Wayne Byres’s testimony in front of the Senate Economics Legislation Committee. I discussed this with Ross Greenwood on 2GB. During the session he said that the 10% cap on banks’ lending to housing investors imposed in December 2014 was “probably reaching the end of its useful life” as lending standards have improved. Essentially it had become redundant. But the other policy, a limit of more than 30% of lending interest only will stay in place. This more recent additional intervention, dating from March 2017, will stay for now, despite it being a temporary measure. The 30% cap is based on the flow of new lending in a particular quarter, relative to the total flow of new lending in that quarter. This all points to tighter mortgage lending standards ahead, but still does not address the risks in the back book.  The mortgage underwriting screws are much tighter now – our surveys show that about a quarter or people seeking a mortgage now cannot get one due to the newly imposed limits on income, expenses and serviceability.

During the sessions, Senator Lee Rhiannon asked APRA about mortgage fraud. This was to my mind the most significant part.

Yet even now, more than 10% of new loans are being funded at a loan to income of more than 6 times. And whilst the volume of interest only loans has fallen to 20% of new loans, well below the 30% limit, it seems small ADI’s are lending faster than the majors. And we know the non-banks are going gang busters.

Now the HIA said their Housing Affordability Index saw a small improvement of 0.2 per cent during the December 2017 quarter indicating that affordability challenges have eased thanks to softer home prices in Sydney where they are now slightly lower than they were a year ago. This makes home purchase a little more accessible, particularly for First Home Buyers they said. But they failed to mention the now tighter lending standards which more than negates any small improvement in their index.

The impact of this tightening came through in the latest data on housing finance from both the RBA and APRA. I made a separate video on this if you want the gory details. The RBA said  that in January  owner occupied lending rose 0.6%, or 8% over the past year to $1.14 trillion. Investment lending rose 0.2% or 3% over the past year to $587 billion and comprises 34% of all housing lending.  They changed the way they report the data this month. It changes the trend reporting significantly. Since mid-2015 the bank has been writing back perceived loan reclassifications which pushed the investor loans higher and the owner occupied loans lower. They have now reversed this policy, so the flow of investment loans is lower (and more in line with the data from APRA on bank portfolios). Investor loans are suddenly 2% lower. Magically! Once again, this highlights the rubbery nature of the data on lending in Australia. What with data problems in the banks, and at the RBA, we really do not have a good chart and compass.  It just happens to be the biggest threat to financial stability but never mind.

The latest APRA Monthly Banking Statistics to January 2018 tells an interesting tale. Total loans from ADI’s rose by $6.1 billion in the month, up 0.4%.  Within that loans for owner occupation rose 0.57%, up $5.96 billion to $1.05 trillion, while loans for investment purposes rose 0.04% or $210 million. 34.4% of loans in the portfolio are for investment purposes. So the rotation away from investment loans continues, and overall lending momentum is slowing a little (but still represents an annual growth rate of nearly 5%, still well above inflation or income at 1.9%!). Looking at the lender portfolio, we see some significant divergence in strategy.  Westpac is still driving investment loans the hardest, while CBA and ANZ portfolios have falling in total value, with lower new acquisitions and switching. Bank of Queensland and Macquarie are also lifting investment lending.

Now searching questions are being asked about Lax Mortgage Lending, and the risks the banks are sitting on at the moment. While better lending controls will help ahead, we have a significant problem now, with many households facing financial difficulty. First there is the issue of basic cash flow, as incomes remain contained, costs of living rise, and mortgage payments still need to be met. We estimate 51,500 households risk default in the year ahead, a small but growing problem. We will release the February mortgage stress data on Monday, so look out for that.

Then there is the question of banks and brokers not doing sufficient due diligence on loan applications. This is something the Royal Commission will be looking at in the next couple of weeks.  We worked with the ABC on a story, which aired this week, looking at the issues around poor lending. Its complex of course, because borrowers have to take some responsibility for the applications they made for credit, and need to be truthful. But both brokers and lenders have obligations to make sufficient inquiry into the applicant’s circumstances to ensure the loan is “not unsuitable” – which is nothing to do with the “best” mortgage by the way, it’s a much lower hurdle. But if a loan were deemed to be unsuitable, the courts may change the terms of the loan, or cancel the loan, meaning a borrower could leave a property without debt. An upcoming court case may clarify the law. But in the ABC piece, Brian Johnston, one of the best analysts in the business said this means it moves from being the borrowers problem to being the banks problem!

This also touches on the role of mortgage brokers, and whether their commission based remuneration might influence their loan recommendations, to the detriment of their customers, which is more than half the market. This is something which both ASIC and the Productivity Commission have been highlighting.  Speaking at a CEDA event, Productivity Commission chairman Peter Harris said more than $2.4bn is now paid annually for mortgage broker services. The commission’s draft report released in early February says that based on ASIC’s findings, lenders pay brokers an upfront commission of $2,289 (0.62%) and a trail commission of $665 (0.18%) a year on an average new home loan of $369,000. He zeroed in on trailing commissions – which he said are worth $1bn per annum – and questioned their relevance.

The Banking Royal Commission says the first round of public hearings will be held in Melbourne at the Owen Dixon Commonwealth Law Courts Building at 305 William Street from Tuesday 13 March to Friday 23 March. They listed the range of matters they are exploring, from mortgages, brokers, cards, car finance, add-on insurance and account administration, with reference to specific banks, including NAB, CBA, ANZ, Westpac, Aussie, and Citi. Responsible lending is the theme.

Talking of mortgage brokers, another question to consider is the ownership relationship between a broker, their aggregator and the Bank. Not only are many brokers effectively directly employed by the big banks, but more have strong associations, these relationships are not adequately disclosed.

The New Daily did a good piece on showing these linkages, most of which are hard to spot. They said that Fans of Married at First Sight and My Kitchen Rules may have noticed over the past few days that popular property website has started advertising a new product: home loans. But Home Loans is not an independent initiative. Far from it. It is a deal between Rupert Murdoch’s News Corp, which owns 61.6 per cent of, and big-four bank NAB. Last June REA Group, the company behind the website, signed what it called a “strategic mortgage broking partnership” with NAB. What REA Group is actually doing is piggy-backing on a mortgage broker called Choice Home Loans. In other words, while the branding may be, the actual mortgage broking firm is Choice Home Loans. And who owns Choice Home Loans? NAB does. If you get conditional approval through, it will be provided by NAB. However, getting conditional approval with NAB does not commit you to a NAB home loan. First, you could choose a ‘white label’ loan. This is a loan that on the face of it looks like it is provided by But once again appearances are deceptive. REA Group does not have a mortgage lenders’ licence. So while these loans may be branded, they are actually provided by a nationwide mortgage lender called Advantedge. And who owns Advantedge? NAB does. If you don’t fancy the home loan, there are other choices. First, there is a range of NAB mortgages. And then, there is a list of mortgages from other providers – more than 30 of them, including big names like Westpac, ANZ, Commonwealth Bank, Macquarie, ING, ME, UBank – the list goes on. Oh, and by the way, that last bank mentioned – UBank – is also owned by NAB. All this highlights the hidden connections and the market power of the big banks. Like I said, these relationships are hard to spot!

Another little reported issue this week was the financial viability of Lenders Mortgage Insurers in Australia, those specialist insurers who cover mortgages over 80% loan to value. QBE Insurance reported their full year 2017 results today and reported a statutory 2017 net loss after tax of $1,249 million, which compares with a net profit after tax of $844 million in the prior year. This is a diverse and complex group, which is now seeking a path to rationalisation.  They declared their Asia Pacific result “unacceptable” and said the strategy was to “narrow the focus and simplify back to core” with a focus on the reduction in poor performing segments. This begs the question. What is the status of their Lenders Mortgage Insurance (LMI) business? They reported a higher combined operating ratio consistent with a cyclical slowdown in the Australian mortgage insurance industry, higher claims and a lower cure rate. Very little detail was included in the results, but this aligns with similar experience at Genworth the listed monoline who reported a 26% drop in profit, and provides greater insight into the mortgage sector. Both LMI’s are experiencing similar stresses, with lower premium income, and higher claims. And this before the property market really slows, or interest rates rise!  Begs the question, how secure are the external LMI’s? Another risk to consider.

Last week’s auction preliminary results from Domain said nationally, so far from the 2,627 properties listed for auction, only 1,794 actually went for sale, and 1,325 properties sold. So the real clearance rate against those listed is 50.4%. Domain though calculates the clearance rate on those going to auction, less withdrawn sales over those sold. This give a higher measure of 68.8% nationally, which is still lower than a year ago. But, we ask, which is the real clearance rate?

Finally, there is a rising chorus demanding that APRA loosen their rules for mortgage lending in the face of slipping home prices. This despite the RBA’s recent comments about the risks in the system, especially relating to investor and interest only loans.  But this is unlikely, and in fact more tightening, either by a rate rise, or macroprudential will be needed to contain the risks in the system. The latter is more likely. Some of this will come from the lenders directly. For example, last week ANZ said it will be regarding all interest-only loan renewals as credit critical event requiring full income verification from 5 March. If loans failed this assessment these loans would revert to P&I loans (with of course higher repayment terms).  We are already seeing a number of forced switches, or forced sales thanks to the tighter IO rules more generally. We will release updated numbers next week. But, as ANZ has pointed out in a separate note from David Plank, Head of Australian Economics at ANZ; household leverage is still increasing, this despite a moderation in housing credit growth over the past year. Household debt continues to grow faster than disposable income. With household debt being close to double disposable income it will actually require the growth in household debt to slow well below that of income in order for the ratio of household debt to income to stabilise, let alone fall. In fact, he questions whether financial stability has really been improved so far, when interest rates are so very low.

So, nothing we have seen this week changes our view of more, and significant falls in property values ahead as mortgage lending is tightened further. This also shows that it is really credit supply and demand, not property supply and demand which is the critical controller of home price movements. Another reason to revisit the question of negative property gearing in my view.


The Interest Only Loan Problem – The Property Imperative Weekly 24 Feb 2018

What’s the story with Interest only? Welcome to the Property Imperative Weekly to 24th February 2018.

Welcome to the latest weekly digest of property and finance news. Watch the video or read the transcript.

Michelle Bullock from the RBA spoke about Mortgage Stress and Investor Loans this week. She argued that, based on HILDA data from 2016, mortgage stress was not a major issue, (we beg to differ) but also warned there were elevated risks to Property Investors, and especially those holding interest only loans.  This mirrors APRA’s warnings the previous week. She said that investors have less incentive than owner-occupiers to pay down their debt. Many take out interest-only loans so that their debt does not decline over time. If housing prices were to fall substantially, therefore, such borrowers might find themselves in a position of negative equity more quickly than borrowers with an equivalent starting LVR that had paid down some principal. The macro-financial risks are potentially heightened with investor lending. For example, since it is not their home, investors might be more inclined to sell investment properties in an environment of falling house prices in order to minimise capital losses. This might exacerbate the fall in prices, impacting the housing wealth of all home owners. As investors purchase more new dwellings than owner-occupiers, they might also exacerbate the housing construction cycle, making it prone to periods of oversupply and having a knock on effect to developers.

So we did some further analysis on Interest Only Loans, we already identified that conservatively $60 billion of loans will fail current underwriting standards on reset, which is more than 10% of the portfolio.  We discussed this with Ross Greenwood on 2GB’s Money Show.

But how many loans are interest only, and what is the value of these loans? A good question, and one which is not straightforward to answer, as the monthly stats from the RBA and ABS do not split out IO loans. They should.

The only public source is from APRA’s Quarterly Property Exposures, the next edition to December 2017 comes out in mid March, hardly timely. So we have to revert to the September 2017 data which came out in December. This data is all ADI’s with greater than $1 billion of term loans, and does not include the non-bank sector which is not reported anywhere!

They reported that 26.9% of all loans, by number of loans were IO loans, down from a peak of 29.8% in September 2015. They also reported the value of these loans were 35.4% of all loans outstanding, down from a peak of 39.5% in September 2015.

So, what does this trend look like. Well the first chart shows the value of loans in Sept 2017 was $549 billion, down from a peak of $587 billion in March 2017. The number of loans outstanding was 1.56 million loans, down from a peak of 1.69 million loans in December 2016.

If we plot the trends by number of loans and value of loans, we see that the value exposed is still very high. Finally, the average loan size for IO loans is significantly higher at $347,000 compared with $264,300 for all loans. Despite the fall in volume the average loan size is not falling (so far). The point is the regulatory intervention is having a SMALL effect, and there is a large back book of loans written, so the problem is risky lending has not gone away.

US Mortgage rates continue to climb, following the recent FED minutes which were more upbeat, and continues to signal more rate hikes this year. As a result, average rates moved to their highest levels in more than 4 years.  Moody’s made the point that US Government debt will likely rise by 5.9% in the next year, significantly faster than private sector debt, yet argued that this might not be sufficient to drive rates higher. On the other hand, Westpac argues that the Fed may have to lift rates faster and higher than many expect thanks to strong wage growth and higher government spending, and are forecasting rises of 1.25% ahead. This would have a significant knock-on effect.  In fact, the recent IMF country report on Australia forecast that the average mortgage rate in Australia would rise by 2% to 7.1% in 2021.  That would cause some pain (and lift mortgage stress from ~920k to 1.25m households on our models. We heard this week that the ACCC is due to release its interim report into residential mortgage pricing shortly. As directed by the Treasurer, a key focus will be on transparency, particularly how the major banks balance the interests of consumers and shareholders in making their interest rate decisions.  And the RBA minutes seemed to suggest a wait and see approach to changing the cash rate.

The Royal Commission continues its deep dive into lending misconduct, and announced the dates for the next set of hearings in early March. They also released a background document spotlighting Mortgage Brokers. The data highlights broker share is up to 55% of mortgages, and some of the largest players are owned by the big banks, for example Aussie, is owned by CBA.

Separately ASIC discussed structural conflicts from the relationship between Financial Planners and Mortgage Brokers and the companies who own them and the commission structures which are in place. To reduce the impact of ownership structure, ASIC proposed that participants in the industry “more clearly disclose their ownership structures”.

When asked whether mortgage brokers should come under “conflicted remuneration laws”, ASIC’s Peter Kell said: “There’s been a lot of work done on this, so it’s difficult to get a yes or no answer, but we’ve obviously highlighted in our report that we think there are some aspects of the way that remuneration works in the mortgage-broking sector that would be better to take out of the sector because they raise unreasonable conflicts.”

However, the Productivity Commission has gone a step further by calling for a legal provision to be imposed by ASIC to require lender-owned aggregators to work in the “best interest” of customers.

Draft recommendation 8.1 reads: “The Australian Securities and Investments Commission should impose a clear legal duty on mortgage aggregators owned by lenders to act in the consumer’s best interests.

“Such a duty should be imposed even if these aggregators operate as independent subsidiaries of their parent lender institution, and should also apply to the mortgage brokers operating under them.”

We caught up with several investment management teams this week who are in the country visiting the major banks as part of their regular reviews. One observation which came from these is that the major banks generally believe there will be very little change coming from the plethora of reviews currently in train, so it will be business as usual. We are less sure, as some of the issues being explored appear to be structurally significant.

Economic news this week included the latest wage price data from the ABS. You can clearly see the gap between trend public and private sector rates, with the private sector sitting at 1.9% and public sector 2.4%. The CPI was 1.9% in December, so no real growth for more than half of all households! Victoria was the highest through the year wage growth of 2.4 per cent and The Northern Territory recorded the lowest of 1.1 per cent. So if you want a wage rise, go to the Public Sector in Victoria!

There were more warnings, this time from comparison site Mozo on the risks of borrowers grabbing the “cheap” special mortgage offers which are flooding the market at the moment. Crunching the numbers in the Mozo database, they found that homeowners could pay as much as 174 basis points more when the ‘honeymoon period’ on their home loan ends. In fact, the research revealed that the average homeowner with a $300,000 home loan could end up paying as much as $3,423 in additional interest charges each year if they’re caught taking the introductory rate bait. But this can become an even more costly error when you consider how much extra interest you could end up paying over the life of the loan.

And mortgage underwriting standards continue to tighten as NAB has made a change to its home lending policy amid concerns over the rising household debt to income ratio and as APRA zeroes in on loan serviceability. From Friday, 16 February, the loan to income ratio used in its home lending credit assessment has been changed from 8 to 7.  With the new change, loan applications with an LTI ratio of 7 or less will proceed as normal and will be subject to standard lending criteria, according to the note. But stop and think about this, because a loan to income of 7 is hardly conservative in the current environment. In fact, when I used to underwrite mortgages we used a basic calculation of no more than 3.5 times one income plus one time any second income. We still think underwriting is too loose.

Finally home prices continued to drift lower, especially in Sydney according to CoreLogic, who also said the final auction clearance rate across the combined capital cities rose to 66.1 per cent across a higher volume of auctions last week, with 1,992 auctions held, increasing from the 1,470 auctions the week prior when 63.7 per cent cleared.  But last week’s clearance rate was lower than the 74.9 per cent recorded one year ago when volumes were higher (2,291). So momentum is still sluggish.

We think lending standards, and misconduct will be coming to the fore in the coming couple of weeks leading up to the next Banking Commission Hearing sessions. Remember this, if a loan is judged as “suitable”, it opens the door for recourse to the lender, which may include cancellation or alternation of the loan. Now, if volumes of interest only loans were judged “not suitable” this could open the flood gates on potential claims. Things might just get interesting!


Turning The Screws On Mortgage Lending – The Property Imperative Weekly 17th Feb 2018

Listen, You Can Hear the Screws Tightening On Mortgage Lending.  Welcome to The Property Imperative Weekly to 17th February 2018.

Watch the video, or read the transcript.

In this week’s digest of finance and property news we start with Governor Lowe’s statement to the House of Representatives Standing Committee on Economics.  He continued the themes, of better global economic news, lifting business investment and stronger employment on one hand; but weak wage growth, and high household debt on the other. But for me one comment really stood out. He said:

it would be a good outcome if we now experienced a run of years in which the rate of growth of housing costs and debt did not outstrip growth in our incomes in the way that they did over the past five years.

This is highly significant, given the fact the lending for housing is still growing faster than wages, at around three times, and home prices are continuing to drift a little lower. So don’t expect any moves from the Reserve Bank to ease lending conditions, or expect a boost in home prices. More evidence that the property market is indeed in transition. The era of strong capital appreciation is over for now.

There was lots of news this week about the mortgage industry. ANZ and Westpac have tightened serviceability requirements.  Westpac recently introduced strict tests of residential property borrowers’ current and future capacities to repay their loans. The change is said to be intended to identify scenarios that might affect borrowers’ capacity to pay back their loans. These scenarios include having dependents with special needs that might require borrowers to spend on long-term care and treatment. ANZ has added “a higher level of approval for some discretions” used in its home loan policy for assessing serviceability, reducing approvals outside normal terms.

Talking of lending standards, APRA released an important consultation paper on capital ratios. This may sound a dry subject, but the implications for the mortgage industry and the property market are potentially significant.  As part of the discussion paper, APRA, says that addressing the systemic concentration of ADI portfolios in residential mortgages is an important element of the proposals. They have FINALLY woken up to the risks in the system, just years too late!  We have significant numbers of loans in the system currently that would now not pass muster. More about that next week.

Their proposals, which focus in on mortgage serviceability, would change the industry significantly, as lower risk loans will be more highly prized (so expect low rate offers for lower LVRs), whilst investment loans, and interest only loans are likely to cost more and be harder to find. Combined this could certainly move the market!  The proposals introduce “standard” and “non-standard” risk categories.

As well as increasing the risk weights for some mortgages, they also continue to close the gap between the advanced (IRB) internal approach used by large lenders, and the standard approach used by smaller players. Those in transition (e.g. Bendigo Bank) may find less of an advantage in moving to advanced as a result. You can watch our separate video on this important topic.

Whilst the overall capital ratios will not change much, there is a significant rebalancing of metrics, and Banks will more investment and interest only loans will be most impacted.  So getting an investment loan will be somewhat harder and this will impact the property market. The proposals are for consultation, with a closing data 18 May 2018.

Another data point on the property market came from a new report by Knight Frank which claims that in 2017, one-third of Australian residential development sites were sold to Chinese investors and developers. The share of sales to Chinese buyers has tripled since 2013, but decreased from the 38 per cent recorded in 2016. The level of Chinese investment in residential development sites varied from state to state: in Victoria, 38.7 per cent of residential site sales were to Chinese buyers; in New South Wales, 35.6 per cent of residential site sales were to Chinese buyers, and in Queensland, Chinese buyers comprised 7.4 per cent of total residential site sale volumes. So this is one factor still supporting the market, though in Australia, the Australian Prudential Regulatory Authority has encouraged local financial institutions to impose stricter controls, while in China the government has attempted to moderate capital outflow with China’s Central Bank imposing new rules for companies which make yuan-denominated loans to overseas entities.

The data from the ABS on Lending Finance, the last part of the finance stats for December, really underscores the slowing momentum in investment property lending, especially in Sydney (though it is still a significant slug of new finance, and there is no justification to ease the current regulatory requirements.) The ABS says the total value of owner occupied housing commitments excluding alterations and additions rose 0.1% in trend terms, total personal finance commitments fell 0.2%. Revolving credit commitments fell 1.4%, while fixed lending commitments rose 0.5%. There was a small rise in lending for housing construction, but overall mortgage momentum looks like it is still slowing and the mix of commercial lending is tilting away from investment lending and towards other commercial purposes at 64%, which is a good thing.

There is an air of desperation from the construction sector, as sales momentum continues to ease, this despite slightly higher auction clearance rates last week. CoreLogic said the final auction clearance rate was 63.7 per cent clearance rate across almost double the volume of auctions week-on-week (1,470). Over the week prior, a clearance rate of 62.0 per cent was recorded across 790 auctions. Both auction clearance rate and volumes were lower than what was seen one year ago, when a 73.2 per cent clearance was recorded across 1,591 auctions. There is significant discounting going on at the moment to shift property, and some builders are looking to lend direct to purchases to make a sale. For example, Catapult Property Group launched a new lending division that will help first home buyers get home loans with a deposit of only $5,000. The Brisbane-based company encourages first home buyers in Queensland to enter the real estate market now by taking advantage of the state government’s $20,000 grant that is ending on 30 June 2018. This is at a time when lenders are insisting on larger deposits, and are applying more conservative underwriting standards.

Economic data out this week showed that according to the ABS, trend unemployment remained steady at 5.5%, where it has hovered for the past seven months.  The trend unemployment rate has fallen by 0.3 percentage points over the year but has been at approximately the same level for the past seven months, after the December 2017 figure was revised upward to 5.5 per cent. The ABS says that full-time employment grew by a further 9,000 persons in January, while part-time employment increased by 14,000 persons, underpinning a total increase in employment of 23,000 persons. The fact is that while more jobs are being created, it is not pulling the rate lower, and many of these jobs are lower paid part time roles – especially in in the healthcare sector. In fact, the growth in employment is strong for women than men.  A rather different story from the current political spin!

In a Banking Crisis, are Bank Deposits Safe? We discussed the consequences of recently introduced enhanced powers for APRA to deal with a bank in distress this week. There were several well publicised Government bail-out’s of banks which got into problems after the GFC. For example, the UK’s Royal Bank of Scotland was nationalised. This costs tax payers dear, so there were measures put in place to try to manage a more orderly transition when a bank gets into difficulty and raises the question of “Bail-in” arrangements.  Take New Zealand for example. There regulators have specific powers to grab savings held in the banks in assist in an orderly transition in the case of a failure, alongside capital and other bank assets.  And, given the New Zealand position (and the tight relationship between banking regulators in Australia and New Zealand), we should look at the position in Australia.  Are deposit funds in Australia likely to be “bailed-in”? Well, the Treasury confirmed that because deposits are not classified as capital instruments, and do not include terms that allow for their conversion or write-off, they cannot be ‘bailed-in’. But we have a catch all clause in APRA’s powers that says they can grab “any other instrument” and deposits, despite the Treasury reassuring words, is not explicitly excluded. So I for one cannot be 100% convinced savings will never be bailed-in. And that’s a worry! I recall the Productivity Commission comment last week, that financial stability had taken prime place compared with competition (and so customer value) in financial services. The issue of bail-in of deposits appears to be shaping the same way. You can watch our separate video discussion on this important topic.

The first round of public hearings for the Banking Royal Commission will focus on lending, including mortgages, credit cards and car loans; we heard during the opening session. The Commission highlighted the large size of the lending market, and the significant number of submissions they have already received on misconduct in this area, including relating to intermediaries, commission and advice. In addition, as part of the opening address, we were told that some of the major players were unable to provide the full range of misconduct information that Commission requested. Some players offered a few case studies, and were then asked to provide more detail over the past 5 years (as opposed to 10) but said they could not meet the required deadline. Based on the opening round, Banks are going to find this a painful process. Not least because The Commission is publishing information on the sector. In its first release, it pointed to declining competition in the banking sector, with the number of credit unions falling due to consolidation and the major banks holding 75 per cent of total assets held by ADIs in Australia. The paper noted that five of the 20 listed companies that make up the ASX20 are banks, noting that the major banks have “generally achieved higher profit margins than other types of ADIs” with a profit margin of 36.4 per cent in the June quarter 2017. They also underscored that Australia’s major banks are “comparatively more profitable” than some of their international peers in Canada, Sweden, Switzerland and the UK.

We expect to hear more from the Royal Commissions on unfair and predatory practices. To underscore this there was some good news for Credit Card holders, with new legalisation passed in parliament to force Credit card providers to scrap unfair and predatory practices. However, the implementation timetable is extended into 2019. The reforms include:

Requiring affordability assessments be based on a consumer’s ability to repay the credit limit within a reasonable period (from July 2018).  This tightens responsible lending obligations for credit card contracts.

Banning unsolicited offers of credit limit increases (from January 2019). At the moment, whilst the law forbids providers from making these sorts of offers in writing, offers can be made by phone and other mediums. This loophole has been exploited, but will now be closed.

Simplifying how credit card interest is calculated, especially, banning the practice of backdating interest rate charges. Currently, some providers were attracting new customers with promotional low rate, or no rate offers, say for the first month. But, if a customer failed to pay off in full a credit card bill after the first month, the credit card company was often retrospectively applying the new interest rate to previous purchases. This was allowed in the banks’ small print, but the government said the practice did “not align with consumers’ understanding and expectation about how interest is to be charged”. This will be banned, from next year.

Requiring credit card providers to have online options to cancel cards or to reduce credit limits (from January 2019). At the moment, some card providers force customers to come into a bank branch to reduce limits or terminate cards, and when they did come in were often persuaded not to do it. The asymmetry between fast credit card approvals online, and slow cancellation will end.

So another week highlighting the stresses and strains in the banking sector, and the forces behind slowing momentum in the property market. And based on the stance of the regulators, we think the screws will get tighter in the months ahead, putting more downward pressure on mortgage lending home prices and the Banking Sector. Something which the RBA says is a good thing!

72 Hours That Changed Banking – The Property Imperative Weekly 10 Feb 2018

Recent events have the potential to create a revolution in Australian Finance. We explore the 72 hours that changed banking forever.

Welcome to the Property Imperative Weekly to 10th February 2018.Watch the video or read the transcript.

In our latest weekly digest, we start with the batch of new reports, all initiated by the current Australian Government – and which combined have the potential to shake up the Financial Services sector, and reduce the excessive market power which the four major incumbents have enjoyed for years.

On Wednesday, the Productivity Commission, Australian Government’s independent research and advisory body released its draft report into Competition in the Australian Financial System. It’s a Doozy, and if the final report, after consultation takes a similar track it could fundamentally change the landscape in Australia. They leave no stone unturned, and yes, customers are at a significant disadvantage. Big Banks, Regulators and Government all cop it, and rightly so. They say, Australia’s financial system is without a champion among the existing regulators — no agency is tasked with overseeing and promoting competition in the financial system.  It has also found that competition is weakest in markets for small business credit, lenders’ mortgage insurance, consumer credit insurance and pet insurance. The report demonstrates the inter-linkages between difference financial entities, and their links to the four majors. They criticised mortgage brokers and financial advisers for poor advice (influenced by commission and ownership structures) and the regulatory environment, where the shadowy Council of Finance Regulators (RBA, ASIC, APRA and Treasury) do not even release minutes of the meetings which set policy direction. You can watch our separate video blog on this.

On Thursday, the Treasurer released draft legislation to require the big four banks to participate fully in the credit reporting system by 1 July 2018.   They say this measure will give lenders access to a deeper, richer set of data enabling them to better assess a borrower’s true credit position and their ability to pay a loan. This removes the current strategic advantage which the majors have thanks to the credit data asymmetry, and the current negative reporting. We note that there is no explicit consumer protection in this bill, relating to potential inaccuracies of data going into a credit record. This is, in our view a significant gap, especially as the proposed bulk uploading will require large volumes of data to be transferred. It does however smaller lenders to access information which up to now they could not, so creating a more level playing field.  Consumers may benefit, but they should also beware of the implications of the proposals.

On Friday, Treasurer Morrison released the report by King & Wood Mallesons partner Scott Farrell in to open banking which aims to give consumers greater access to, and control over, their data and which mirrors developments in the UK.  This “open banking” regime mean that customers, including small businesses, can opt to instruct their bank to send data to a competitor, so it can be used to price or offer an alternative product or service. Great news for smaller players and fintechs, and possibly for customers too. Bad news for the major players. The report recommends that the open banking regime should apply to all banks, though with the major banks to join it first. For non-banks and fintechs, the report wants a “graduated, risk-based accreditation standard”. Superannuation funds and insurers are not included for now. In terms of implementation, data holders should be required to allow customers to share information with eligible parties via a dedicated application programming interface, not screen scraping.  A period of approximately 12 months between the announcement of a final Government decision on Open Banking and the Commencement Date should be allowed for implementation. From the Commencement Date, the four major Australian banks should be obliged to comply with a direction to share data under Open Banking. The remaining Authorised Deposit-taking Institutions should be obliged to share data from 12 months after the Commencement Date, unless the ACCC determines that a later date is more appropriate.

Then of course the Royal Commission in Financial Services starts this coming week. We discussed this on ABC The Business on Thursday.  Lending Practice is on the agenda, highly relevant given the new UBS research (they of liar loans) suggesting that incomes of many more affluent households are significantly overstated on mortgage application forms.   And The BEAR – the bank executive behaviour regime legalisation – passed the Senate, and as a result of amendments, Small and medium banking institutions have until 1 July 2019 to prepare for the BEAR while it will commence for the major banks on 1 July 2018.

APRA Chairman Wayne Byers spoke at the A50 Australian Economic Forum, Sydney. Significantly, he says the temporary measures taken to address too-free mortgage lending will morph into the more permanent focus on among other things, further strengthening of borrower serviceability assessments by lenders, strengthened capital requirements for mortgage lending, and the comprehensive credit reporting being mandated by the Government.

Adelaide Bank is ahead of the curve, as it introducing an alert system that will monitor property borrowers that are struggling with their repayments. The bank and its subsidiaries and affiliates will compare monthly mortgage repayments with borrowers’ income ratios. In addition, extra scrutiny will be applied where the loan-to-income ratio exceeds five times or monthly mortgage repayments exceed 35% of a borrower’s income.

But combined, data sharing, positive credit and banking competition and regulation are all up in the air, or are already coming into force and in each case it appears the big four incumbents are the losers, as they are forced to share customer data, and competition begins to put their excessive profitability under pressure.  It highlights the dominance which our big banks have had in recent years, and the range of reforms which are in train. The face of Australian Banking is set to change, and we think customers will benefit. But wait for the rear-guard actions and heavy lobbying which will take place ahead.

Of course the RBA left the cash rate on hold this week, and signalled the next move will likely be up, but not for some time.  Retail turnover for December fell 0.5% according to the ABS seasonally adjusted.  This is the headline which will get all the coverage, but the trend estimate rose 0.2 per cent in December 2017 following a rise of 0.2 per cent in November 2017. Compared to December 2016 the trend estimate rose 2.0 per cent. This is in line with average income growth, but not good news for retailers.

The latest Housing Finance Data from the ABS shows a fall in flows in December. In trend terms, the total value of dwelling finance commitments excluding alterations and additions fell 0.1% or $31 million. Owner occupied housing commitments rose 0.1% while investment housing commitments fell 0.5%. Owner occupied flows were worth $14.8 billion, and down 0.3% last month, while owner occupied refinancing was $6.2 billion, up 1.2% or $73 million. Investment flows were worth 11.9 billion, and fell 0.5% or $62 million. The percentage of loans for investment, excluding refinancing was 45%, down from 49% in Dec 2016.  Refinancing was 29.5% of OO transactions, up from 29.2% last month. Momentum fell in NSW and VIC, the two major states. In original terms, the number of first home buyer commitments as a percentage of total owner occupied housing finance commitments fell to 17.9% in December 2017 from 18.0% in November 2017 – the number of transactions fell by 1,300 compared with last month. But the ABS warns that the First Time Buyer data may be revised and users should take care when interpreting recent ABS first home buyer statistics.  The ABS plans to release a new publication which will see Housing Finance, Australia (5609.0) and Lending Finance, Australia (5671.0) combined into a single, simpler publication called Lending to Households and Businesses, Australia (5601.0).

We continue to have data issues with mortgage lending, with the RBA in their new Statement on Monetary Policy saying it now appears unnecessary to adjust the published growth rates to undo the effect of regular switching flows between owner occupied and investment loans as they have been doing for the past couple of years.  So now investor loan growth on a 6-month basis has been restated to just 2%. More fluff in the numbers! Additionally, the RBA will publish data on aggregate switching flows to assist with the understanding of this switching behaviour.

More data this week highlighting the pressures on households.  National Australia Bank’s latest Consumer Behaviour Survey, shows the degree of anxiety being caused by not only cost of living pressures but also health, job security, retirement funding as well as Australian politics.  Of all the things bothering Australian households in early 2018, nothing surpasses cost of living pressures. Over 50% of low income earners reported some form of hardship, with almost one in two 18 to 49-year-olds being effected.

Despite improved job conditions and households reporting healthier financial buffers, the overall financial comfort of Australians is not advancing, according to ME’s latest Household Financial Comfort Report. In its latest survey, ME’s Household Financial Comfort Index remained stuck at 5.49 out of 10, with improvements in some measures of financial comfort linked to better employment conditions – e.g. a greater ability to maintain a lifestyle if income was lost for three months – offset by a fall in comfort with living expenses.

We released the January 2018 update of our Household Financial Confidence Index, using data from our rolling 52,000 household surveys. The news is not good, with a further fall in the composite index to 95.1, compared with 95.7 last month. This is below the neutral setting, and is the eighth consecutive monthly fall below 100. Costs of living pressures are very real, with 73% of households recording a rise, up 1.5% from last month, and only 3% a fall in their living costs. A litany of costs, from school fees, child care, fuel, electricity and rates all hit home. You can watch our separate video on this.

We also published updated data on net rental yields this week, using data from our household surveys. Gross yield is the actual rental stream to property value, net rental is rental payments less the costs of funding the mortgage, management fees and other expenses. This is calculated before any tax offsets or rebates. The latest results were featured in an AFR article. The results are pretty stark, and shows that many property investors are underwater in cash flow terms – not good when capital values are also sliding in some places. Looking at rental returns by states – Hobart and Darwin are the winners; Melbourne, and the rest of Victoria, then Sydney and the rest of NSW the losers. The returns vary between units and houses, with units doing somewhat better, and we find some significant variations at a post code level.  But we found that more affluent households are doing significantly better in terms of net rental returns, compared with those in more financially pressured household groups. Batting Urban households, those who live in the urban fringe on the edge of our cities are doing the worst.  This is explained by the types of properties people are buying, and their ability to select the right proposition. Running an investment property well takes skill and experience, especially in the current rising interest rate and low capital growth environment. Another reason why prospective property investors need to be careful just now.

Finally, we saw market volatility surge, as markets around the world gyrated following the “good news” on US Jobs last week, which signalled higher interest rates.  In our recent video blog we discussed whether this is a blip, or something more substantive.  We believe it points to structural issues which will take time to play out, so expect more uncertainly, on top of the correction which we have already had. This will put more upward pressure on interest rates, and also on bank funding here.

Overall then, a week which underscores the uncertainly across the finance sector, and households. This will not abate anytime soon, so brace for a bumpy ride. And those managing our large banks will need to adapt to a fundamentally different, more competitive landscape, so they are in for some sleepless nights.

If you found this useful, do like the post, add a comment and subscribe to receive future updates. Many thanks for taking the time to watch.

The Home Price Crunch – The Property Imperative Weekly – 03 Feb 2018

The Home Price Crunch is happening now, but how low will prices go and which areas will get hit the worst? Welcome to the Property Imperative Weekly to 3rd February 2018.

Welcome to our digest of the latest finance and property news. Watch the video or read the transcript.

There was lots of new data this week, after the summer break. NAB released their Q4 2017 Property Survey and it showed that property dynamics are shifting.  They see property prices easing as foreign buyers lose interest, and a big rotation from the east coast.  Tight credit will be a significant constraint. National housing market sentiment as measured by the NAB Residential Property Index, was unchanged in Q4, as big gains in SA and NT and WA (but still negative) offset easing sentiment in the key Eastern states (NSW and VIC). Confidence levels also turned down, led by NSW and VIC, but SA and NT were big improvers. First home buyers (especially those buying for owner occupation) continue raising their profile in new and established housing markets, with their share of demand reaching new survey highs. In contrast, the share of foreign buyers continued to fall in all states, except for new property in QLD and established housing in VIC, with property experts predicting further reductions over the next 12 months. House prices are forecast to rise by just 0.7% (previously 3.4%) and remain subdued in 2019 (0.8%). Apartments will under-perform, reflecting large stock additions and softer outlook for foreign demand.

Both CoreLogic and Domain released updated property price data this week. It is worth comparing the two sets of results as there are some significant variations, and this highlights the fact that these numbers are more rubbery than many would care to admit.  Overall, though the trends are pretty clear. Sydney prices are sliding, along with Brisbane, and the rate of slide is increasing though it does vary between houses and apartments, with the latter slipping further. For example, Brisbane unit prices have continued their downward slide, down to $386,000; a fall of 2.2 per cent for the quarter and 4.4 per cent for the year. Here units are actually at a four-year low. Momentum in Melbourne is slowing though the median value was up 3.2 per cent to $904,000 in the December quarter, according to Domain. Perth and Darwin remains in negative territory. Domain said Darwin was the country’s worst performer with a 7.4 per cent drop in its median house price to $566,000 and a 14 per cent plunge in its unit price to $395,000, thanks to a slowing resources sector. It also hit Perth, with a house median fall of 2.5 per cent to $557,000, and its units 1.7 per cent to $369,000. On the other hand, prices in Hobart and Canberra are up over the past year and Hobart is the winner, but is it 17% or 12%, a large variation between the two data providers?  And is Canberra 8% or 4%? It depends on which data you look at. Also, these are much smaller markets, so overall prices nationally are on their way down.  My take out is that these numbers are dynamic, and should not be taken too seriously, though the trend is probably the best indicator. Perhaps their respective analysts can explain the variations between the two. I for one would love to understand the differences. The ABS will provide another view on price movements, but not for several months.

The latest ABS data on dwellings approvals to December 2017 shows that the number of dwellings approved fell 1.7 per cent in December 2017, in trend terms, and has fallen for three months. Approvals for private sector houses have remained stable, with just under 10,000 houses approved in December 2017, but the fall was in apartments, especially in NSW and QLD.  More evidence of the impact of the rise in current supply of apartments, and why high rise apartment values are on the slide.  Also, the ABC highlighted the fact that Real estate sales companies are using big commissions to tempt mortgage brokers, financial planners and accountants to sell overpriced properties to unsuspecting clients. This is a way to offload the surplus of high-rise apartments, and looks to be on the rise, another indicator of risks in the property sector.

In other economic news, the ABS released the latest Consumer Price Index (CPI) which rose 0.6 per cent in the December quarter 2017. Annual inflation in most East Coast cities rose above 2.0 per cent, due in part to the strength in prices related to Housing.  This follows a rise of 0.6 per cent in the September quarter 2017. However, there were some changes in methodology which may have impacted the results. Softer economic conditions in Darwin and Perth have resulted in annual inflation remaining subdued at 1.0 and 0.8 per cent respectively. Many commentators used this data to push out their forecast of when then RBA may lift the cash rate – but my view is we should watch the international interest rate scene, as this is where the action will be.

Whilst the FED held their target rate this week, there is more evidence of further rate rises ahead. Most analysts suggest 2-3 hikes this year, but the latest employment data may suggest even more. The benchmark T10 bond yield continues to rise and is at its highest since 2014, and now close to that peak then of about 3%. Have no doubt interest rates are on their way up. This will put more pressure on funding costs around the world, and put pressure on mortgage rates here. In fact Alan Greenspan, the former Fed Chair, speaking about the US economy said “there are two bubbles: We have a stock market bubble, and we have a bond market bubble”. “Irrational exuberance” is back! He said we’re working, obviously, toward a major increase in long-term interest rates, and that has a very important impact, on the whole structure of the economy. Greenspan said. As a share of GDP, “debt has been rising very significantly” and “we’re just not paying enough attention to that.”  US rate hikes will lift international capital market prices, putting more pressure on local bank margins.

We published our latest mortgage stress research, to January 2018, Across Australia, more than 924,000 households are estimated to be now in mortgage stress compared with 921,000 last month. This equates to 29.8% of borrowing households. In addition, more than 20,000 of these are in severe stress, down 4,000 from last month. We estimate that more than 51,500 households risk 30-day default in the next 12 months, down 500 from last month. We expect bank portfolio losses to be around 2.7 basis points, though with losses in WA are likely to rise to 4.9 basis points. Some households have benefited from refinancing to cheaper owner occupied loans, giving them a little more wriggle room in terms of cash flow. The typical transaction has saved up to 45 basis points or $187 each month on a $500,000 repayment mortgage. You can watch our separate video blog on the results, where we count down the top 10 most stressed postcodes.

But the post code with the highest count of stressed households, once again is NSW post code 2170, the area around Liverpool, Warwick Farm and Chipping Norton, which is around 27 kilometres west of Sydney. There are 7,375 households in mortgage stress here, up by more than 1,000 compared with last month. The average home price is $815,000 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, which is more than 33% of average incomes.

We continue to see mortgage stress 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 note that it is not necessarily those on the lowest incomes who are most stretched. Banks have been more willing to lend to these perceived lower risk households but the leverage effect of larger mortgages has a significant impact and the risks are underestimated.

The latest data from The Australian Financial Security Authority, for the December 2017 quarter shows a significant rise in personal insolvency – a bellwether for the financial stress within the Australian community. The total number of personal insolvencies in the December quarter 2017 was 7,578 and increased by 7.4% compared to the December quarter 2016. This year-on-year rise follows a rise of 8.0% in the September quarter 2017.

This is in stark contrast to the latest business conditions survey from NAB. They say that the business confidence index bounced 4pts to +11 index points, the highest level since July 2017, perhaps driven by a stronger global economic backdrop and closes the gap between confidence and business conditions. Business confidence is strongest in trend terms in Queensland and SA and to a lesser extent NSW. Confidence is also reasonable in WA, and is in line with business conditions in the state. Victoria and Tasmania meanwhile are reporting levels of confidence which are lower than their reported level business conditions. But the employment index suggests employment growth may ease back from current extraordinary heights.

The RBA credit aggregates data reported that lending for housing grew 6.3% for the 12 months to December 2017, the same as the previous year, and the monthly growth was 0.4%.  Business lending was just 0.2% in December and 3.2% for the year, down on the 5.6% the previous year.  Personal credit was flat in December, but down 1.1% over the past year, compared with a fall of 0.9% last year. This is in stark contrast to the Pay Day Loan sector, which is growing fast – at more than 10%, as we discussed on our Blog recently (and not included in the RBA data).  Investor loans still make up around 36% of all loans, and a further $1.1 billion of loans were reclassified in the month between investment and owner occupied loans, and in total more than 10% of the investor mortgage book has been reclassified since 2015.

The latest data from APRA, the monthly banking stats for ADI’s shows a growth in total home loan balances to $1.6 trillion, up 0.5%. Within that, lending for owner occupation rose 0.59% from last month to $1.047 trillion while investment loans rose 0.32% to $553 billion. 34.56% of the portfolio are for investment purposes. The portfolio movements within institutions show that Westpac is taking the lion’s share of investment loans (we suggest this involves significant refinancing of existing loans), CBA investment balances fell, while most other players were chasing owner occupied loans. Note the AMP Bank, which looks like a reclassification exercise, and which will distort the numbers – $1.1 billion were reclassified, as we discussed a few moments ago.

Standing back, the momentum in lending is surprisingly strong, and reinforces the need to continue to tighten lending standards. This does not gel with recent home price falls, so something is going to give. Either we will see home prices start to lift, or mortgage momentum will sag. Either way, we are clearly in uncertain territory. Given the CoreLogic mortgage leading indicator stats were down, we suspect lending momentum will slide, following lower home prices. We will publish our Household Finance Confidence Index this coming week where we get an updated read on household intentions. But in the major eastern states at least, don’t bank on future home price growth.

If you found this useful, do like the post, leave a comment or subscribe for future updates. By the way, our special post on Bitcoin will be out in the next few days, we have had to update it based on recent market gyrations.

Housing Affordability and Employment – The Property Imperative Weekly 27 Jan 2018

Housing in Australia is severely unaffordable, and despite the growth in jobs, unemployment in some centres is rising. We look at the evidence. Welcome the Property Imperative Weekly to 27th January 2018.

Thanks to checking out this week’s edition of our property and finance digest.   Watch the video or read the transcript.

Today we start with employment data. CommSec looked at employment across regions over the last year. Despite the boom in jobs, the regional variations are quite stark, with some areas showing higher rates of unemployment, and difficult economic conditions. Unemployment has increased in several Queensland regional centres in recent years. Queensland’s coastal regional centres such as Bundaberg, Gympie, Bundaberg and Hervey Bay, known more broadly as Wide Bay (average 9.0 per cent), together with Townsville (albeit lower at 8.5 per cent) have elevated jobless rates. Unemployment also increased along the suburban fringes and city ‘spines’ such as Ipswich (8.1 per cent) in Brisbane and the western suburbs of Melbourne (9.0 per cent). In Western Australia, Mandurah, south of Perth, experienced a significant decline in the jobless rate to an average of 7.0 per cent in December from 11.2 per cent a year ago. Higher income metropolitan areas, especially in Sydney’s coastal suburbs, dominate the regions with the lowest unemployment rates. However, the corridor between Broken Hill and Dubbo has Australia’s lowest regional unemployment rate at 2.9 per cent, benefitting from agricultural, tourism and mining-related jobs growth. You will find there is a strong correlation with mortgage stress, as we will discuss next week.

The Victorian Government has reaffirmed their intent to shortly accept applications for its shared equity scheme known as HomesVic from up to 400 applicants. We do not think such schemes help affordability, they simply lift prices higher, but looks good politically.  This was first announced in March 2017. The $50-million pilot initiative aims to make it easier for first-home buyers to enter the market by reducing the size of their loan, hence reducing the amount they need to save for a deposit. The initiative targets single first-home buyers earning an annual income of less than $75,000 and couples earning less than $95,000. Eligible applicants must buy in so-called “priority areas” which include 85 Melbourne suburbs, seven fringe towns and 130 regional towns and suburbs. In Melbourne, the list includes suburbs around Box Hill, Broadmeadows, Dandenong, Epping, Fishermen’s Bend, Footscray, Fountain Gate, Frankston, LaTrobe, Monash, Pakenham, Parkville, Ringwood, Sunshine and Werribee. Regional centres on the list include Ballarat, Bendigo, Castlemaine, Geelong, La Trobe, Mildura, Seymour, Shepparton, Wangaratta, Warrnambool and Wodonga. The state government said the locations were chosen in growth areas where there was a high demand for housing and access to employment and public transport. Some of these locations are where mortgage stress, on our modelling is highest – we will release the January results next week. The scheme is not available in most of Melbourne’s bayside suburbs, the leafy inner eastern suburbs or some pockets of the inner north.

Overseas, the US Mortgage Rates continue to rise, heading back to the worst levels in more than 9 months.  Rates have risen an eighth of a percentage point since last week, a quarter of a point from 2 weeks ago, and 3/8ths of a point since mid-December.  That makes this the worst run since the abrupt spike following 2016’s presidential election. While this doesn’t necessarily mean that rates will continue a linear trend higher in the coming months, the trajectory is up, reflecting movements in the capital markets, and putting more pressure on funding costs globally.

The Bank for International Settlements (BIS) has published an important reportStructural changes in banking after the crisis“. The report highlights a “new normal” world of lower bank profitability, and warns that banks may be tempted to take more risks, and leverage harder in an attempt to bolster profitability. This however, should be resisted. They also underscore the issues of banking concentration and the asset growth, two issues which are highly relevant to Australia. The report says that in some countries the 2007 banking crisis brought about the end of a period of fast and excessive growth in domestic banking sectors.  Worth noting the substantial growth in Australia, relative to some other markets and of particular note has been the dramatic expansion of the Chinese banking system, which grew from about 230% to 310% of GDP over 2010–16 to become the largest in the world, accounting for 27% of aggregate bank assets.

Back home, an ASIC review of financial advice provided by the five biggest vertically integrated financial institutions (the big four banks and AMP) has identified areas where improvements are needed to the management of conflicts of interest. 68% of clients’ funds were invested in in-house products. ASIC also examined a sample of files to test whether advice to switch to in-house products satisfied the ‘best interests’ requirements. ASIC found that in 75% of the advice files reviewed the advisers did not demonstrate compliance with the duty to act in the best interests of their clients. Further, 10% of the advice reviewed was likely to leave the customer in a significantly worse financial position. This highlights the problems in vertically integrated firms, something which the Productivity Commission is also looking at. The real problem is commission related remuneration, and cultural norms which put interest of customers well down the list of priorities.

The Financial Services Royal Commission has called for submissions, demonstrating poor behaviour and misconduct. It will hold an initial public hearing in Melbourne on Monday 12 February 2018. The not-for-profit consumer organisation, the Consumer Action Law Centre (CALC) said the number of Aussie households facing mortgage stress has “soared” nearly 20 per cent in the last six months, and argued that lenders are to blame. Referencing Digital Finance Analytics’ prediction that homes facing mortgage stress will top 1 million by 2019, CALC said older Australians are at particular risk. The organisation explained: “Irresponsible mortgage lending can have severe consequences, including the loss of the security of a home. “Consumer Action’s experience is that older people are at significant risk, particularly where they agree to mortgage or refinance their home for the benefit of third parties. This can be family members or someone who holds their trust.” Continuing, CALC said a “common situation” features adult children persuading an older relative to enter into a loan contract as the borrower, assuring them that they will execute all the repayments. “[However] the lack of appropriate inquiries into the suitability of a loan only comes to light when the adult child defaults on loan repayments and the bank commences proceedings for possession of the loan in order to discharge the debt,” CALC said. We think poor lending practice should be on the Commissions Agenda, and we will be making our own submission shortly.

The latest 14th edition of the Annual Demographia International Housing Affordability Survey: 2018, continues to demonstrate the fact that we have major issues here in Australia. There are no affordable or moderately affordable markets in Australia. NONE! Sydney is second worst globally in terms of affordability after Hong Kong, with Melbourne, Sunshine Coast, Gold Coast, Geelong, Adelaide, Brisbane, Hobart, Perth, Cains and Canberra all near the top of the list. You can watch our separate video where we discuss the findings and listen to our discussion with Ben Fordham on 2GB.  When this report comes out each year, we get the normal responses from industry, such as Australia is different or the calculations are flawed. I would simply say, the trends over time show the relative collapse in affordability, and actually the metrics are well researched.

Fitch Ratings published its Global Home Prices report. They say price growth is expected to slow in most markets and risks are growing as the prospect of gradually rising mortgage rates comes into view this year. Their data on Australia makes interesting reading. Fitch expects Sydney and Melbourne HPI to stabilise in 2018, due to low interest rates, falling rental yields, increasing supply, limited investment alternatives and growing dwelling completions, partially offset by high population growth. Fitch expects the increase in FTB to be temporary; low income growth, tighter underwriting and rising living costs will maintain pressure on affordability for FTB. As mortgage rates are currently low, any material rate rise will weigh further on mortgage affordability and serviceability. The rising cost of living and sluggish wage growth are likely to increase pressure on recent borrowers who have little disposable income. Fitch expects mortgage lending growth to slow to around 4% in 2018, based on continued record low interest rates and stable unemployment. This will once again be offset by continued underemployment, reduced investor demand and tougher lending practices.

Finally, the latest weekly data from CoreLogic underscores the weakness in the property market. First prices are drifting lower, with Sydney down 0.4% in the past week and Melbourne down 0.1%.  The indicator of mortgage activity is also down, suggesting demand is easing as lending rules tighten. But then we always have a decline over the summer break. The question is, are we seeing a temporary blip, over the holiday season, or something more structural? We think the latter is more likely, but time will tell.

So that’s the Property Imperative Weekly to 27th January 2018. If you found this useful, do like the post, add a comment and subscribe to receive future editions. Many thanks for taking the time to watch.






The 200% Club – The Property Imperative Weekly – 20th Jan 2018

Lenders are facing a dilemma, do they chase mortgage lending growth, and embed more risks into their portfolios, or accept the consequences of lower growth and returns as household debt explodes and we join the 200% Club!

Welcome to the Property Imperative weekly to 20 January 2018. We offer two versions of the update, the first a free form summary edition in response to requests from members of our community:

Alternatively, you can watch our more detailed version, with lots of numbers and charts, which some may find overwhelming, but was the original intent of the DFA Blog – getting behind the numbers.

Tell us which you prefer. You can watch the video, or read the transcript.

In our latest digest of finance and property news, we start with news from the ABS who revised housing debt upward, to include mortgage borrowing within Superannuation, so total Household Liabilities have been increased by approximately 3% to $2,466bn. The change, which required the accurate measurement of property investment by self-managed superannuation funds, brought the figure up from 194 per cent so we are now at 200% of income. A record which no-one should be proud of. It also again highlights the risks in the system.   Australian households are in the 200% club.

The final set of data from the ABS – Lending Finance to November 2017 which also highlights again the changes underway in the property sector. Within the housing series, owner occupied lending for construction fell 0.88% compared with the previous month, down $17m; lending for the purchase of new dwellings rose 0.25%, up $3m; and loans for purchase of existing dwellings rose 0.11%, up $12m.

Refinance of existing owner occupied dwellings rose 0.28%, up $16m.

Looking at investors, borrowing for new investment construction rose 5%, up $65m; while purchase of existing property by investors fell $74m for individuals, down 0.75%; and for other investors, down $21m or 2.28%.

Overall there was a fall of $16m across all categories.

We see a fall in investment lending overall, but it is still 36% of new lending flows, so hardly a startling decline. Those calling for weakening of credit lending rules to support home price growth would do well to reflect that 36% is a big number – double that identified as risky by the Bank of England, who became twitchy at 16%!

Looking then across all lending categories, personal fixed credit (personal loans rose $70m, up 1.74%; while revolving credit (credit cards) fell $4m down 0.18%.  Fixed commercial lending, other than for property investment rose $231m or 1.12%; while lending for investment purposes fell 0.25% or $30m. The share of fixed business lending for housing investment fell to 36.7% of business lending flows, compared with 41% in 2015. Revolving business credit rose $6m up 0.06%.

A highlight was the rise in first time buyer owner occupied loans, up by around 1,030 on the prior month, as buyers reacted to the incentives available, and attractor rates. This equates to 18% of all transactions. Non-first time buyers fell 0.5%. The average first time buyer loan rose again to $327,000, up 1% from last month. We do not think the data gives any support for the notion that regulators should loosen the lending rules, as some are suggesting.  That said the “incentives” for first time buyers are having an effect – in essence, persuading people to buy in at the top, even as prices slide. I think people should be really careful, as the increased incentives are there to try and keep the balloon in the air for longer.

So, what can we conclude? Investment lending momentum is on the turn, though there is still lots of action in the funding of new property construction for investment – mostly in the high rise blocks around our major centres. But in fact momentum appears to be slowing in Brisbane, Sydney and Melbourne. This does not bode well for the construction sector in 2018, as we posit a fall in residential development, only partly offset by a rise in commercial and engineering construction (much of which is state and federal funded). What I’m noticing is that those in the construction sector – from small builders to sub-contractors – have significantly lower confidence levels than they did six months ago, based on our surveys.

Whilst lending to first time buyers is up, there are risks attached to this, as we will discuss later.

The good news is lending to business, other than for housing investment is rising a little, but businesses are still looking to hold costs down, and borrow carefully. This means economic growth will be slow, and potential wages growth will remain contained.

Fitch Ratings says Australian banks’ profit growth is likely to slow in 2018 as global monetary tightening pushes up funding costs, loan-impairment charges rise, and tighter regulation has an impact on business volumes and compliance costs from the 15 or so inquiries or reviews across the sector (according to UBS). They say Australian banks are more reliant on offshore wholesale funding than global peers, as the superannuation scheme here has created a lack of domestic customer deposits. Global monetary tightening could therefore push up banks’ funding costs. Indeed, The 10-Year US Bond yield is moving higher, and whilst the US Mortgage rates were only moderately higher today, the move was enough to officially bring them to the highest levels since the (Northern) Spring of 2017.

The main risks to banks’ performance stem from high property prices and household debt. Australian banks are more highly exposed to residential mortgages than international peers, while households could be sensitive to an eventual increase in interest rates or a rise in unemployment, given that their debt is nearly 200% of disposable income. Indeed, Tribeca Investment Partners said this week that local equities may be hurt by troughs in the domestic property market. “A heavily indebted household sector that is experiencing flat to negative real income growth, as well as dealing with higher energy and healthcare costs, and which has drawn down its savings rate, is unlikely to fill the gap in growth”

In local economic news, the latest ABS data on employment to December 2017, shows the trend unemployment rate decreased slightly to 5.4 per cent in December 2017, after the November 2017 figure was revised up to 5.5 per cent.  The trend unemployment rate was 0.3 percentage points lower than a year ago, and is at its lowest point since January 2013.

The seasonally adjusted number of persons employed increased by 35,000 in December 2017. The seasonally adjusted unemployment rate increased by 0.1 percentage points to 5.5 per cent and the labour force participation rate increased to 65.7 per cent.  The number of hours worked fell. By state, trend employment rose in NT, WA and SA.  Over the past year, all states and territories recorded a decrease in their trend unemployment rates, except the Northern Territory (which increased 1.6 percentage points). The states and territories with the strongest annual growth in trend employment were Queensland and the ACT (both 4.6 per cent), followed by New South Wales (3.5 per cent).

The ABA released new research – The Edelman Intelligence research conducted late last year which tracks community trust and confidence in banks. Whilst progress may be being made, the research shows Australian banks are behind the global benchmark in terms of trust. Based on the Annual Edelman Trust Barometer study released in January 2017, Australia remains 4 points behind the global average.

The Australian Financial Review featured some of our recent research on the problem of refinancing interest only loans (IO).  Many IO loan holders simply assume they can roll their loan on the same terms when it comes up for periodic review.  Many will get a nasty surprise thanks to now tighter lending standards, and higher interest rates.  Others may not even realise they have an IO loan!

Thousands of home owners face a looming financial crunch as $60 billion of interest-only loans written at the height of the property boom reset at higher rates and terms, over the next four years.

Monthly repayments on a typical $1 million mortgage could increase by more than 50 per cent as borrowers start repaying the principal on their loans, stretching budgets and increasing the risk of financial distress.

DFA analysis shows that over the next few years a considerable number of interest only loans (IO) which come up 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.  The value of loans is significant. And may be understated.

We also featured research on the Bank of Mum and Dad, now a “Top 10” Lender in Australia. Our analysis shows that the number and value of loans made to First Time Buyers by the “Bank of Mum and Dad” has increased, to a total estimated at more than $20 billion, which places it among the top 10 mortgage lenders in Australia. Savings for a deposit is very difficult, at a time when many lenders are requiring a larger deposit as loan to value rules are tightened. The rise of the important of the Bank of Mum and Dad is a response to rising home prices, against flat incomes, and the equity growth which those already in the market have enjoyed.  This enables an inter-generational cash switch, which those fortunate First Time Buyers with wealthy parents can enjoy. In turn, this enables them also to gain from the more generous First Home Owner Grants which are also available. Those who do not have wealthy parents are at a significant disadvantage. Whilst help comes in a number of ways, from a loan to a gift, or ongoing help with mortgage repayments or other expenses, where a cash injection is involved, the average is around $88,000. It does vary across the states. But overall, around 55% of First Time Buyers are getting assistance from parents, with around 23,000 in the last quarter.

There was also research this week LF Economics which showed that some major lenders are willing to accept a 20% “Deposit” for a mortgage from the equity in an existing property, and in so doing, avoided the need for expensive Lenders Mortgage Insurance.

Both arrangements are essentially cross leveraging property from existing equity, and is risky behaviour in a potentially falling market. More evidence of the lengths banks are willing to go to, to keep their mortgage books growing. We think these portfolio risks are not adequately understood.

So, we conclude that banks are caught between trying to grow their books, in a fading market, by offering cheap rates to target new borrowers, and accept equity from existing properties, thus piling on the risk; while dealing with rising overseas funding, and in a flat income environment, facing heightened risks from borrowers as they join the 200% club.

That’s the Property Imperative Weekly to 20 January 2018. If you found this useful, do leave a comment, subscribe to receive future updates and check back for our latest posts. Many thanks for watching.

The Game Is Up – The Property Imperative Weekly 13 Jan 2018

The game is up. Major changes are rippling through the property market, with continued pressure on many households, so we examine the latest data.

Welcome to the Property Imperative weekly to 13 January 2018. Watch the video or read the transcript.

In this week’s review of the latest finance and property news, we start with the AFG Mortgage Index with data to December 2017. While the view is myopic (as its only their data) it is useful and really highlights some of the transitions underway in the industry.  First, there has been an astonishing drop in the number of interest only loans being written, from 60% of volume in 2015, to 20% now – WOW! We also see a small rise in first time buyer volumes, as expected. So the regulatory intervention is having some impact. However, average loans size is rising (and faster than income and inflation), and Victoria stands out as the state to watch with an increase in average loan size over the past 12 months nearly double the size of the increase in New South Wales. So more still needs to be done on the regulatory front. Overall, the national average loan size is up 2.8% over the past 12 months. The average loan size in New South Wales is now $613,084. Queensland has increased by 3.4% to now be sitting at $416,921. South Australia is up 3.4% to $390,706. The Northern Territory is up 22% to $469,502, albeit from a low volume. Reflecting the challenges being encountered by the WA economy, the state’s average loan size is down 1.1% to $439,944. Finally, the share of the major’s banks is falling, as we have seen from other data, as smaller players and non-banks pick up the slack. The majors now have just 64.2% of the market compared to the non-majors sitting at 35.8%.

There is more evidence of poor mortgage lending practice, according to online property lender Tic:Toc Home Loans as reported in The Australian Financial Review. This is another version of the ‘liar loans’ story, and shows that borrowers are more stretched than some lenders suspect. Tic:Toc says, one in five property borrowers are exaggerating their income and nearly half understating their spending, triggering new concerns about underwriting standards and vulnerability to sharp economic corrections. We see similar issues in our own surveys, as households stretch to get the largest mortgage they can, whatever the cost, and whatever the risk.

APRA  released the final version of the revised reporting requirements for residential mortgage lending. It comes into effect from March and lenders will have to report more fully, including data on gross income, (excluding super contributions), new reporting on self-managed superannuation funds (SMSFs) and non-residents, as well as all family trusts holding residential mortgages. Reporting of refinanced loans should include date of refinance (not original funding date) and APRA says the original purpose of the loan is not relevant to reporting when refinanced. Once again we see APRA in catch-up mode trying to get the data to manage the mortgage lending sector more effectively. We think they have been late to the party, and have much to do.

The chairman of the Australian Competition and Consumer Commission has revealed that there will be some “surprises” in the upcoming draft report into how the banks price residential mortgage products. The inquiry into how the major banks price their mortgage is the first undertaking of the ACCC’s new Financial Sector Competition Unit, which is tasked with undertaking regular inquiries into specific competition issues across the financial sector. Starting with the $1.2 million inquiry into residential mortgage product pricing, the ACCC is aiming to understand how the banks affected by the major bank levy explain any changes or proposed changes to fees, charges or interest rates in relation to residential mortgage products. The inquiry relates to prices charged until 30 June 2018. A draft report will be published in February or March. This will be an important piece of work especially, as the corporate watchdog has also previously warned that the big banks could be in breach of the ASIC Act over the reasons given for hiking interest rates.

Turning to broader economic news, The November data from the ABS shows that Australian retail turnover rose 1.2 per cent in November 2017, seasonally adjusted, with Black Friday and iPhone X sales driving the outcome This follows a 0.5 per cent rise in October 2017. Some will spruke this as a positive sign. However, the more reliable trends are less positive, with the estimate for retail turnover up 0.1 per cent in November 2017 the same as October 2017. This is just 1.7 per cent over that past year, so still weak, reflecting stagnant wage growth, rising costs and high levels of debt. The state trend data showed NSW, ACT and QLD had no change, NT fell 0.2% along with WA, while VIC rose 0.3% and SA 0.4%, and TAS rose 0.2%. Online retail turnover was a new record at 5.5 per cent of total retail turnover. But the key takeaway is that households are continuing to keep their wallets firmly in their pockets.

The latest ANZ Job Ads series for December in seasonally adjusted terms, fell 2.3% largely unwinding the increase over the previous two months. On an annual basis job ads are up 11.4%, a slight moderation from 12.0% y/y growth the previous month. The labour market in 2017 was characterised by widespread job growth (particularly in full time jobs), an increase in participation and a fall in the unemployment rate to a four-year low of 5.4%. Growth in ANZ Job Ads provided a leading signal of this strong performance. But of course this has not been converted to rising wages growth so far.

The Building Approvals data from the ABS was much stronger than expected, with the number of dwellings approved up 0.9 per cent in November 2017, in trend terms, and has risen for 10 months. The strong results were driven by renewed strength in approvals for apartments. Approvals for private sector houses fell 0.1 per cent in November. Private sector house approvals fell in Western Australia (3.3 per cent), New South Wales (0.8 per cent) and Queensland (0.4 per cent), but rose in South Australia (1.3 per cent) and Victoria (1.1 per cent).

Consumer Confidence was stronger in the first week of January according to the ANZ/Roy Morgan index, which jumped 4.7% to 122 last week, leaving it at the highest level since late 2013. It often jumps after Christmas, and perhaps the holidays and ashes victory are colouring perspectives. Certainly, it makes an interesting contrast to our own Household Financial Security Index, which we released this week, based on December 2017 survey data. The latest edition of the Digital Finance Analytics Household Financial Security Confidence Index, fell from 96.1 last month to 95.7 this time, and remains below the neutral measure of 100. You can watch our video where we discuss the research.

Analysis of households by their property owning status reveals that property investors are in particular turning sour, as flat net rental incomes, and rising interest rates hit many, at a time when property capital growth is stalling. Owner occupied households are faring a little better, thanks to a range of ultra-cheap mortgage rates on offer at the moment, but they are also concerned about price momentum. Those without property interests remain the least confident, as the costs of renting outstrip income growth, and more are slipping into rental stress.

More questions came out this week, when The ABC is reporting that a Treasury  FOI request has shown that Federal Labor’s negative gearing overhaul would likely have a “small” impact on home values, official documents reveal, contradicting Government claims the policy would “smash” Australia’s housing market. The previously confidential advice to Treasurer Scott Morrison from his own department said the Opposition’s plan might cause “some downward pressure” and could have “a relatively modest downward impact” on prices. This is further evidence that tackling negative gearing should be a strategic priority to help bring our housing market back to reality.

There is also a blind spot at the heart of macroeconomics according to Claudio Borio Head of the BIS Monetary and Economic Department – the BIS is the Central Bankers Banker. He argues that a core assumption implicit in policy setting is that macroeconomics can treat the economy as if it produced a single good through a single firm. The net effect of this assumption is to drag down interest rates and productivity. The truth is much more complex, and within the economy there are “zombie firms” where resources are effectively misallocated, leading to reduced productivity and lower than expected economic outcomes, which will cast a long shadow through the economic cycle. The bottom line is first, credit booms tend to undermine productivity growth as they occur and second, the subsequent impact of the labour reallocations that occur during a financial boom is much larger if a banking crisis follows. This may also help to explain the current gap between employment and wages growth.

Finally, if you want more evidence of the risks in the system look at the RBA chart pack which was released this week. You can watch our video on this, but first, relative to the ultra-low cash rate, actual mortgage rates are rising – no surprise given the rise in mortgage stress we are registering. Next, home loan approvals are on the slide – expect more of this as tighter underwriting standards bite, and many interest only borrowers are forced to switch to higher cost interest and principal loans. Home price indices are trending lower (but still net positive growth overall at the moment). Expect more falls in the months ahead. Household debt continues higher. Now double disposable income, and we have some of the most highly in debt households in the world. Lending growth is still three times income, so this is likely to continue higher. All this is bearing down on household consumption as real income growth stalls. The savings ratio is falling, as households tap these to prop up their finances, OK in the short term, but unsustainable longer term.

In summary, UNSW’s Professor Richard Holden wrote that troubling borrowing and lending markers in the Australian housing market suggest that the lessons from the US mortgage meltdown have not been learned. He rightly draws comparisons with the USA, as we discussed in last week’s Property Imperative, with loose lending standards, a high penetration of interest only loans, many of which will need to be refinanced to higher rate principal and interest loans down the track, and liar loans. Plus, there are questions about where borrowers are getting their deposits from (even drawing from credit cards or borrowing from the Bank of Mum and Dad), and while more loans are originated via brokers, he suggests the banks are myopic to the risks in their portfolio.  He says we are still left with highly indebted households who have nearly $2 of debt for every $1 of GDP, a raft of interest-only loans that will soon involve principal repayments, and stagnant wage growth, and concludes “Having lived in the US during the mortgage meltdown I’m sorry to say that I’ve seen this movie before. The question is: why haven’t our bankers?” I would add, our Regulators should answer the same question. We are on the brink; the game is up!

And that’s the Property Imperative weekly to 13 January 2018. If you found this useful, do like the post, add a comment, or subscribe to receive future updates. In the past week our YouTube Channel followers have grown by a third, so thanks to all those who joined and the comments you left.  We are busy collecting questions for our next Q&A session, so keep a look out for that.

Meantime, we will be back with more insights in the next few days, and many thanks for taking the time to watch.