Slow, Slow, Down Down, Slow…The Property Imperative Weekly to 14th July 2018

Welcome to the Property Imperative weekly to 7th July 2018, our digest of the latest finance and property news with a distinctively Australian flavour.

By the way if you value the content we produce please do consider joining our Patreon programme, where you can support our ability to continue to make great content. Here is the link.

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

My interview with John Adams on the $1 trillion of foreign debt Australia is saddled with, was well received this week, with considerable interest not only from audiences in Australia, but also in the US.  It’s worth noting that global debt, of all type stands at a record US$237 trillion and by the way the nonfinancial debt as a share of GDP in the US is also at a record 46%.  We are drowning in debt. The discussion around how companies are borrowing more to boost shareholder returns in the short term and the risks ahead, resonated with many who watched our discussion. Our next one will focus on the apparently simple question of what is money and will touch on value destruction. So watch out for that.

We also covered household finance and mortgage stress this week, on a range of mainstream media outlets, including the ABC and Seven Sunrise; as more banks, including Macquarie, Bendigo and AMP Bank all lifted their mortgage rates in the week between 8 and 17 basis points depending on the bank loan type because of ongoing funding pressures. My headline of 1 million households in stress by September if the majors followed suite received significant attention, despite some analysts choosing to say there is no issue at all because rates are so low, or confusing stress with default, clearly the education must continue… To which I reply, look at the data, one third of owner occupied households have no wriggle room to accommodate rising rates. Even small increases – 10 basis points on an average $750,000 Sydney mortgage is another $60 each and every month. Given rising costs and flat incomes this is significant.  It is also worth noting that CBA this week dropped the base rate on its NetBank Saver account by 30 basis points after Westpac last week also cut the return on its eSaver product by the same amount. Three of the major banks – CBA, Westpac and ANZ – are now offering annual rates of only 0.5 per cent on their online savings accounts. So depositors are also getting hit hard and this could in fact make banking funding costs in the capital markets go even higher as savers look for alternatives and withdraw funds from bank deposit accounts.

APRA reported the outcomes of their bank stress tests were fine, but our own analysis of the data using the same high risk scenario came out with a more worrisome result. You can watch our video “When Is A Test, Not A Test” for more.   According to the Australian, CLSA analyst Brian Johnson said it was “a bit late for the regulator to acknowledge housing as a potential systemic risk” after it “watched from the sidelines” as household debt exploded and house prices reached “bubble-ish” territory. He also said Mr Byre’s speech was indicative of an “accommodative” stance that would let the banks continue to lend largely unrestrained. More evidence of the ongoing debt balloon.

The outgoing secretary of the Australian Treasury John Fraser warned in a speech at an economist’s forum published by Treasury, against lifting interest rates saying “considerable care” needed to be taken to unwind the extreme fiscal and monetary policy interventions of the past decade.  “As we all know, these interventions have left fiscal and monetary policymakers with difficult legacies: structural balance deficits and high net debt levels and official interest rates at historically very low levels,” “Judgment is required, together with a healthy scepticism about what economic models alone might be telling us,” he said. My own view is we see more and more evidence of the politicisation of the Treasury, as reflected in their unrealistically optimistic forecasts.

The latest edition of NAB’s quarterly property industry survey contained data which showed that demand for property from foreign buyers has fallen to levels not seen since 2010.  This is true of both new and existing properties, and is the result on tighter credit controls and higher transaction fees. Another reason why we think property prices will continue to fall. And data from NSW shows again the significant drop in the number of foreign buyers transacting at the moment.

CoreLogic’s home price indices continues to record weekly falls, with no state rising and Melbourne falling 0.2% on the prior week, followed by Sydney and Perth both down another 0.1%.  Auction clearance rates have remained relatively consistent over the past 2 months; remaining within the low to mid 50 per cent range.  Volumes have been trending lower over each of the last 4 weeks, and also tracking lower relative to volumes from the same period last year. CoreLogic says Melbourne’s final auction clearance rate fell to 56.1 per cent across 631 auctions last week, down from the 57.2 per cent across a higher 791 auctions over the previous week. Over the same week last year, 818 homes went to auction and a clearance rate of 72.9 per cent was recorded. Sydney’s final clearance rate has been fairly stable over the last 3 weeks, with last week’s final clearance rate coming in at 50.1 per cent across 552 auctions, compared to 49.7 per cent across 634 auctions the week prior. This time last year, 656 homes went under the hammer, returning a clearance rate of 68.6 per cent. There is noise in the data here because of the high number of unreported auctions, so in fact the true situation is considerably worse. We discussed this at length in our video “Auction Results Under the Microscope”.

The AFR reported that at the end of May, the average days on market in Sydney for houses has risen to 63 days up from about 45 days at the peak of the market last year. Days on market have been hovering around the 60s since March. For units, that number is now 64 days, rising from last year’s peak of 54 days. It takes an average of 48 days to sell a house privately, rather than through auction, in Melbourne. That number has remained fairly stable in 2017 and 2018 so far. For units, the average days on market in Melbourne has improved to 75 days down from nearly 100 days last year.

There was significant discussion from the analysts this week, with Morgan Stanley’s forward-looking housing model – MSHAUS – at a new historical low at -1.0 in the June quarter. Their model includes consideration of construction, credit availability and other factors including the Royal Commission.  They conclude “National and Sydney dwelling prices are down ~2.3% and 4.8% from their peak, respectively, and auction clearance rates are tracking around 50%.  As a result, consensus has turned negative on the market, but the debate now pivots on the extent of any decline. At this stage, we remain of the view that a price adjustment will be closer to 10%, while noting that deeper falls would bring a monetary or prudential policy adjustment into the debate. “Credit has tightened further, sentiment is slipping, and additional stock is hitting the market,” said Morgan Stanley strategists Daniel Blake and Chris Nicol.

Deloitte released its Australian Mortgage Report 2018, which forecasts that Australia’s housing correction will continue on the back of falling mortgage volumes. Australia’s leading lenders and mortgage brokers predict the nation’s housing settlement volumes will either remain flat or more likely decrease by up to 5% from the highs of previous years. “It is already appearing as if 2018 will be the second consecutive year since 2012 that settlement volumes (that is, the level of new mortgages issued in the market) either flattens off or reduces.  Deloitte Access Economics’ Director Michael Thomas said: “Regulators aiming to restrain increasing property debt amid concerns of an overheating market, have targeted investor lending. Tighter lending standards and restrictions on the volume of ‘interest-only’ loans to total new residential mortgages, have pushed up rates for investors. Market activity has begun cooling, with house price growth slowing in the latter half of 2017 and continuing into 2018.”.

The ANZ-Property Council Survey for the September 2018 quarter shows that sentiment in Australia’s property sector worsened from last quarter’s record peak. The fall occurred across most states and territories, with only Queensland and South Australia recording mild increases. The latter has continued its impressive run and is now the country’s most optimistic region. The fall in sentiment is entirely due to the residential segment. In a sharp reversal from the stabilisation of previous quarters, the outlook for capital values in residential property has deteriorated markedly. Staffing levels, construction activity and the forward work schedule are all expected to ease in the residential space. Importantly, survey respondents expect the availability of debt finance to worsen. We believe this has been the main driver of the current weakness in the housing market. Any further tightening of credit will put more pressure on the industry.

This is all about credit tightening.

Chief executive of Aussie Home Loans, James Symond said that after banks have tightened credit standards “dramatically” in the last year, more customers Aussie was dealing with were falling outside the lending policies of banks, which have ramped up their scrutiny of customers’ living expenses. …”I’m hoping everyone is looking at it very, very carefully, because I’m seeing a credit marketplace tightening a lot, a real lot. And if we saw it tighten any more, I think that you mightn’t get the desired outcomes you want,” he said in an interview with Fairfax Media.

But CBA announced further expense checks on mortgage applicants, with to two rounds of detailed quizzing about their weekly spending on everything from school fees to gym memberships, children and pets. The formal categories cover: children; pets; clothing and personal care; communication; education; food and groceries; housing and property expenses; insurance; medical, health and fitness; recreation, travel and entertainment; and transport and auto. I doubt most households would have a clue, bearing in mind that according to our surveys half maintain no formal household budgets, so many will take a guess, and carry the liability of so doing. Further evidence of credit tightening, and importantly risk transference to the borrower, because once you sign the expenses declaration, the bank is insulated from “not unsuitable” liability.

HashChing, also said this week that lending regulations have gone overboard, and the tightening restrictions have, at times, become the reason for the unnecessary disapproval of loan applications.

Yet the credit data from the ABS this week showed that there was still some credit growth, despite investors falling off a cliff, especially in Sydney and Melbourne. The ABS data shows that total lending stock grew again in May. This is original data split between owner occupied and investment loans. Total housing loan stock rose 0.5% in the month to $1.66 trillion. Within that owner occupied lending rose 0.5% to $1.1 trillion and and investment lending rose just 0.1% to $563 billion. Investment loans fell to be 33.8% of all loans. Overall growth is circa 6% annualised. As for whether growth at 3 times income is “healthy” to quote Wayne Byers; well that’s another story.   Remember debt has to be repaid, eventually. Growth has been strongest in owner occupied lending, but investment lending was also higher. If anything, further tightening is in order…

On the markets bank stocks did quite well this week, with the ASX 100 up to 5,155, despite the latest round in the trade wars. CBA up to 74.85 and Westpac ended at $29.60 but above the recent lows and a little lower on Friday. Clearly concerns about their mortgage books are not translating to share prices at the moment.

And the Aussie Dollar was a little stronger, although the drift down from the start of the year has continued, and many think it will go further.

On the US markets, Wall Street ended the week higher, with all the major indices closing in the green. The Dow ended at 25,019, still below the February highs. Tech stocks were winners for the week. The tech-heavy Nasdaq finished up more than 1%. Among the big winners in tech land was Amazon. The stock got a boost on a price target raise by Canaccord to $2,000 from $1,800 Thursday and again when S.G. Cowen raised its price target on the stock to $2,100 from $2,000 Friday. Alphabet’s Google, Apple and Facebook all closed up for the week. But Netflix, ended in the red, hurt by a Friday selloff ahead of their results. There are likely a few jitters about what numbers Netflix would have to report to spur more buying with the stock up around 100% year to date. The top 20 internet leaders highlight the concentration in a small number of the stocks, with Amazon and Alphabet right at the top.

Inflation data was paramount during the week, especially after last Friday’s employment report gave mixed signals of strong continued job creation but weaker-than-expected wage growth. The numbers grabbing the headlines were the levels in wholesale and retail inflation not seen for a while. The producer price index (PPI) was up 3.4% in June year over year, the highest level in 6-1/2 years. The June consumer price index (CPI) posted a year-over-year rise of 2.9%, the largest rise in six years. But the stock market tends to focus more on the month-on-month numbers and those figures were mixed. CPI was in line with expectations month over month, while core CPI, which excludes volatile food and energy prices, was up less than expected. PPI and core PPI came in just a little hotter than expectations. So, while prices are definitely rising, the US economy is so far avoiding the spikes that would fuel fears over interest rates rising quickly.

More significant for those zoned in on the Fed’s rate-hike path than the inflation data was likely the shift of Chicago Fed President Charles Evans comments in a wide-ranging interview with The Wall Street Journal that the economy could handle a move to neutral rates. That was interpreted to mean he’d support two rate-hikes this year. There is currently a more-than-80% of a rate hike in September and a more-than-55% chance of one in December.  This would of course flow on to higher capital market funding costs. The 3 month US Bond rate was higher again on Friday,

The bank earnings were supposed be the highlight of the week. But the mixed results from Citigroup, JPMorgan Chase and Wells Fargo failed to spur anything but a muted reaction from the market Friday. Instead, Delta Air Lines likely offered the most insight for investors. Shares climbed Thursday after the airline beat second-quarter profit expectations thanks to fare increases. But it also highlighted a jump in fuel costs of nearly 40% in the quarter, a $2 billion increase. That’s trouble for the airline sector as whole, which is already struggling in 2018. The Dow Transports are off about 0.6% year to date. But there could be more weakness ahead if fuel costs remain high and companies like FedEx and UPS are hit by trade battles.

Until earnings arrived in earnest on Friday, the summer, low-volume market has been especially susceptible to the vagaries of trade tensions. The week started off with more saber rattling between the U.S. and its trade partners. The U.S. released a list on Tuesday of $200 billion more in Chinese goods that it would assess for tariffs of 10%. China again promised retaliation. That same day, ahead of his trip to Europe, President Donald Trump tweeted that the U.S. loses $151 billion on trade with the EU and that the single bloc charges the U.S. big tariffs and enacts trade barriers. But worries were reduced on Thursday when Treasury Secretary said there was a possibility that the U.S. and China could restart trade talks. And the president, while hammering allies of NATO spending, has not made any remarks about specific trade action against Europe. The rosier outlook on trade was reflected in the performance of Boeing, which is particularly sensitive to trade battles given the amount of its overseas business. Boeing was one of the best Dow performers for the week.

Oil prices fell for the week, but energy stock bulls will be heartened by crude oil’s ability to stay above $70 mark on Friday. Crude oil futures for August delivery settled at $71.01 per barrel, up 1% on the day. Oil did dip below $70 in morning trading, rose steadily through the rest of the day, then sold off late. For the week, mixed signals on supplies scaled back investor expectations for a global supply shortage as Libya resumed exports, U.S. supplies fell more than expected, while bets on a significant loss of Iranian crude were trimmed.

Gold prices resumed their decline and remained on track for their lowest settlement in nearly two weeks as easing trade-war concerns offset the dollar’s retreat against its rivals from a two-week high. The U.S. dollar index, which measures the greenback’s strength against a trade-weighted basket of six major currencies, rose by 0.01% to 94.58, but remained well below its intraday of high of 95.00.

Dollar-denominated commodities such as gold are sensitive to moves in the dollar. A rise in the dollar makes gold more expensive for holders of foreign currency, reducing demand for the precious metal.

So amid all the market noise the fragile US bank results and the prospect of higher interest rates ahead shine through as factors which could flow through into our own markets, which remain bullish, despite the warning signs of more downside risk from the finance and property sectors locally. As I said to the AFR on Friday, I have never seen so much interest in offshore investors seeking ways to short our market, given the next moves are likely to be lower as we move into spring. Expect further falls ahead.

Before I sign off, mark your diary. On the 17th July at 8 PM Sydney time I will be running our next live streaming session, where you can discuss in real time the issues in play. Judging by the previous session, it will be a lively event. This time we will be focussing on Financial Resilience. I have scheduled the event on our YouTube channel.  Or send me questions beforehand via the comments section below.

When Will The “Debt Elastic” Ping Back? – The Property Imperative Weekly 7th July 2018

Welcome to the Property Imperative weekly to 7th July 2018, our digest of the latest finance and property news with a distinctively Australian flavour.  By the way if you value the content we produce please do consider joining our Patreon programme, where you can support our ability to continue to make great content. Here is the link.

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

This week the RBA left the cash rate on hold once again at 1.5% and continued the trend of doing nothing. In fact, reading the release from Tuesday, it is worth noting two things. First they are being very gentle in referring to home price falls, saying “Nationwide measures of housing prices are little changed over the past six months. Conditions in the Sydney and Melbourne housing markets have eased, with prices declining in both markets. Housing credit growth has declined, with investor demand having slowed noticeably. Lending standards are tighter than they were a few years ago”. Second, we think they would like to lift rates to more normal levels, but cannot thanks to high debt, and downside risks. They are stuck. I believe the next move will be down as the economy weakens (dragged down by the fading property market, rising interest rates internationally, and concerns about China’ economic dynamo). But not yet.

Now compare this with a BIS report also out this week. The BIS is worried by the current low interest rate environment, and in a new report by a committee chaired by Philip Lowe, warn of the impact on financial stability across the financial services sector, with pressures on banks via net interest margins, and on insurers and super funds.  They warn that especially in competitive markets, risks rise in this scenario.  Low interest rates may trigger a search for yield by banks, partly in response to declining profits, exacerbating financial vulnerabilities. In addition, keeping rates low for longer may create the need to lift rates sharper later with the risks of rising debt costs and the broader economic shock which follows. A salutatory warning! We discussed this in more detail in our post “To “Bail-In” Or To “Bail-Out”, That Is Indeed The Question”.

The contrast between the theoretical macro policy position, and the local situation here in Australia, must at very least be giving Mr Lowe a bit of a headache!

The trajectory of global rates is upwards as we will discuss later. The latest from the FED is that further rate rises are required, and expected. So the FED is doing what the BIS report suggested. But the net result is pressure on Bank funding here, remember that around 30% of bank funding comes from overseas and the BBSW is higher still.

Two points to make here. First as credit availability is the strongest influence of home prices, the easy access to international capital markets the banks have had in recent years meant they could lend more, up to 30% more, hence disastrously higher home prices. Second the weight of evidence is that more banks will lift rates.  Citigroup for example, forecasts that the rising cost of funding will prompt Australia’s four major banks to increase their mortgage interest rates independently of the RBA, with the banks tipped to begin lifting their mortgage rates by an average of eight basis points by September. Citigroup adds that the rise in banks’ short-term funding costs since early 2018 is likely to be sustained.  And in effect the tenor of the RBA minutes signals to the banks they can go ahead and lift rates.

As rates have fallen, households have leveraged up, supported by lose lending policy and driving home prices to massive multiples of household income as data from IFM Investors showed this week.

And even small rate rises will hurt, as we showed in our latest Mortgage Stress release for June, which was out this week. Mortgage stress continues to rise. Across Australia, more than 970,000 households are estimated to be now in mortgage stress (last month 966,000). This equates to 30.3% of owner occupied borrowing households. In addition, more than 22,000 of these are in severe stress. We estimate that more than 57,100 households risk 30-day default in the next 12 months. We expect bank portfolio losses to be around 2.8 basis points, though losses in WA are higher at 5.2 basis points.  We continue to see the impact of flat wages growth, rising living costs and higher real mortgage rates. We discussed this in our post “The Debt Pips Are Squeaking”, in which we also discussed the latest anaemic retail sales figures, and the latest household debt to income ratio from the RBA which are now at a record 190.1. We are literally drowning in debt. And its structural.

The Australian Institute of Health & Welfare released a new report showing that home ownership is out of reach to growing numbers of Australians, thanks to high prices and poor affordability.  They say that over the last 20 or so years Australia has seen a shift from outright ownership to owning with a mortgage, and a shift from overall home ownership to private rental Between 1995 and 2015, the proportion of outright owner-occupied households fell from 41.8% to 30.4%. Comparatively, the proportion of households owning with a mortgage has increased, from 29.6% to 37.1%, over the same period. Overall, the proportion of households in home ownership fell from 71.4% to 67.5%. There has also been an increase in the proportion of households renting privately (from 18.4% to 25.3%), and a decline in the proportion of households renting through state and territory housing programs (from 5.5% to 3.5%). Equally telling is home ownership rates between 1971 and 2016, by selected 5-year age groups. The home ownership rate of 30–34 year olds was 64%, and 50% for 25–29 year olds, in 1971. Forty-five years later these rates have decreased notably, with the home ownership rate of 30–34 year olds falling 14 percentage points to 50%. Similarly, that of 25–29 year olds fell 13 percentage points (to 37%). While declines are evident for other age groups they are much less marked. So fewer Australians are tending to own their home at retirement. For Australians nearing retirement, for example, age groups 50–54, 55–59, and 60–64, home ownership rates peaked in 1996 at 80%, 82% and 83%, respectively Since 1996 however, there has been a gradual decline in home ownership rates, most notably in the 50–54 age group which has seen a 6.6 percentage point fall over these 20 years (from 80.3% to 73.7%). This is one reason why we are watching closely our “Down Trader” segment – people seeking to sell and release capital. There are 1.2 million in this state, compared with around 600,000 up Traders, and 150,000 first time buyers. So on simple supply demand logic, more people selling than buying means prices will fall further.

And on that note, CoreLogic said that the weighted average clearance rate has tracked below 60 per cent for 8 consecutive weeks now, while over the same 8-week period last year clearance rates were tracking within the low 70 to high 60 per cent range. Last week Melbourne’s final auction clearance rate fell to 57.2 per cent across a lower volume of auctions week-on-week with 791 held, down on the 941 auctions over the week prior when a higher 59.9 per cent cleared. In Sydney, less than half of the homes taken to auction sold last week. The city returned a final auction clearance rate of 49.7 per cent, down slightly on the 50.1 per cent the previous week, with volumes across the city remaining relatively steady over the week with a total of 634 held. All of the remaining auction markets saw a lower volume of auctions last week, with the final clearance rate across each market also falling week-on-week.  There were also a large number of passed in auctions.

Gerard Minack from Minack Advisors said this week that the housing market looks ‘thin’, hinting that prices may be unusually sensitive to a change in demand. Historically housing market turnover tracked price growth. However, turnover has been soft relative to price gains over the past 3-4 years, and in the March 2018 quarter turnover fell to the lowest level since the 1990 recession.

There are still many economists talking of just a small slide in prices over the next few months, but we suspect they are underestimating the impact of tighter credit. For example, Macquarie suggested from their annual mystery shopping survey mortgage power – the amount people could get when applying for a mortgage had not dropped that much at all. But in fact, it seems the non-banks, those not under so much scrutiny from APRA is where the bigger loans reside.

Whereas UBS, the arch property bears, suggest that credit tightening will continue, as lending flows ease, saying one of the key recommendations of the Royal Commission is likely to be a stricter interpretation of Responsible Lending. In particular “reasonable steps” required to verify customers’ financial positions. This is likely to require credit licensees (banks and non banks) to verify living expenses from customers’ transaction banking and credit card data over a period of around 12 months. They go to say that as ANZ stated in its submission to the Royal Commission, verifying living expenses from transaction accounts and credit cards is operationally complex and will likely require substantial investment in technology to automate this process. So UBS believes that while the major banks will be able to absorb these costs, such technological investments may be prohibitive for many of the smaller players. Therefore, they believe that any potential regulatory mismatch benefiting the smaller banks and non-banks is unlikely to be sustainable. In other words, credit will be tighter soon, driving prices lower.

The Corelogic’s Housing Index showed that prices slipped again last week in Sydney, down 0.13%, Melbourne down 0.11%, Adelaide down 0.01% and Perth down 0.07%.  Brisbane rose 0.02%. On a 12 month basis, Sydney on average has dropped 4.69%, while Perth has fallen 2.08%. The other centres have risen just a little. But it is worth remembering that Sydney prices are still 66% from the last trough, Melbourne 56%, Brisbane 21% and Adelaide 19%. Perth is only 0.4% higher, thanks to the prevailing weak economic conditions in the West. This weakness also has translated into rental rates, with Perth seeing just a 3% rise over the past 10 years for houses, and a small fall for units. Compare this with a national rise in rentals over the same period of 25.7%. At the other end of spectrum rentals rose 53.8% for Hobart houses, and 44.7% for units, highlighting the housing cost pressure there.

Despite the falls in property values, and the expected future further falls, the AFR said Labor has shrugged off suggestions from the property industry that its planned changes to negative gearing rules should be scrapped because of market conditions. They reported that Shadow treasurer Chris Bowen told a Property Council of Australia forum in June the changes were about making long-term structural adjustments, rather than addressing the short-term cycle. The policy was a once in a generation reform. We think he is right.

The Royal Commission in Darwin this week heard about the thousands of Aboriginal people who are sold unsuitable financial products and vulnerable consumers are targeted by instant cash loan machines because the financial landscape supports predatory practices. Insurance agents were able to exploit and target Aboriginal people because the industry isn’t fully regulated. An excellent The Conversation Article made the point that the cultural, economic and political arrangements that allow this to happen are called “practice architectures”. They include the complex language used to deceive consumers into buying unsuitable products, incentivised high pressures sales tactics, and a lack of care and concern for vulnerable consumers. All of these aspects are within the scope of financial regulators. The funeral insurance industry can push dodgy products because no one is watching. Predatory financial practices will continue until governments and/or regulators do something about it.

More evidence of regulators not doing their job, and the financial sector simply exploiting their customers to make a quick buck.

We heard this week that ASIC has accepted court enforceable undertakings from the Commonwealth Bank of Australia and Australia and New Zealand Banking Group under which the banks have agreed to change the way they distribute superannuation products to their customers. ASIC investigated CBA’s distribution of its Essential Super product and ANZ’s distribution of its Smart Choice Super and Pension product through bank branches. ASIC found a common practice of offering those products to customers at the conclusion of a fact-finding process about customers’ overall banking arrangements. ASIC was concerned that customers may have thought, due to the proximity of the fact-finding process to the offer of Essential Super or Smart Choice Super, that the CBA branch staff or the ANZ branch staff were considering risks specific to the customer when this was not the case. These court enforceable undertakings prevent CBA from distributing Essential Super in conjunction with a Financial Health Check and ANZ from distributing Smart Choice Super in conjunction with an A-Z Review. They also require CBA and ANZ to each make a $1.25 million community benefit payment. If there is a breach of the undertaking ASIC can, under the ASIC Act, apply for orders from the court to enforce compliance.  But whilst individuals risk being sent to prison as one Perth finance  broker, did this week, or permanently banned from the finance industry for loan fraud, the asymmetric penalties  between the small guys and the big firms is – well shameful.  It seems to me regulators are going for the easy targets who cannot fight back, whilst imposing mild penalties on the big guys, for fear of court proceedings. The balance is just wrong.

Finally, looking across the markets, shares in Australia started the new financial year well, with most banking stocks going higher. Bendigo Bank was up 1.72%, Suncorp up 0.54% and even the languishing Bank of Queensland rose 0.77%. Westpac was up 0.85%, ANZ up 1.97% on its buybacks, NAB up 1.6% and CBA up 1.2%, though still below its peak in 2017 when it was above $82. So risks in the mortgage book are clearly not worrying investors that much just now. This despite the 90-Day mortgage default rates going higher as reported in the S&P Ratings SPIN Index. Macquarie, who has more business offshore than on shore rose 0.42%, at 122.96, just off its all-time highs, The ASX 200 ended higher up 0.91% to 6,272, a solid rise. The Aussie Dollar did a little better too against the US Dollar settling at 74 cents, up 0.57% and against the Chinese Yuan up 0.7% to $4.94.

Now back to global debt. Deutsche Bank published a chart which showed that of the $50 trillion global bond market, about $8 Trillion of these bonds are now trading at negative interest rates, thanks to changes in interest rates across the market. Within the $50 trillion, the amount of nonfinancial corporate bonds has increased 2.7 times over the past decade to $11.7 trillion, according to Mckinsey. Debt in China has outgrown that in the USA, based on GDP, with non-financial corporate debt in China sitting at 160% of GDP, compared with 97% in the USA, according to JP Morgan. The China credit boom, is well, booming…

This all signals more trouble ahead, given that the US 3 Month bond rate and LIBOR are sitting at highs, and the 10 Year US Bond Rate remains elevated, reflecting the expectation of more FED rate hikes ahead.  And the latest from the FED is that further rate rises are required, and expected.

U.S. stocks finished the week mostly higher, thanks mainly to low-volumes of buyers on Friday. The S&P 500 finished the week up about 1.5% and the Dow ended about 0.8% higher for the week. The big winner was the tech-heavy NASDAQ Composite, which closed up about 2.4% for the week. The DOW ended the week up 0.41% to 24,456 after light holiday trading.

US employment data showed still-solid growth in payrolls, but lower-than-expected wages, which eased inflation concerns. Nonfarm payrolls rose by 213,000 in June. That was higher than the consensus estimates of 200,000. The jobless rate unexpectedly rose to 4.0% from 3.8%, missing consensus expectations for it to remain unchanged as more people entered the labor force. Average hourly earnings advanced 0.2% month-on-month in June, below expectations. The data still suggests the Federal Reserve will gradually raise interest rates. The markets are still pricing in two more rate hikes this year.

The real unknown though is the U.S, China Trade Battle which is now officially underway. The U.S. has put tariffs in place on $34 billion worth of Chinese goods and the Chinese hit right back with tariffs on $34 billion on U.S. goods going into effect. China said the U.S. had “launched the largest trade war in economic history to date.” And the U.S. administration is already looking at ramping up the amount of tariffed goods, threatening another 16 billion dollars in two weeks, and then more later. No one knows where this will lead. But there are risks for Australia and other countries getting caught in the cross-fire.

The U.S. dollar endured a tough week that was not helped by the mixed jobs numbers that offered little encouragement for traders looking for faster Fed hikes. The dollar index, which compares the greenback to a basket of six currencies, was down about 0.7% for the week. The dollar also faced pressure from the euro during the week. German Chancellor Angela Merkel resolved an immigration battle and with her interior minister that had threatened the future of her coalition government.

Oil continued higher through the week, as supply limits kicked in, up 1.33% to 73.91, and Gold fell again, down 0.23% as risks abated.

And finally, Bitcoin recovered a little to 6,615 but remains volatile, while the broader VIX index sits slightly above the lows seen last year, but below the peak of a few months back.

So it seems that investors are banking on the debt elastic not snapping back anytime soon, but we will be watching for further signs of stress given the massive amount owing out there as rates rise. Meantime banks are making hay, despite the levels of uncertainly out there.  As the BIS report put it “A key takeaway is that, while a low-for-long scenario presents considerable solvency risk for insurance companies and pension funds and limited risk for banks, a snapback would alter the balance of vulnerabilities,”. We have been warned.

Before I sign off, mark your diary. On the 17th July at 8 PM Sydney time I will be running our next live streaming session, where you can discuss in real time the issues in play. Judging by the previous session, it will be a lively event. I will schedule it shortly on our YouTube channel.

When Will The “Debt Elastic” Ping Back? – The Property Imperative Weekly 7th July 2018

The latest edition of our weekly summary of property and finance news, with a distinctively Australian flavour.

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When Will The "Debt Elastic" Ping Back? - The Property Imperative Weekly 7th July 2018
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A Year In A Day – The Property Imperative Weekly 30 June 2018

Welcome to the Property Imperative weekly to 30th June 2018, our digest of the latest finance and property news with a distinctively Australian flavour.

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

On the global stage, U.S. stocks were met with heavy selling pressure this week as the trade war hotted up. While earlier in the week, Donald Trump decided against imposing measures to restrict Chinese investment in U.S. based technology, the market is still reacting to the initial U.S. and Chinese tariffs which are coming into effect next week. In the world of bricks and click, Amazon was back in the headlines after the e-commerce giant announced its entry into the pharmacy sector with the purchase of Pillpoint. This triggering widespread panic, sending shares of brick-and-mortar drug stores sharply lower. Nike, meanwhile, showed improved results after revealing its first positive North America sales number in over a year. The S&P 500 closed 0.08% higher to close 2,718.37.

Boomberg says a leaked report from a Chinese government-backed think tank has warned of a potential “financial panic” in the world’s second-largest economy, a sign that some members of the nation’s policy elite are growing concerned as market turbulence and trade tensions increase.    Bond defaults, liquidity shortages and the recent plunge in financial markets pose particular dangers at a time of rising US interest rates and a trade spat with Washington, according to a study by the National Institution for Finance & Development The think tank warned that leveraged purchases of shares have reached levels last seen in 2015 – when a market crash erased $US5 trillion of value.     “We think China is currently very likely to see a financial panic,” NIFD said in the study, which appeared briefly on the internet on Monday, before being removed. “Preventing its occurrence and spread should be the top priority for our financial and macroeconomic regulators over the next few years.” The Australian dollar fell against the Chinese yuan from March to early May.

The China effect is on top of damming criticism of Central Bank’s policy by the Bank For International Settlements, which we discussed in our post “Red Alert From The Bankers’ Banker”. They say, economies are trapped in a series of boom-bust boom-bust cycles which are driving neutral interest rates ever lower and driving debt higher. The bigger the debt the worse the potential impact will be should rates rise (as they are thanks to the FED). Yet in each cycle “natural” interest rates are driven lower. Implicitly the current settings are wrong. This was in the Bank for International Settlements latest annual report. They also discussed how banks are fudging their ratios using Repo’s  in our post “Are Some Banks Cooking the Books?” Within its 114 pages, the BIS report painted a worrying picture of where the global economy stands. In fact, the risks in the global monetary system remain from the Lehman crisis in 2008 and aggregate debt ratios are almost 40 percentage points of GDP higher than a decade ago.

Crude oil prices were strongly up, their highest since November 2014 extending a rally for a fourth-straight week as focus shifted to the prospect of deeper losses of Iranian crude supplies as the U.S. threatened sanctions on countries that fail to halt Iranian crude imports by Nov. 4. Then there were unexpected disruptions in Canada, Libya and Venezuela, together curbing supply and in addition, U.S. crude supplies fell by 9.9 million barrels. Crude futures settled 65 cents higher on Friday as data showed U.S. oil rigs counts fell for the second straight week, pointing to signs of tightening domestic output.

The US dollar was roughly unchanged for the week as heavy selling pressure on Friday reversed earlier gain after the euro rallied sharply on news of EU members agreeing on measures to tackle the migrant crises in the EU including stepping up border security and setting up holding centers to handle asylum seekers. A signal of easing political uncertainty within the bloc sent the EUR/USD sharply higher, to $1.1677, up 0.94%. The US dollar fell 0.82% to 94.22 against a basket of major currencies on Friday.

Gold tumbled further again this week and suffered its biggest monthly slump since September as investors preferred the US$. This was partly because the FED indicated they were comfortable with inflation running above the inflation target over the near-term, in reaction to the news that inflation hit the Fed’s 2% target for the first time since May 2012, raising the prospect of a faster pace of rate hikes.

And the crypto crunch continues. Bitcoin for example went below $6,000 and it could go lower still. No one is sure where the firm base is, so expect more volatility ahead.

And talking of volatility the COBE VIX index ended the week at 16.09, having been higher earlier in the week, up from the 10-12 range seen earlier in the year, but well below the peaks seen in February. As an indicator of perceived risk, this suggests there are more in the system than last year.

Locally the Australian Dollar ended at 74 cents, and the trend down since February is striking, perhaps mirroring rising UD Bond rates, higher capital market interest rates, and the Financial Services Royal Commission which recommenced this week in Brisbane with a focus on country’s $50 billion farm sector and farm finance, 70% of which resides in Queensland, New South Wales and Victoria. And it was more really bad news for the banks, who again demonstrated poor practice, and in some cases deception. But this is a complex area, with farmers sensitive to weather extremes, global commodity prices, and changing land prices. And players such as liquidators seemed to profit from the failure of farmers, despite selling land and equipment well below value. They are not in scope for the Royal Commission, but we think they should be.  There is clearly a case for ASIC to take a more hands-on role in farm finance as some rural lenders, such as the non-bank ones, are not covered by existing complaints-handling systems. But overall, this is another example of poor culture in the banking industry, and players including ANZ and CBA are under the microscope. The findings were so damming that the Commission decided to spend more time looking at farming case studies.  For bank-originating farm debt, some lenders changed loan contract terms for farm businesses that were late with payments or in default without warning or explanation. More broadly, the Commission heard about declining access to banking services for the 6.9 million Australians in rural areas, the inflexibility of lenders toward farm-specific challenges like weather, trade disputes, and lack of customized regulations for the sector.

The latest credit data from APRA and RBA, out yesterday, showed that May credit slowed sharply to equal a 6-year low of 0.2% m/m, and a 4-year low of 4.8% y/y. We discussed this in our post “May Credit Snapshot Tells the Story”.

As UBS highlights, private credit growth has weakened more quickly than expected to only 0.2% m/m, the equal weakest since 2012; also dragging the y/y to an equal 4-year low of 4.8% (after 5.1%). Also, total deposits growth collapsed in recent months to only 2.4% y/y, the weakest since the last recession in 1991. Meanwhile, the household debt-to-income ratio lifted to a record high of 190% in Q1- 18. However, mainly due to falling house prices, household wealth declined by 0.4% q/q, the largest fall since 2011. While this followed a surge to a record high level of $10.3 trillion in Q4-17, the change in wealth drives the household saving ratio, consistent with a fading ‘household wealth effect’ dragging consumption ahead. They say this will spill over and an ~8-10% fall in new car sales volumes is a strong possibility, Further evidence of the second order impacts.

Housing auction clearance rates slid to a ~6-year low of ~54%, housing credit growth eased to a >4- year low dragged by investors slumping to a record low, while industry data on owner occupier home loans suggests this also started to drop in May; while home prices are falling the most since 2012. Macroprudential policy is reducing borrowing capacity and leading to a clear weakening of housing, which will continue ahead.

CoreLogic says last week, 1,849 auctions were held across the combined capital cities, returning a final clearance rate of 55.5 per cent, increasing from the previous week when 52.4 per cent of the 2,002 auctions held were successful, the lowest clearance rate seen since late 2012. This time last year, the clearance rate was 66.5 per cent across 2,355 auctions.

Melbourne’s final clearance rate was recorded at 59.9 compared with a clearance rate of 70.7 per last year. Sydney’s final auction clearance rate was 50.1 per cent compared with a clearance rate of 68.2 per cent last year. Across the smaller auction markets, clearance rates improved everywhere except Tasmania, however only 3 auctions were held there over the week. Of the non-capital city auction markets, Geelong returned the highest final clearance rate, with a success rate of 71.4 per cent across 26 auctions.

This week they expect to see a lower volume of auctions this week with CoreLogic currently tracking 1,557 auctions, down from 1,849 last week.

Home prices are falling with the CoreLogic 5-city daily dwelling price index, which covers the five major capital city markets, declined another 0.15%. So far in June home values have fallen 0.24%, driven by Melbourne, Sydney and Perth. So far in 2018, home values have declined by 1.72%, with only Brisbane and Adelaide recording a value increase. Over the past 12 months, home values have fallen by 1.72%, driven by Sydney and Perth. Despite the continuing falls. values are now up 36.2% since the 2010 peak at the 5-city level, driven overwhelmingly by exceptionally strong gains in Sydney at 60.2% followed by Melbourne 42.6% and Adelaide 9.8%. Brisbane is 8.3% and Perth is down 11.4% This is before inflation adjustments, which means in real terms only Sydney and Melbourne prices are ahead.

We see more banks lifting rates on the back of the higher BBSW and LIBOR rates. For example, effective Friday 3 July, ING in Australia said it was making changes to variable rates for existing owner occupier home loan customers. This means interest rates for existing residential home loan customers will increase by 0.10%.

Bank of Queensland announced the variable home loan rate for owner occupiers (principal and interest repayments) will increase by 0.09 per cent, per annum; variable home loan rate for owner occupiers (interest only repayments) will increase by 0.15 per cent, per annum; variable home loan rate for investors (principal and interest and interest only repayments) will increase by 0.15 per cent, per annum; and Owner occupier and investor Lines of Credit will increase by 0.10 per cent, per annum. Anthony Rose, Acting Group Executive, Retail Banking said today’s announcement is largely due to the increased cost of funding. “Funding costs have significantly risen since February this year and have primarily been driven by an increase in 30 and 90 day BBSW rates, along with elevated competition for term deposits.

This just extends the list of players lifting rates, and we think more will follow. So it was interesting to see Bendigo Bank chairman Robert Johanson saying that he believes the RBA has waited too long to move rates. “They’ve been trying to do too much work with monetary policy,” he told Banking Day. “I’m concerned that apart from the impact we’ve already seen on asset values, mortgage rates are going to break from the official cycle and will do so in a disruptive way.” The funding pressures on lenders are emerging at an awkward time for the Turnbull Government, which is required to call a federal election within the next 12 months. A series of out-of-cycle increases across the industry could induce a blistering political response from government politicians who are cognizant of the historical links between election outcomes and mortgage rate rises. Even small hikes would create significant pain as a piece on Nine News, using our mortgage stress data explained.

I discussed the current situation with Economist John Adams this week in an extended interview – see Australia’s Debt Bomb. I recommend this post as we go through the critical issues are how it may play out.

Finally, as we hit the end of the financial year, it’s worth reflecting on the highlights and lowlights of the past year. It has been a bit of a roller coaster, but those with shares invested direct, or via superfunds will have done well, again – as in 9 of the past 10 years has proved to be.  We suspect the next 12 months will be less positive, as rising interest rates, trade wars and political tensions all mount. We also have an election ahead, which will also potentially create waves.  Trade wars is the area to watch. Our dollar has been sliding through the year, and this is likely to continue next year as we struggle with GDP growth in this volatile environment.

Corporate profits have been growing fast, as companies cut costs and rationalise their businesses and this has translated to higher dividends – and about half have come from the financial services sector overall.  Banks will be hard pressed to maintain their dividends ahead, as lending growth slows, pressure on their culture continues thanks to the Royal Commission and regulators exercising their muscles. And the greatest of these is mortgage lending growth which we think will continue to languish. Provisions, which were cut this year, may need to rise ahead as 90 days plus default rates are rising, as wages and cost pressure hit home.  Remember also the next round of penalty rate reductions for 700,000 workers in across sectors such as retail will cut pay by 10% comes in 1 July.

Property has done less well, despite being well up over the past year, in that the recent monthly trends are signalling a fall. In some states we will end the year well up, for example Hobart, Adelaide and Melbourne, in others less well. We expect more falls ahead because prices are most strongly linked to credit supply, which is being throttled back. Most centres will be impacted as investors tread water and foreign buyer momentum slows. This might be good news for first time buyers who have been enticed back into the market, partly thanks to recent FTB incentives. We are bearish on the property sector next financial year.

Those needing to get income from savings and deposit accounts have had a torrid time, as banks have cut, and cut again their returns on savings. Many are getting less than inflation, so their hard earned cash has taken a hit. This is likely to continue, despite banks lifting mortgage rates as international funding pressure continues to bite in the months ahead. Households continue to be taxed on their savings at their marginal rate, while those with property get massive tax breaks. If Labor does win the next election, this is set for a shake up!

So overall a mixed year, with some highs and lows, and we think next year will be no different, only more so. Credit trajectory is the one to watch.

The Calm Before The Storm – The Property Imperative Weekly – 23 June 2018

Welcome to the Property Imperative weekly to 23th June 2018, our digest of the latest finance and property news with a distinctively Australian flavour.

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

There is something weird going on at the moment. This week bank stocks rose significantly, with CBA up 1.2% on Friday as the AUSTRAC issue was finally put to be in court; Westpac up 1%, NAB up 1.2% and ANZ up a massive 2.8% as the bank announced a further stock buyback. The banks comprise more than a quarter of our market, so no surprise the ASX 200 went higher in the week, though fell back slightly by Friday, reflecting further concerns about the escalating trade wars. Potentially traders closing out their positions, the end of the financial year have driven prices higher but next week a number of key stocks go ex-dividend, suggesting this we may have seen the top.  The lower Aussie dollar may also be helping, (expect it to continue to fall) as it makes Australian stocks cheaper on an international basis, and yields are still pretty good, representing better value to investors than many emerging markets which are entering a difficult phase.

But scratch below the surface and things look less certain. For example, APRA’s March 2018 property exposure data showed a significant fall in investment lending, and a massive fall in interest only loans, at 16%, dropping the stock of loans by $93 billion, plus more loans are being approved outside normal serviceability criteria, and lending standards tighten. We discuss this in more detail in our post “The State of Mortgage Lending In Three Slides”.  Remember that our analysis shows that around $120 billion of interest only loans will require refinancing each year for the next few years, and many – around 20% – won’t pass muster, meaning they have to switch to more expensive loans, or sell.  ABC’s 7:30 did a segment on IO Loans this week.

As UBS put it, the data signals the “end of the beginning of the housing market correction” and the risks of a credit crunch is rising. Mortgage underwriting standards continue to tighten, as lenders finally comply with the existing legalisation and guidelines, the Royal Commission will not necessarily need to recommend tighter rules, the question in our view is compliance with the existing ones – APRA please note!

UBS also made the point that Debt To Income has been in focus since APRA directed ADI’s to develop “internal risk appetite limits on the proportion of new lending at very high DTI levels [>6x], and policy limits on maximum DTI levels for individual borrowers” in April 2018. Prior to this, DTI was not a focus, largely because neither APRA nor the banks had reliable data available. However, that will soon change with the introduction of Comprehensive Credit Reporting (CCR – the first phase of Open Banking) expected on July 1 2018. They conclude that If APRA does decide to impose a hard cap on loans to customers with a DTI > 6x we should expect a further tightening in credit availability.

Morgan Stanley discussed what they call Macroprudential 3.0 saying that this is consistent with international trends restricting consumer leverage in a low interest rate environment.  They say the adoption of DTI limits provides a further restriction and may become a binding constraint for customers who have very low assumed living expenses or purchased multiple investment properties. The sustainability of Sydney house prices at >9x median income and Melbourne at ~8x median income become problematic when borrowing limits are restricted to 6x income. A 6x DTI limit assuming a 20% deposit would put the median Sydney house out of range for the median buyer.

The ABS home price data confirmed falls in the major centres. We discussed this in our post “Property Prices are Officially falling”. You can watch our video on this, or listen to our podcast, (our podcasts by the way are being well received, judging by the number of listens).  As the ABS said “Sydney recorded the third consecutive quarter of falling property prices down 1.2 per cent and the first annual price fall down 0.5 per cent since the March quarter 2012, while Melbourne property prices fell 0.6 per cent, the first quarterly price fall since September quarter 2012”. We also contributed to a piece on ABC’s The Business, discussing the future outlook for prices.

More recent data from CoreLogic continues to confirm falls, with weekly drops in Sydney, Melbourne, Brisbane and rises in Adelaide and Perth. But of course, Sydney prices on average are still up 66.8% from their previous lows, Melbourne 56.3% Brisbane 20.9%, Adelaide 18.9% and Perth 0.9%. This suggests that further falls in the eastern states are likely as credit dries up. And elsewhere CoreLogic made the point that more property is being listed, its taking longer to sell, and it has become a buyers’ market saying “Overall as the housing market is slowing, the number of properties for sale is climbing in Sydney and Melbourne, providing for less urgency amongst buyers and more time to negotiate. As stock levels rise, buyers become more empowered and vendors may need to rethink their pricing expectations and marketing strategies.”

SQM research also released this week showed that rental vacancies decreased over the year in Adelaide down 0.4%, Perth down -1.0%, Brisbane down 0.6% and Canberra down 0.2%, but significantly, increases were recorded in Sydney up 0.8%, Darwin up 0.2% and Hobart up 0.2%, and Melbourne’s vacancy rate was flat. Annual asking rents are rising faster than incomes in Melbourne, Canberra and Hobart, while weak or falling asking rents were recorded in Sydney, Adelaide, Brisbane, Perth and Darwin. SQM said “there are considerably more vacancies in Sydney now compared to a year ago, so landlords have lowered their asking rents slightly, which is favouring renters”.  More pressure on investors then.

Macquarie said that they expect the current modest rate of decline in national dwelling prices to continue for some time, but they suggest a fall of only around 2% over the course of 2018. Over the next couple of years, they expect national prices to have fallen 4-6% from the peak, with Sydney prices forecast to be down around 10% from the mid-2017 peak. Australia has had six previous episodes of declining housing prices since 1980, with the peak-to-trough range of 2.5% to 8%. Nearly all previous corrections occurred following interest rate rises, a drag unlikely to be repeated anytime soon in this cycle. To which I reply, credit tightening is continuing and the BBSW rate is rising, so past performance may not be helpful here.

ANZ also opined on home prices. We now expect to see peak-to-trough price declines of around 10 per cent in Sydney and Melbourne, with smaller declines elsewhere. This cycle is being driven by tighter credit, rather than higher interest rates. Exactly. Sydney and Melbourne are expected to be the primary drivers of this fall, as their high prices and highly leveraged households will be more sensitive to tighter credit conditions and rising interest rates.

It’s also worth noting here the heroic assumptions in the NSW state budget which was out this week, and included a projection of future stronger auction clearance rates, after a small blip. Lower stamp duty flows will lead to a shortfall, as Moody’s observed when they said “NSW is projecting average revenue growth of 2.5% from fiscal 2019 to 2022, reflecting a drop in growth for transfer duties, particularly from housing, where the state forecasts that residential turnover will drop around 8% in fiscal 2019 and price growth will moderate. Additionally, at 2.5%, average revenue growth is expected to fall below the average expenditure growth of 3.2%. This imbalance would lead to growth in debt over the forecast period, challenging NSW’s credit profile”. So recovering home prices, and interest rate cuts are required to bring this home. As I say, heroic!

There was some interesting commentary on the ever rising benchmark Bank Bill Swap Rate (BBSW). The AFR reported that Nomura rates strategist Andrew Ticehurst, observed that multinationals outside the US are holding fewer US dollars and there is a global dimension to this starting with the US”.  Tamar Hamlyn, portfolio manager at fixed income boutique Ardea said “There’s nothing to suggest that it’s sinister just yet, we expect these things to be high as we get to quarter-end as the historical pattern shows,”. But we suspect its more about rising concerns in the risk profile of the banks, as the spread movements are larger here than in other countries.  This will put pressure on bank margins, and may force them to lift mortgage prices, or further trim rates on deposits.  Oh, and commendatory this week from the RBA suggests that official rates are not going anywhere, despite the fact that the latest minutes omitted the oft repeated clause that the next move will be up.

The FED released their stress testing of major US banks, and gave them a clean bill of health, though in our separate post “Testing, Testing..” we discussed the limitations of their approach.  First, losses from trading and counter-party losses were estimated at only $133 billion US dollars, stemming from 9 institutions, including $17.3 billion from Bank of America Corporation, $16.3 billion from Citigroup, $13.3 billion from Goldman Sachs, $29.4 billion from JP Morgan $29.4 billion, Morgan Stanley $11.7 billion and $12.2 billion from Wells Fargo. These estimate of losses are calibrated based on historical performance, but given the massive size of the derivatives market, this is just a best guess. We discussed the size and shape of the derivatives market recently in the $37 trillion dollar black hole post. Second, it’s hard to estimate the potential impact of contagion and freezing of the markets as happened into 2007, as each bank is modelled separately. This begs the question as to whether the system level modelling is robust enough. Especially if one major counter-party fell over during a crisis. 2007 showed the problem when trust across the markets falls, and margins widen significantly. Third the assumptions are that things will revert to normal conditions in a few years – suggesting this is a “blip type crises.” Some of the smaller banks may have performed better in the tests than they would in the real world. But the bottom line, according to the FED is that the banks can stand on their own two feet in the mother of all crises, so not excuse for any bail-out then… We will see.

Looking more broadly across the global markets, the trade war continues to threaten, leaving the major U.S. indexes nursing a weekly loss. The U.S. and China exchanged a fresh volley of trade threats, scaling back investor appetite for risker assets amid fears of a tit-for-tat trade war between the world’s two largest economies. This is in my view now getting quite serious.

However, trade war concerns failed to stem demand for tech stocks as major tech blue chips such as Facebook, Netflix and Google rallied sharply, helping the Nasdaq close at a record high this week. This despite internet retailers like eBay and Amazon coming under pressure after the U.S. Supreme Court overturned the Quill ruling, allowing states and local governments to start collecting sales taxes from internet retailers. The S&P 500 posted a weekly loss despite closing 0.25% higher Friday at 2,759.50.

OPEC agreed Friday to a modest increase in output, sending crude oil prices soaring on expectations that the fresh supply into the market would be curbed as some countries lack the capacity to raise output. OPEC said it wanted countries –part of the production cut agreement – to increase production, returning to 100% compliance with agreed quotas by 1 July 2018. Analysts said the agreement would equate to increase in production of about 600,000 barrels a day as numerous countries in the accord aren’t capable of increasing production. Crude prices were also supported by a mixed U.S. inventory report as domestic crude supplies fell for the second straight week while crude products such as gasoline and distillate increased by more than analysts had forecast. Crude futures settled 4.64% higher at $68.58 higher on Friday.

The dollar ended the week lower as trade war concerns flared up, stoking demand for safe-haven yen, while a rebound in the euro on mostly positive economic data also weighed on sentiment. EUR/USD rebounded from an 11-month low seen Thursday, prompting traders to flee the greenback despite lingering concerns over Italian political uncertainty and lower-for-longer interest rates in the Eurozone. The dollar’s sluggish end to the week comes just days after its rise to fresh 2018 highs was met by a wave of resistance despite expectations that a more hawkish Federal Reserve would provide further room for upside in the greenback. “The divergence between U.S. and rest of the world monetary policy will support longer and greater USD strength than we had anticipated,” Barclays said earlier this week in a note to clients. The dollar was also held back by yen strength supported by rising trade tensions between the U.S. and China. The dollar fell 0.36% to 94.20 against basket of major currencies on Friday.

Gold prices bounced from fresh 2018 lows this week but remained under pressure struggling to take advantage of a weaker dollar and rising safe-haven demand as sentiment on the yellow metal waned. Fearing a faster pace of Federal Reserve rate hikes, investors have shunned the yellow metal even as safe-haven demand grows on the back of an ongoing trade spat between the U.S. and China.

Fresh selling was seen in Bitcoin on Friday, as the crypto hit its lowest level since February after Japan’s regulatory crackdown on the industry triggered a selloff. Japan’s largest crypto exchange, bitFlyer, suspended the creation of new accounts after Japan’s Financial Services Agency ordered several cryptocurrency exchanges to step up their efforts to combat money laundering. That sent shockwaves through the crypto industry amid fears other crypto exchanges in Japan could also be forced to scale back operations as they seek to beef up their practices. As Japan is the largest market for bitcoin trading, the threat of a reduction in fresh fund inflows, sparked selling across cryptos, wiping more than $20 billion from the crypto market in under 24 hours. The total crypto market cap fell to about $261 billion, from about $289 billion Thursday. Bitcoin was down to 6,015, down 10%. Again highlighting the volatility of the sector.

So, to conclude, while many of the major indicators were higher, this could well be the calm before the storm, as below the hood, the data does not lie. Locally, the tighter credit supply will spill over to lower home prices, and as the next round of the Royal Commission starts next week, we think the banks will be back in the spotlight, but not in a good way.

The Nasty Cocktail; And Who’s Drinking – The Property Imperative Weekly – 16 June 2018

Welcome to the Property Imperative weekly to 16th June 2018, our digest of the latest finance and property news with a distinctively Australian flavour.

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

We start with the international markets, because familiar market foes returned this week as the U.S. and China vowed to move ahead with trade tariffs. China ignored U.S. President Donald Trump’s threat of further tariffs in the event of retaliation, vowing to immediately impose penalties of the “same scale” on American goods, raising the prospect of a tit-for-tat trade war between the world’s two largest economies.

The Fed rate hike on Wednesday was accompanied by a more hawkish outlook on rate hikes. The U.S. central bank hinted at the prospect of two additional rate hikes this year, taking the expected total rate hikes for 2018 to four from three previously. The odds of a fourth rate hike at the Fed’s December meeting has soared to 51.1% from 33.8% the previous week. While the prospect of a faster pace of US monetary policy tightening also weighed on sentiment, that didn’t stop US stocks from notching a third-straight weekly win as a rally in tech and media stocks underpinned investor demand.  The VIX volatility index, which signals the relative uncertainty in the market, was down again, from its peak a few weeks ago.

The U.S. District Court ruled in favour of the AT&T and Time Warner merger earlier this week, sparking a wave of action in media stocks and a day after the ruling, Comcast launched a $65 billion bid for Twenty-First Century Fox assets that Walt Disney had already struck a deal to buy, setting the stage for perhaps an intense bidding war. The S&P 500 posted a weekly win despite closing 0.25% lower Friday at 2,781.50 reacting to the escalating trade wars.

Crude oil prices settled sharply lower on Friday on concerns that OPEC would lift limits on production restrictions, paving the way for an uptick in global output, threatening the pace of rebalancing in oil markets. Investor fears that OPEC and its allies would hike output at its June 22 meeting came to the fore this week amid remarks from both Russia’s and Saudi Arabia’s Energy Ministers. Both agreed to gradually increase production. Crude futures settled 2.74% lower on Friday as data showed U.S. oil rigs continued to climb.

The US dollar closed at year-to-date highs against its rivals despite a modest setback on Friday, as a sharp tumble in the euro earlier this week encouraged traders to pile into the greenback. The euro suffered its worst daily loss in two years on Thursday after the European Central Bank said that it would leave interest rates unchanged until the summer of 2019, although they will taper down QE through this year. That came a day after the Federal Reserve had signalled a faster pace of rate hikes for this year and the next, further encouraging investor appetite for the greenback. The dollar fell 0.16% to 94.79 against a basket of major currencies on Friday. The Aussie Dollar slipped against the US Dollar, which signals a risk of importing inflation into Australia and risks to the local economy.

Gold prices fell to 2018 lows on Friday as traders appeared to unwind their holdings of gold despite the growing prospect of a trade war between the U.S. and China.  That, however, failed to lift demand for safe-haven gold amid expectations the dollar will continue its upside momentum.

And crypto currencies slid this week, wiping more than $60 billion from the market, as bitcoin fell to a near four-month low before staging a timid rebound. Bitcoin started the week on the back foot after South Korean crypto exchange Coinrail confirmed in a tweet that cyber thieves had made off with over $30 million worth of lesser-known cryptocurrencies following a successful cyberattack. That proved to be touch paper for further selloffs as the popular crypto fell close to a four-month low of $6,125.7, rattling traders’ appetite to hold cryptos as billions of dollars were pulled from the market.

The total crypto market cap fell to about $282 billion, from about $342 billion a week ago. Over the past seven days, Bitcoin fell 18.67%, Ethereum fell 14.04%, while Ripple XRP fell 19.29%. More evidence, if you needed it that crypto is not a stable currency alternative.

But risks lurk in the dark corners, according to Fitch Ratings. Global trade tensions have risen significantly this year, but at this stage they say the scale of tariffs imposed remains too small to materially affect the global growth outlook. A major escalation that entailed blanket across-the-board geographical tariffs on all trade flows between several major countries would be much more damaging.

In addition, populist political forces continue to create policy risk and increase the threat of rising tensions within the eurozone that could adversely affect the outlook for investment, a key driver of growth last year. Fitch made only a modest downward revision to their eurozone investment forecast for this year (to 3.3% from 3.9% in March), but a further escalation in uncertainty represents an important downside risk.

And a much sharper-than-anticipated pick-up in US inflation remains a key risk to the global outlook they said. The decline in US unemployment – to 3.8% in May – is becoming more important to watch, and they forecast the rate to hit a 66-year low of 3.4% in 2019. A wide array of indicators of US labour market tightness suggest it is now only a matter of time before sharper upward pressures on US wage growth start to be seen. They said that “An inflation shock in the US could bring forward adjustments in US and global bond yields and sharply increase volatility, harming risk appetite. In particular, it could lead to a rapid decompression of the term premium, which remains negative for US 10-year bond yields. In combination with a likely aggressive Fed response, this would be disruptive for global growth.

Indeed, the synchronised global economic growth that began in 2018 appears to be running its course, according to NAB.  ‘Synchronised global growth’ was a favoured expression by economists and research houses at the end of last year, with each of the 45 major economies tracking upward growth.

But according to the latest economic summary by NAB this global growth rate may have reached its peak. Growth in the major economies was 2.2 per cent year-on-year in the first quarter of 2018, a small drop from the 2.4 per cent growth in the last quarter of 2017. “Although this slowdown was modest, it points to a divergence in conditions across countries, which over recent years have displayed relatively synchronised growth.” In addition, many short- and long-term interest rates have started to increase, or will do so over the forecast period”.

Turning to the local scene, Moody’s confirmed Australia’s rating of Aaa, which puts us in an exclusive club alongside United States, Switzerland, Sweden, Norway, Denmark, Netherlands and New Zealand. They just reviewed the rating (some other agencies still have a negative watch on Australia, as they are more concerned about the outlook, given our exposure to foreign trade and debt) but Moody’s concluded that thanks to good GDP numbers, relatively low (on an international basis) Government debt – at only 42% of GDP, though up from 26.5% five years ago and our strong institutions (RBA and APRA), the rating is confirmed. The bonus income from higher resources prices also helped. They did highlight some concerns about the Government needing to control spending in order to bring the budget back into balance as forecast, against a fraught political background and also the risks from high levels of household debt in a flat wage environment.  They suggest that household income growth will be lower than government forecasts, but they are still looking for GDP growth around 2.75%. They also suggest that Government spending will remain under pressure given the expected 6% rise in social welfare programmes including health and NDIS. In terms of risks, they see two, first is rising household debt, which they say exposes the economy and government finances. Second is Australia’s reliance on overseas funding, which may be impacted by changes in international investor sentiment. Rate rises abroad might lift the cost of government and bank borrowing, adding extra pressure on the economy. But their judgement is these risks are not sufficient to dent the prized Aaa rating. So that’s OK then, except that…

S&P Global Ratings RMBS Performance Watch to 31st March 2018 said that the prime 30-day SPIN was 1.37% in Q1 2018, up from 1.07% the previous quarter. They say that loans more than 90 days in arrears were at a historically high level at the end of Q1, indicating that mortgage stress has increased for some borrowers. Western Australia meanwhile again recorded the nation’s highest arrears, at 2.71%. Arrears rose during Q1 in most parts of the country. And they warned of the consequences of higher interest rates ahead. You can grab our separate post “What the Rating Agencies Are Saying” for more details.

Our latest Household Financial Security Index showed a further fall dropping to 90.2, down from 91.7 last month. This is below the neutral setting of 100. Property-related sentiment is hitting hard, especially in New South Wales and Victoria where price falls are most evident. Younger households the budget pressure on them remains severe, especially those paying rent, or mortgages. Those entering the retirement phase, 60+ continue to wrestle with outstanding mortgages (many hold these loans into retirement now) and also lower returns from deposits. You can get the full results in our post “Household Financial Security Tanks In May, As Property Falls Hit Home”.

It’s worth putting this alongside the RBA comments this week on wages growth, which suggests that any lift from the current anaemic levels will be slow.  And real debt burdens will stay higher for longer in this scenario. Many people who borrowed expected their incomes to grow at something like the old rate rather than the current rate. With their expectations not being realised, the real value of the debt stays higher than they expected and this is likely to affect their spending decisions. And beyond these purely economic effects, the slow wages growth is diminishing our sense of shared prosperity. If this remains the case, it can make needed economic reforms more difficult.

Oh, and the employment data out this week superficially looked OK, with an increase in the total number of jobs, and a fall in the seasonally adjusted rate of employment from 5.6% last month to 5.4% in May.  But in fact we think this is another soft result, thanks to a slide in the number of hours worked, anaemic and falling jobs growth, a further shift to part time employment, and a rise in underemployment. The monthly trend unemployment rate remained steady at 5.5 per cent, well above the 5% level at which wage rises may kick in according to the bank. See more at our post “Unemployment Signals More Trouble Ahead”.  The trend participation rate decreased by less than 0.1 per cent to 65.5 per cent in May 2018.

The auction results last week were down again but hardly worth a mention, given the long weekend in many states. But the trend of slowing property continues to bite harder. CoreLogic once again have been looking at where prices are falling.  They say that across the combined capital cities, dwelling values have fallen 1.1% over the past 12 months. Looking at the 1st decile, values have increased by 1.3% over the past year while across the 10th decile values have fallen by -5.7%. Of note is that when values fall, declines across the most affordable properties have been significantly smaller than the declines across the most expensive properties. The opposite is generally the case during the growth phase, where the most expensive properties have generally outperformed the broader market.

Sydney has seen the largest declines of all capital cities over the past year with values -4.2% lower. Across the 1st decile, values are 1.0% higher while the 10th decile has recorded value falls of 7.3%. Over the past year, Melbourne dwelling values have increased by 2.2% with the 1st decile recording an increase of 10.3% while the 10th decile has seen value fall -3.5%.

This makes it clear that you need to get granular across the property market, something which we discussed in our interview with Buyers Agent Chris Curtis, last week. The full interview “Property Dispatches from The Front Line” is still available and I recommend it. This post hit top spot on both our blog and YouTube sites.   It seems that first time buyers are helping to support the market, though the latest figures show that total number of first time buyer loans in May fell by 8%.

Indeed, overall lending growth is slowing as the ABS data this week showed. They confirm the macro trends we already reported. Lending volume flows are solidly down, and the trends suggest more in the months ahead. We are entering a new phase in the credit cycle, and this will put further pressure on home prices. You can get more from our post “Yet More Evidence Of The Property Slowdown

Finally, as the AFR pointed out, the banks are under intense margin pressure now as they are being squeezed by higher borrowing costs as the US Federal Reserve accelerates its interest rate hikes and drains liquidity from global financial markets while the Hayne royal commission makes it difficult for them to raise home loan rates. They said that analysts estimated that the spreads paid by Australian banks have climbed by close to 40 basis points since the beginning of the year, which has swollen the wholesale borrowing costs of the country’s banks by some $4.4 billion a year. They quoted AMP’s head of investment strategy, Shane Oliver, who said the blowout in the BBSW could reflect Australian borrowers rushing to lock in funding before the end of the financial year, for fear that the borrowing situation could worsen.  Dr Oliver said the banks were likely to be absorbing the higher funding costs in their margins. But, he warned, the “risk is that they will start to increase some mortgage rates”.

But we think something else is going on, because the spreads in Australia are a lot bigger now than other markets, and we suspect it’s a lack of confidence in our local banks, thanks to the revelations from the Royal Commission. A quick look at the recent share prices of for example Westpac, the largest investment loan lender, and CBA the largest owner occupied loan lender tells the story. The markets are nervous.  The pincer movements of higher funding, less confidence and a slowing and more risky housing market are all adding to the banks’ woes.  They are stuck because any lift in mortgage rates will drive prices lower and lift defaults from overleveraged households.  Actually this is the reason why we think the RBA may be forced to cut the cash rate ahead. A nasty cocktail.

 

 

The Crunch Is Nearer Now – The Property Imperative Weekly 26 May 2018

Welcome to our latest summary of finance and property news to the 26th May 2018 with a distinctively Australian flavour.

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

I had a number of interesting discussions with people who follow our analysis of the property market this past week.  One in particular which stood out was from Melbourne who told me that in February 2017 he decided to sell his home, and got an indication it would sell conservatively for 1.3 million dollars. After a delay he took it to auction in August 2017 and struggled to see $1.25 million. But that property is now worth $1.15m a $150,000 drop from Feb 2017 to May 2018 or 11%.  He also told me that back in 2017 he could have got a mortgage of $980,000, but now, on the same financial basis he can only access $670,000 today.

That in a nutshell is what is happening in the major markets, with people’s mortgage borrowing power being curtailed, and as a result home prices are falling. And they will fall further.

We had a bevy of analysts revising down their forecasts for future home prices this week. It is tricky to determine the extent of any fall ahead, and most predictions will of course be wrong. But the more significant factor in play is the significant change in the atmospherics around the housing sector. More are going negative. And when the largest lender in Australia signals they expect a fall, even a mild one, this is significant.

Recently Morgan Stanley said it is predicting property prices could fall by about 8% in 2018, and lending by more than a third. Morgan Stanley suggests there’ll not only be further price weakness in the months ahead, but also the likelihood of renewed softening in building approvals. It says these two factors will likely weigh on household consumption and building activity, seeing Australian economic growth decelerate, rather than accelerate, this year.

CBA has also gone negative on housing, now forecasting a mild correction. Gareth Aird, senior economist at CBA says that Australian residential property prices have fallen over the past six months. Additional declines appear likely over the next 1½ years due to a further tightening in lending standards, a continued lift in supply, potentially higher mortgage rates and more rational price expectations from would-be buyers. But he says a hard landing, however, looks unlikely and “is not our central scenario”.

We discussed this analysis in more detail in our recent release “Another Bank Goes Negative On Housing” which is still available.  And remember CBA is the largest mortgage lender for owner occupied loans. Until recently they were bullish on prices, so this reversal is significant.

And UBS, who called the top of the market earlier than most, says macroprudential tightening ‘phase 3’, is a ‘game changer’ that will materially further tighten credit ahead, with higher living expense assumptions & debt to-income limits cutting borrowing capacity ~30-40%. Indeed, they says, housing is already weakening more quickly than our bearish view, with home loans dropping by ~10% since Aug-17, before the full Royal Commission impact. We have shifted our base case towards our ‘credit tightening scenario’, where home loans falls ~20%, credit growth drops to ~flat, prices fall persistently, & the RBA holds for longer. This coupled with record housing supply in coming years & a slump in foreign buyers sees us downgrade our house price outlook to fall 5%+ over the next year; below our prior 0 to -3% y/y. They conclude that housing activity will correct & prices to fall; still with downside risk: We still expect commencements, activity & prices to have an ongoing ‘downturn’ until at least 2019 – with downside risk from a ‘credit crunch’ scenario amid regulatory tightening & the Royal Commission. But housing should not ‘crash’ without (unexpected) RBA rate hikes or higher unemployment. So that’s ok then…

CoreLogic added some colour to the question of home prices by assessing home price growth across each decile, which confirms that values have fallen fastest at the premium end of the market. The broad trend findings in the CoreLogic May Decile Report showed that values have been falling on an annual basis across the 10th decile (the premium end of the market), while all other valuation deciles enjoyed positive (albeit restrained) growth over the twelve months to April 2018. National dwelling values were 0.2% higher over the 12 months to April 2018 – the slowest annual rate of growth since values fell -0.3% over the 12 months to October 2012.  Analysing deeper at a decile level, it was only the most expensive 10% of properties that recorded a fall in values over the year (-4.3%) and all other sectors recorded annual growth greater than 0.2%.

In Sydney the most expensive decile, have fallen 7.2% over the past year, while in Melbourne the same decile fell just 2.4%. In contract the cheapest 10% of houses rose 1.5% in Sydney, and 11.9% in Melbourne over the past year. This is thanks partly to first home buyer stamp duty concessions implemented by both state governments from 1 July 2017. But be warned, if Perth is any guide, the top of the market falls first, but other sectors soon follow. This is one reason why we continue to hold the view prices will drop further than many analysts are predicting.

The credit tightening is real, borrowing power is being reduced, and investors are voting with their feet. We continue to see investors planning to exit the market before prices fall further.  If you want further evidence, look no further than the latest auction clearance rates. CoreLogic says the combined capital city auction market continues to soften throughout 2018; while volumes have remained relatively steady over each of the last 3 weeks the weighted average clearance rate has continued to decline. Last week, the combined capitals returned a final auction clearance rate at a record year-to-date low of 56.8 per cent, the last time clearance rates were tracking at a similar level was in early 2013.  With 2,100 homes taken to auction last week almost half of these failed to sell, over the same period last year the clearance rate was a much higher 73.1 per cent across 2,824 auctions.

In Melbourne, the final auction clearance rate increased last week across a slightly lower volume of auctions, with 62 per cent of the 1,033 auctions reported as selling, up on the previous week when the final clearance rate across the city dropped below 60 per cent (59.8 per cent- 1,099 auctions).

Sydney’s final auction clearance rate fell to 54 per cent last week, the lowest recorded since late 2017, with 672 homes taken to auction which was lower than the week prior when 787 auctions were held and a higher 57.5 per cent cleared.

Across the remaining auction markets, Adelaide was the only capital city to see a rise in clearance rate last week with volumes also increasing across the city.

This trend is set to continue with CoreLogic currently tracking 2,164 auctions, increasing slightly on last week’s final figures which saw 2,100 auctions held. Sydney is expected to see the most notable difference in volumes this week; increasing by 15 per cent on last week with a total of 775 homes scheduled for auction.  Australia’s other largest auction market Melbourne is set to host 1,064 auctions this week, remaining somewhat consistent on the 1,033 auctions held last week at final results.  In any case there are doubts about the auction stats, as we discussed in “Auction Results Under the Microscope”.

Across the smaller auction markets, Tasmania is the only other auction market to see a rise in week-on-week volumes, with Adelaide and Perth down more than 30 per cent on last week, while Brisbane and Canberra’s volumes are down to a lesser degree.

When compared to activity last year, both volumes and clearance rates were tracking considerably higher, with 2,885 auctions held on this same week one year ago when the success rate of auctions were tracking consistently above the 70 per cent mark throughout the first half of 2017; a much different trend to what we are currently seeing.

All the indicators are for more falls.

As the property market rotates, and demand slackens, property developers with a stock of newly built, or under construction dwellings – mostly high-rise apartments are trying tactics from deep discounting, cash bribes, or 100% mortgages to persuade people to buy. Remember there are around 200,000 units coming on stream over the next year or two and demand is falling.  So we were interested to see (thanks to a tip off from our community) a WA initiative which was recently announced by Apartments WA – “Backed by the foundations of the BGC Group – Western Australia’s largest residential home builder and largest private company, we make your buying journey a seamless process from finding you the right apartment, assisting with obtaining finance, right through to settlement and key handover”.

They have coined the “Preposit”.  In essence a buyer gets to live in a property, whilst saving for a deposit, and when that deposit is accumulated, they can complete a purchase. It’s a way to get currently vacant apartments occupied by people who ultimately may buy.   They call it ” the Afterpay© of the real estate industry”.   The weekly payments, would cover the equivalent of rent and saving for a deposit. Finance is provided by Perth based Harrisdale Pty Ltd trading as The Loan Company. They hold a financial service licence. There are few details on the Preposit site, and we have no idea of the financial arrangements below the surface. So we suspect any prospective buyer should ask some hard questions about the overall risks and real effective costs. Remember that they are not an Authorised Depository Institution, so any money “saved” with them for a deposit could be at risk. I put in a call to the company, who said they would call back to discuss “Preposit”, but they never did!

I have been following the latest rounds of hearings at the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, which is exploring lending for small businesses.

It’s been quite dramatic, with stories of business owners with impossible dreams, walking into commercial ventures which had a limited chance of success. The banks on the stand appear to have made procedural mistakes, and when things go wrong often went for the jugular to cover their losses. This included relying on guarantees even if it meant selling the guarantors property, and the case studies included sad stories of people losing their homes.  This included a disabled pensioner, blind and riddled with medical problems; her daughter, a budding small business operator. Or an ambitious woman trying her hand at running a pie shop with the hope of retiring early.

But the way the story is presented is only half the story. Yes, the banks failed in their duties on occasions, but on the other hand many businesses need finance if they are to start, and banks want to lend. What is really going wrong?

My theory is there small businesses are not get access to the advice they need to make a balanced assessment as to the viability of their operation.  By default, they assume if the bank provides funding then the business must be viable – but this is not necessarily so. The bank is only concerned with protecting their loan, and ensuring they can cover the risk of loss – this is not the same as considering the business in the round. We discussed this analysis in more detail in our recent release “The Problem With Small Business Lending”.   And remember about 53 per cent of the nation’s 2.2 million small to medium businesses need finance to continue trading.

The Australian Financial Review reported on our recent research on the Bank of Mum and Dad funding business start-ups. More than 33,000 business owners are estimated to have seed finance – or ongoing financial support – from loans that are secured with their parents’ home, analysis of home ownership and borrowing numbers reveals. The average cash injection is about $56,000 but loans typically range from few hundred dollars to more than $1 million, the analysis reveals. But while the number of parents providing direct cash support to their siblings’ business is increasing there has been a big fall in the number willing to put their houses on the line. That’s because of increased understanding that a lender could foreclose if there a default, which means parents’ best intentions risk the threat of homelessness by prodigal sons or daughters, according to financial advisers. said the number of parents guaranteeing a loan with their homes has fallen by about 8 per cent in the past year. This is because of the greater focus on financial advice and a better understanding of the risks involved with a guarantee, plus thanks to the strong rises in property there is more equity in a property.

Next, we look at the latest from the US where the adjustments to the Dodd-Frank Act (DFA) – sound familiar?) are expected to be signed into law next week. The changes ease the capital and regulatory requirements for smaller institutions and custody banks by raising the systemic threshold to $250 billion from $50 billion for enhanced prudential standards (EPS), reduce stress testing requirements and modify applicability of proprietary trading rules (the Volcker Rule). The legislation reduces regulations for U.S. small to mid-size banks in particular, while only providing de-minimis regulatory relief to the largest U.S. banks. The change to the systemic threshold reduces the number of banks subject to heightened regulatory oversight to 12 from 38. Regulators will still have discretion to apply EPS to banks with $100 billion-$250 billion in assets. Banks above $250 billion in assets would not see much benefit from the legislation.

Fitch Ratings says stress testing has provided discipline for banks and is an important risk governance practice that is considered in its rating analysis. The elimination or meaningful reduction of stress testing would likely have negative ratings implications. And this at a time when debt is very high.

Moody’s says the return of a 3% 10-year Treasury yield is making itself known in the housing industry. Markets have already priced in a loss of housing activity to the highest mortgage yields since 2011. They conclude that just as it is overly presumptuous to predict the nearness of a 4% 10-year Treasury yield, it is premature to declare an impending top for the benchmark Treasury yield. Thus far in 2018, the 11% drop by the PHLX index of housing-sector share prices differs drastically from the accompanying 3% rise by the market value of U.S. common stock. In addition, the CDS spreads of housing-related issuers show a median increase of 78 bp for 2018-to-date, which is greater than the overall market’s increase of roughly 23 bp. Finally, 2018-to-date’s -1.97% return from high-yield bonds is worse than the -0.13% return from the U.S.’ overall high-yield bond market. Despite the lowest unemployment rate since 2000, the sum of new and existing home sales dipped by 0.7% year-over-year during January-April 2018. All this shows the impact on the housing sector as rates rise.

The highest effective 30-year mortgage yield in seven years has depressed applications for mortgage refinancings. For the week-ended May 18, the MBA’s effective 30-year mortgage yield reached 5.01% for its highest reading since the 5.04% of April 15, 2011. The effective 30-year mortgage yield’s latest fourweek average of 4.95% was up by 63 bp from the 4.32% of a year earlier. March 2018’s 7% yearly drop by the NAR’s index of home affordability showed that the growth of after tax income was not rapid enough to overcome the combination of higher home prices and costlier mortgage yields. March incurred the 17th consecutive yearly decline by the home affordability index. The moving three-month average of home affordability now trails its current cycle high of the span-ended January 2013 by 23%.

And according to the  latest from The St.Louis Fed On The Economy Blog, individuals who were in financial distress five years ago were about twice as likely to be in financial distress today when compared with an average individual. They argued that financial distress is not only quite widespread but is also very persistent. They show that the share of households with past financial distress increased from approximately 6.6 percent in 1998 to 12.2 percent in 2016. They conclude that households that have encountered an episode of financial distress in the past are 1.5 times more likely to delay payment today, compared to average households.

Why is this US data relevant to us? Well first, the debt levels in the US are significantly lower than here as home prices relative to income are lower there. We have more households in financial difficulty as a result. Second, the higher rates are likely to impact local funding costs here, which will put pressure on local banks funding costs, and third, higher rates will further tighten credit availability, and as in the US, this is likely to impact the construction sector – so expect to see more unnatural acts to try to attract buyers into a falling market – to which I reply, caveat emptor – let the buyer beware!

Finally, the latest data from S&P Global Ratings using their Mortgage Performance Index (SPIN) to March 2018 shows a rise in arrears – they increased to 1.18% in March from 1.16% in February and there was a significant hike in 90+ defaults.  WA and NT continue their upward trends, both above 2% and rising.  Home loan delinquencies fell in New South Wales, Queensland, South Australia, and the Australian Capital Territory in March. Of note, mortgage arrears in South Australia appear to have turned a corner; the state’s March 2018 arrears of 1.35% are well down from a peak of 1.81% in January 2017. This reflects a general improvement in economic conditions in South Australia, in line with national trends. Western Australia remained the state with the nation’s highest arrears, sitting at 2.37% in March.

But S&P says say arrears more than 90 days past due made up around 60% of total arrears in March 2018, up from 34% a decade earlier. This shift partly reflects a change in the reporting of arrears for loans in hardship that came in response to regulatory guidelines. Even accounting for this, however, there has been a persistent rise in this arrears category, though the level of arrears overall remains low.  And I recall Wayne Byers recent comment to the effect that at these low interest rates, defaults should be lower!

The pressure on households is set to continue. The crunch is getting nearer.

The Great Credit Crunch – The Property Imperative Weekly 12 May 2018

Welcome to The Property Imperative Weekly to 12 May 2018.

In this week’s review of the latest finance and property news we look at the impact of the impending credit crunch. Watch the video or read the transcript.

The evidence is mounting that we are entering a credit crunch, driven by tighter lending restrictions, and the recent revelations from the Royal Commission. And the implications of this are profound, not just in terms of the immediate impact on home prices, but also, and perhaps more significantly, on the broader economy. Housing and finance for housing has formed a significant plank in the trajectory of the economy over recent years and when coupled with construction activity it has supported the transition from the mining boom. But now that could change, and the impact on households and the broader economy is potentially profound, as borrowers deal with massively higher debt levels, and the inability to spend as a result; and new loans harder to get. As a result, home prices will fall, further and harder. Let’s look at the evidence.

First there is a quite a strong relationship between auction volumes and home price growth. This is why we watch the auction results so closely.  Now we know there is a lot of noise in the system because of the way auction volumes are reported – for more on that watch our separate video – Auction Results Under The Microscope, but CoreLogic reported that the auction volumes fell last week. There was a total of 2,311 auctions held, which returned a final clearance rate of 62.1 per cent. Over the same week last year, the clearance rate was much stronger with 73.0 per cent of the 1,689 auctions cleared. Melbourne’s final clearance rate has been fairly stable over the last 3 weeks. Last week’s final clearance rate came in at 63.7 per cent across 1,144 auctions, compared to 63.9 per cent across 1,334 auctions the previous week. This time last year, 792 homes went under the hammer, returning a clearance rate of 77.5 per cent. Sydney’s final auction clearance rate increased to 63.1 per cent across 797 auctions last week, after falling to 55.8 per cent across 829 auctions over the previous week, the lowest clearance rate recorded across the city all year. Over the same week last year, 592 homes went to auction and a clearance rate of 73.8 per cent was recorded. Across the smaller auction markets, Canberra was the only city to see an increase in auction volumes with 102 auctions held, up from 92 over the previous week. Clearance rates were varied with Adelaide, Brisbane and Perth recording lower clearance rates week-on-week.  Of the non-capital city auction markets, Geelong returned the highest final clearance rate of 75.0 per cent across 58 auctions.

They are expecting lower auction volumes this Saturday with Melbourne, the busiest city at 1,012 auctions being tracked so far, down from 1,144 last week while Sydney has 696 auctions scheduled this week, down from 797 last week.

Lending criteria are tighter now with a focus on real expenses, supported by evidence. (Why this was not happening previously is a whole other discussion). Our household surveys reveal that more households simply cannot meet the current new and tighter borrowing requirements. Borrowing power has been reduced – significantly. For example, in one scenario, take a household with incomes of close to $200k. Previously they might have been able to get a $1million loan, but now if they provide more detailed expenses – including the fact they pay for child care, their borrowing power will now be scaled back closer to $650,000.  Most lenders are applying stricter criteria – though we see in our data the non-banks are still more flexible. But the lending tap is being turned down, significantly.

It is already impacting the ABS housing finance data to March 2018. The trends are pretty clear, lending is slowing, and bearing in mind our thesis that lending and home prices are inextricably linked, this signals further home price falls ahead, which will be exacerbated by even tighter lending standards we think are coming. You can watch our recent video “The Absolute Link Between House Prices and Credit” for more on this. And remember debt is still rising faster than inflation or wages, so household debt will continue to rise from its already overextended level. The rolling 12 month rolling trend says it all, and we see that both owner occupied and investor loan flows are slowing, with investor lending shrinking faster. You can watch our separate video on the data “Housing Credit Goes into Reverse”. The proportion of investor loan flows slid again (excluding refinance) to 43.6%.

CoreLogic did a neat piece of analysis showing the strong correlation between home prices and investor property lending.  They said that since macro prudential measures were announced and implemented by APRA, the trends in housing related credit have changed remarkably.  Soon after APRA announced the ten percent annual speed limit for investment lending in December 2014, investment housing finance commitments peaked at 55% of mortgage demand and investment credit growth moved through a cyclical peak rate of annual growth at 10.8%.  Around the same time, the quarterly rate of home value appreciation peaked in Sydney and Melbourne; the two cities where investment has been most concentrated. As credit policies were tightened in response to the APRA limits, then loosened as lenders overachieved their APRA targets, the housing market responded virtually in concert.  Interest rate cuts in May and August of 2016 helped to support a rebound in the pace of capital gains, however as lenders came close to breaching the 10% limit, at least on a monthly annualised basis, credit once again tightened and the second round of macro prudential, announced in March 2017, saw credit availability restricted further.  The result of changes in credit availability has been evident across most housing markets, but is very clear in Sydney and Melbourne; dwelling values started to track lower in Sydney from July last year and peaked in Melbourne in November last year.

And the latest trends in home price movements shows further falls in Sydney and Melbourne. In fact, from the start of the year, only Brisbane has shown any increase, all other capital cities fell with an average of 0.26%, and this before the tighter lending standards have started to bite. But of course, whilst we see some slippage now, this is small beer relative to the average gained since May 2012 of 46.7% with the strongest gains in Sydney at 60.9% followed by Melbourne at 43.8%.

Others are now revising their forecasts on future home price momentum with SQM research downgrading their estimates for Sydney, Melbourne, Brisbane, Darwin, Canberra and The Capital City Average.  They have tended to be more bullish than some other analysts, but gravity is finally catching up and they also said property prices in Sydney and Melbourne are massively overvalued against fundamentals –  by up to 45% we agree.

UBS also published analysis which suggests that home prices are likely to fall, on the back of weaker credit. Once again, gravity will win.

You may remember the RBA warned recently of the potential for credit availability to become more constrained. And economists are now all beginning to highlight the potential impact – the question now is, how tight will lending become? Will the regulators try to alleviate the impact, for example freeing up property investor lending, and will the next move in interest rates be up, or down in the months ahead. More importantly, if lending tanks as we expect, then the spill over effects on the broader economy, growth, home prices, all compound the problems. We are in for a credit crunch, so my scenario 2 – see our video on “Four Potential Finance and Property Scenarios – None Good”.

And if you want more evidence of the economic indicators, look at Retail turnover  from the ABS this week which showed further evidence of the stress on households. Retail turnover showed no growth in March, in seasonally adjusted terms following a 0.6 per cent rise in February 2018. Our preferred trend estimates for Australian retail turnover rose 0.3 per cent in March 2018, following a rise (0.3 per cent) in February 2018. Compared to March 2017, the trend estimate rose 2.6 per cent. And across the states there were some significant variations, with NSW up 0.3%, VIC. Up 0.5%, QLD and SA up 0.1%, WA and flat, the Northern territories up 0.3% and ACT 0.4%.

And this is consistent with our Household Finance Confidence Index, to the end of April 2018, which showed that households remain concerned about their financial situation. This is consistent with rising levels of mortgage stress, as we reported recently. The index fell to 91.7, down from 92.3 in March. This remains below the neutral 100 setting, and continues the decline since October 2016. You can watch our separate video “Household Financial Confidence Takes Another Dive” Again, we continue to see little on the horizon to suggest that household financial confidence will improve. Currently, wages growth will remain contained, and home prices are likely to slide further, while costs of living pressures continue to grow. Whilst banks have reduced their investor mortgage interest rates to attract new borrowers, we believe there will also be more pressure on mortgage interest rates as funding costs rise, and lower rates on deposits as banks trim these rates to protect their net margins. In the last reporting round, the banks were highlighting pressure on their margins as the back-book pricing benefit from last year ebbs away.

We got half year results from Westpac this week which were an interesting counterpoint to recent announcements, with stronger NIM, including from Treasury. Their CET1 ratio fell a little, but they are still well placed.  Mortgage delinquencies were a little higher but and they had been able to lift margin by reducing rates on some deposits, though they did signal higher funding at the moment and the risks of higher rates ahead. They defended the quality of their mortgage portfolio. One slide in the investor presentation said “Australian mortgages performing well”. The data showed that Westpac originated $5 billion in mortgages in the first half 18, or about $10 billion over a year, or the same as the bank funded as far back as 2014. Compare that with the $18 billion in 2017 and 17 billion the year before that. Momentum is slowing. Analysts, UBS, who called out potential “liar loans” at the bank said they say they remain concerned with the findings of APRA’s ‘Targeted Review’ into WBC’s mortgage serviceability assessment and in particular comments from Wayne Byres (APRA Chairman) that WBC was a “significant outlier” and WBC’s Board Papers which stated its performance was “poor, both absolutely and relative to peers”. Further, WBC stated in the March quarter ~20% of loans were approved with Debt-to-Income (DTI) > 6x. This as a very high level especially given the concerns that mortgagor gross household income appears to be overstated across the industry, and the total debt position of customers is not yet fully visible (the mandatory comprehensive credit reporting regime begins 1 July 2018). You can watch our separate video “Westpac and The Liar Loans Incident

CBA reported their Q3 unaudited trading results, with a statutory net profit of approximately $2.30bn, in the quarter and unaudited cash net profit of approximately $2.35bn in the quarter. This is down 9% on an underlying basis compared with 1H18. We see some signs of rising consumer arrears, and a flat NIM (stark contrast to WBC earlier in the week!).  Expenses were higher due to provisions for regulatory and compliance. They reputation is in question.

The impact of reputational risk is highlighted by AMP’s Q118 results.  They said cashflows were subdued in Australian wealth management but there was continued strength in AMP Capital and AMP Bank. AMP Bank’s total loan book up 2 per cent to A$19.8 billion during the quarter. The portfolio review of manage for value businesses continues. In response to ASIC industry reports, AMP continues to review adviser conduct, customer fees, the quality of advice, and the monitoring and supervision of its advisers. They anticipate that this review will lead to further customer remediation costs and associated expenses and they will provide a further update at or before the 1H 18 results. This will include enhancements to AMP’s control frameworks, governance and systems.

AMP’s share price has fallen significantly, to levels not seen since 2003, and in a vote of no confidence, Australian Ethical has announced it will completely divest from AMP following revelations of “systemic prudential and cultural issues” at the royal commission. They will not reinvest until AMP demonstrates they have addressed their underlying issues. And they are watching the two of the four major banks they have holdings in, in the light of the findings from the royal commission too.

Finally, It’s worth looking at the impact of higher interest rates on the market. The Bank of England made small adjustments from a low base recently, and the results have been negative and predictable. The UK economy remains in the doldrums, so no surprise, the cash rate remained unchanged this month. In fact, the small rises made before have translated directly to lower home prices, reflecting the highly leverage state of many households. GDP is expected to grow by around 1¾% per year on average over the forecast period. Household consumption growth remains subdued. CPI inflation fell to 2.5% in March, lower than expected.

Indeed, Fitch Ratings says the UK household sector’s worsening financial health reduces consumer resilience to income or interest rate shocks and presents risks for UK consumer loan portfolios. Consumer credit has been a key driver of rising household debt. But weaker household finances reduce the resilience of consumer spending – by far the largest demand component of UK GDP – to shocks. A major interest rate shock appears unlikely (they forecast the UK base rate to rise gradually, to 1.25% by end-2019), but a more immediate shock could come from tightening credit supply. The impact of the Brexit referendum on real wages may be fading, but Brexit uncertainty creates risks of a bigger shock to growth and employment.  They say that UK banks are highly exposed to UK households, but mostly through mortgages, with consumer credit accounting for just 10% of banks’ lending to the sector. High household debt is a constraint on UK banks’ operating environment. Does this sound familiar?

The Property Imperative Weekly – 28 April 2018

Welcome to the Property Imperative Weekly to 28th April 2018.

In this weeks digest of finance and property news we review the implications from the Royal Commission, the latest on the Westpac loans issue, APAC mortgage lending and rising near-prime non-bank lending.

In this week’s summary of the latest finance and property news we start with the Royal Commission into Financial Services Misconduct. The latest hearings wrapped up on Friday, with a litany of company breaches and illegal behaviour being called out. During the close, it was suggested AMP might face criminal prosecution for misleading the corporate regulator. But large institutions, adviser groups, individual advisers, industry associations and regulators all failed to meet our expectations.

I’ve been amazed by the coverage these issues are getting in the media, and also the surprise being expressed, as many industry insiders have been aware of significant issues for years. But then companies, with the deep pockets and aggressive stances have largely contained them. I think the live streaming of the sessions has had a significant impact, and it shows the power and reach of digital. But now, exposed is the lopsided focus on shareholder returns at all costs, even if customers are disadvantaged and laws are broken. In a way this mirrors the behaviour we saw in the previous rounds on lending practice.

It’s also worth noting that Kelly O’Dwer, who tried to defend the un-defendable on ABC Insiders last Sunday arguing that the Government did not drag their feet with regards to the calling of the Commission, did an about face saying on Friday “”With the benefit of hindsight we should have called it earlier, and I am sorry we didn’t, and I regret not saying this when asked earlier this week”. But Ms O’Dwyer maintains the Government was not sitting on its hands in the months leading up to the commission, and has again argued it used the time to strengthen regulations in the sector and beef up penalties for misconduct.

But we need to understand that corporates across many sectors actually exhibit the same type of behaviour, whether it is Telstra, who was fined by the ACCC this week for charging customers for online services, without their consent, Ford for failing to fix faulty vehicles, electricity providers allowing customers to sit on high priced non discounted tariffs, or Pay Day loan providers now offering instant loans via ATM type machines. I could go on.

We need to stand back, and think about the corporate values which all these examples signify –profit at all cost, and a willingness to sail close to the wind, without a moral compass, or worse just break the law. Whilst we can expect tighter laws, and higher fines ahead, I think we need a new philosophy of the company, which puts the interests of customers first, rather than last. Now that is a major challenge, but also an opportunity; and I am waiting for real leaders to take a stand. They are now all on notice.

Turning to the latest home prices and auctions, Corelogic reported that last week, the final auction clearance rate increased to 62.2 per cent after the prior week’s lowest level seen over the year-to-date, of 61.7 per cent. They say that volumes are around the 1,800- 1,900 level, much lower than last year. And of course there are still questions about the accuracy of the data, in the light of the higher number of property’s withdrawn prior to auction, as we discussed in our recent post “Auction Results Under the Microscope

They say that Melbourne and Sydney returned an equal 63.6 per cent auction clearance rate last week, both higher than the prior week. Looking at volume of auctions, Melbourne recorded a slightly higher volume week-on-week with 914 held, increasing on the 873 the previous week, while Sydney saw a fall in activity with 588 auctions held, down on the 795 auction held the week prior. The performance across the smaller auction markets were mixed last week, with clearances rates improving in Brisbane and Tasmania, while Adelaide, Canberra and Perth all saw a fall in the final clearance rate over the week.  Of the non-capital city regions, Geelong recorded the highest clearance rate with 85.3 per cent of auctions clearing last week.

This week, the number of auctions scheduled to take place across the combined capital cities is expected to rise, with 2,342 currently being tracked by CoreLogic, increasing from the 1,799 auctions held last week. Both Melbourne and Sydney is expected to see an increase in activity this week, with 1,218 homes scheduled for auction across Melbourne, while Sydney is set to host 737 auctions, increasing on the 914 and 588 auctions held last week respectively.

I posted on the latest UBS report recently, “On Mortgage Underwriting Standards and Risks”. They continued their forensic dissection of the mortgage industry with the release of their analysis of data from Westpac, which the lender provided to the Royal Commission. This was representative data from the bank of 420 WBC mortgages analysed by PwC as part of APRA’s recent review. APRA Chairman Wayne Byres found WBC to be a “significant outlier”, with PwC finding 8 of the 10 mortgage ‘control objectives’ were “ineffective”.

UBS says for the first time information on borrower’s Total Debt-to-Income ratios (not Loan-to-Income) has been made available. They found WBC’s median Debt-to-Income at 5.4x, with 35% of the sample having Debt-to-Income ratios of >7x. Further 46% of the mortgage applications had an assessed Net Income Surplus of <$250 per week.

This data raises questions regarding the quality of WBC’s $400bn mortgage book (70% of its loans). While WBC has undertaken significant work to improve its mortgage underwriting standards over the last 12 months, we expect it and the other majors to further sharpen underwriting standards given the Royal Commission’s concerns with Responsible Lending. This could potentially lead to a sharp reduction in credit availability.

So I was amused by a piece in the AFR from Christopher Joye, who argued that there was nothing to see here. PwC found that 38 of the 420 loans failed APRA’s loan assessment standards and should not, on this test, have been originated. He argued that on Thursday Westpac disclosed that PwC used a limited data file on each borrower, and once Westpac applied its full data file 37 of the 38 loans were, in fact, appropriately approved. And the one loan that should not have passed its credit scoring system is “currently ahead on its repayments”. Also, Westpac highlighted that 90 of the 420 loans have already been fully repaid, which combined with its other evidence suggests that the bank’s loan portfolio remains of a high quality. Westpac’s chief financial officer Peter King hammered this point home, noting that “our mortgage delinquencies and losses remain low both relative to historical and industry standards”. That’s important because Westpac has aggressively raised its interest-only loan rates, which should have propagated higher defaults. And he says …Contrary to Tony Abbott’s suggestion the regulators should be sacked in response to the royal Commission, APRA has generally been doing an excellent job. The housing boom kicked- off in 2013 and APRA has been hounding banks on loan serviceability standards since late 2014, when it introduced a raft of rules and established a prudential mortgage lending guide.

Trouble is, we know that in a low interest rates environment most loans will survive, it’s when rates rise that things start to go wrong. And the issues around HEM and APRA (and remember ASIC has commenced proceedings against Westpac) suggests they have questions to answer.  So I did not find Joye convincing.  I do not think the regulator has done a great job!

As I said the other day, the results from the UBS work raises two questions. First how much tighter will credit availability now be ahead? We continue to expect an absolute fall in loan volumes, and this will translate to lower home prices.

Second, is this endemic to the industry, or is Westpac really an outlier? From our data we see similar patterns elsewhere, so that is why we continue to believe we have systemic issues.

  1. Income is being overstated and expenses understated.
  2. Customers have multiple loans across institutions and these are not always being detected, so their total debt burden is higher than the bank sees.

Combined these are significant and enduring risks. Chickens will come home to roost! Especially if rates rise. In fact, UBS has now put a sell recommendation on Westpac.

Now back to APRA, the banking regulator announced plans to remove the investor loan growth benchmark and replace it with more permanent measures to strengthen lending standards. This could be seen as an easing strategy to allow banks to lend more freely, but I do not think it is. In fact, it underscores the tighter lending standard now being imposed.

In summary, for the 10 per cent benchmark to no longer apply, Boards will be expected to confirm that: i) lending has been below the investor loan growth benchmark for at least the past 6 months; ii) lending policies meet APRA’s guidance on serviceability; and iii) lending practices will be strengthened where necessary.

As part of these measures, APRA also expects ADIs to develop internal portfolio limits on the proportion of new lending at very high debt-to-income levels, and policy limits on maximum debt-to-income levels for individual borrowers. This they say provides a simple backstop to complement the more complex and detailed serviceability calculation for individual borrowers, and takes into account the total borrowings of an applicant, rather than just the specific loan being applied for.

Remember the Bank of England imposed limits on high loan to income loans a couple of years ago to cool the market, so in a sense APRA is belatedly following suit, having argued previously that everything in the mortgage garden was rosy. What a change of tune!

Combined these underscore that credit growth will continue to slow, and there will be intense focus on credit underwriting.  If you want arguments as to why home prices will continue to drift lower and perhaps fall faster, you need look no further.

And high home prices and debt is not just an Australian thing. Fitch Ratings issued an interesting note saying that banks in Asia-Pacific (APAC) will face heightened property risks over the medium term, given their relatively high exposure to the sector and the susceptibility of heavily indebted household sectors to a rise in interest rates or unemployment.

Residential property risks are highest for Australian and New Zealand banks, and may remain elevated in the short term as low interest rates and high house prices continue to drive mortgage growth, albeit it a slower rate. Residential property loans accounted for 43% of Australian bank assets in December 2017, up from 39% five years earlier, while in New Zealand the share rose to 46% from 43%. Australian and New Zealand households also have some of the region’s highest debt burdens.

Hong Kong banks’ property risks are increasing, with the territory being one of the few markets where property lending has accelerated over the past year, while intense competition continued to pressure margins. Mortgages account for a relatively low proportion of system assets, but a sharp housing market downturn could hurt sentiment and expose vulnerabilities, as rising prices have boosted private-sector wealth, banks’ reserves and collateral valuations. Banks’ rising exposure to mainland Chinese property is driving real-estate lending growth.

Korea’s high household debt would make its economy less resilient to shocks, including a housing market downturn. Household debt ratios are unlikely to decline over the medium term. However, household assets are also relatively high and banks’ property exposure is healthy overall, with low delinquencies and moderate LTV ratios. The same is also broadly true for Singapore, where we expect a more buoyant property market to support bank lending in 2018.

APAC regulators have actively tightened macro-prudential measures in an effort to strengthen banking-sector resilience to potential property risks. These measures have helped cool property markets in Singapore and Taiwan, while the tight stance has generally bolstered loss-absorption buffers and supported lending standards. Nevertheless, continued rapid lending and a further rise in risk appetite could increase the prospects of negative ratings action in the medium term, particularly in the absence of commensurate reinforcement to buffers.

Household leverage has started to decline in the emerging markets where it is highest – Malaysia and Thailand. We expect some fallout from over-supply in Malaysia, but risks to banks should be manageable as their exposure to the more vulnerable segments has remained small. Strong commercial real-estate lending growth by Thai banks in 2017 reflected an improving operating environment and followed sluggish growth in previous years, although there are still risks associated with consumer lending. Real-estate lending growth has also remained high in the Philippines.

Chinese banks shifted toward retail banking and mortgage lending in 2017, amid pressures in the corporate and financial sectors. However, increases in household leverage have been from a low base and have not reached the levels of most developed economies, suggesting that any near-term risks from China’s household debt burden remain moderate. Bigger risks would emerge if household lending was left unchecked over the medium term.

They conclude that rapid mortgage lending growth, incrementally higher risk-taking and relaxed mortgage pricing amid competitive pressures are likely to have created vulnerabilities that could be tested by a change in economic conditions. Rising interest rates are a potential trigger, despite saying that monetary tightening will be much slower in APAC than in the US.

Worth remembering this as the US 10-year bond has moved above 3%. Here is the latest chart. This is further evidence of the continued rise in rates in the USA, as the FED executes its plan to reverse QE and take rates higher. This follows through to higher mortgage rates in the US, as shown by this chart.

This will indeed have consequences as the capital markets rates will follow, putting more pressure on local banks, who still fund significant portions of their books from overseas. This will continue to put pressure on the BBSW, and is likely to translate into higher mortgage rates ahead.

Next, CBA subsidiary Bank West has announced that it is implementing changes to its broker commission payment model, including changes to trail and the adoption of CIF recommendations, effective from 1 July. The bank is the first lender to make major moves to change broker remuneration following the ASIC remuneration review, Combined Industry Forum package reforms and the ongoing commissions. Bankwest has said that it is bringing in the changes to “align itself with evolving industry practice and regulator expectations”. The changes, which will be effective on settlements from 1 July 2018, include:  The reintroduction of Year 1 trail commission. The reduction of trail commissions in Year 3 to 0.15 per cent and from Year 5 and onwards to 0.20 per cent. The adoption of the Combined Industry Forum (CIF) recommendations on paying commissions on utilised funds and net of offset. There will be no changes to the upfront commission rate.

Commenting on the industry recommendations, Bankwest said: “Bankwest has been a very long-standing supporter of the broker industry, going back to the very start some four decades ago, and we remain committed to brokers as a channel of choice for customers. We support the current upfront and trail model as well as the improvements to the model outlined in the ASIC review and the Combined Industry Forum (CIF) recommendations. We understand the lack of Year 1 trail has been outstanding for some time and we are pleased to reintroduce this to bring us back in line with the market.  Our contract stipulates that trail commissions represent payment for continuous customer maintenance and services, and we believe trail remains warranted for brokers to ensure ongoing support is provided to customers they refer to Bankwest.”

Our own view is the broker commissions are likely to be replaced by a fixed service fee, following the Royal Commission revelations.  We also think mortgage brokers and financial advisers should be regulated under a common set of best interest rules. You can watch our separate post “We Need Common Rules for Mortgage Brokers and Financial Advisers”.

Finally, this week, Non-bank lender, Bluestone Mortgages, has announced its entry into the near prime mortgage space.  The move includes rate cuts of up to 2.25 basis points across its entire product suite, at a time when “PAYG and credit impaired customers are affected by the tightening criteria of traditional lenders”.  It comes off the back of extra funding through the acquisition of Cerberus Capital Management. The Crystal Blue portfolio is being seen as particularly ambitious, comprising of full and alt doc products geared to support established self-employed borrowers and PAYG borrowers with a clear credit history. Bluestone Mortgages said, “The recent acquisition of the Bluestone’s Asia-Pacific operations by Cerberus Capital Management has enabled a number of immediate opportunities to be realised, most notably the assessment of our full range of products and to ensure they fully address market demands. This comes at an opportune time as a growing volume of self-employed, PAYG and credit impaired customers are affected by the tightening criteria of traditional lenders. Unlike big banks, we don’t have credit scorecards, which means we’re able to assess every borrower based on their merits and individual circumstances. We’re not one-size-fits-all by any means, which is increasingly appreciated.

So this is all playing out as expected. As the majors throttle back on new mortgage lending under tighter controls, the non-bank sector continues to pick up the slack. This is a concern as the regulatory environment for these lenders is weaker, with both ASIC and APRA now involved, ASIC from a responsible lending perspective and APRA from new supervision on the non-bank sector, despite their failure in the core banking sector. So we expect to see significant non-prime non-bank lending growth, ahead, which will stoke the current massively high household debts even higher.

The Property Imperative 10 Report Released

The latest and updated edition of our flagship report “The Property Imperative” is now available on request with data to April 2018.

This Property Imperative Report is a distillation of our research in the finance and property market, using data from our household surveys and other public data. We provide weekly updates via our blog – the Property Imperative Weekly, but twice a year publish this report.  This is volume 10.

Residential property, and the mortgage industry is currently under the microscope, as never before. The currently running Royal Commission has laid bare a range of worrying and significant issues, and recent reviews by the Productivity Commission and ACCC point to weaknesses in both the regulation of the banks and weak competition in the sector. We believe we are at a significant inflection point and the market risks are rising fast. Portfolio risks are being underestimated.  Many recent studies appear to support this view. There are a number of concerning trends.

Around two thirds of all households have interests in residential property, and about half of these have mortgages. More households are excluded completely and are forced to rent, or live with family or friends.

We have formed the view that credit growth will slow significantly in the months ahead, as lending standards tighten. As a result, home prices will fall. We note that household incomes remain flat in real terms, the size of the average mortgage has grown significantly in the past few years, thanks to rising home prices (in some states), changed lending standards, and consumer appetite for debt. In fact, consumer debt has never been higher in Australia. Household finances are being severely impacted, and more recent changes in underwriting standards are making finance less available for many. But the risk is in those loans made in recent years under looser standards, including interest only loans.

Property Investors still make up a significant share of total borrowing, and experience around the world shows it is these households who are more fickle in a downturn. Many use interest only loans, which create risks downstream, and regulators have recently been applying pressure to lenders to curtail their growth.  Already we are seeing a drop in investor loans, and a reduction in interest only loans. A significant proportion will be up for review within tighter lending rules. This may lift servicing costs, at very least and potentially cause some to sell.

We hold the view that home prices are set to ease in coming months, as already foreshadowed in Sydney. We think mortgage rates are more likely to rise than fall as we move on into 2019.

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

If you are seeking specific market data from our Core Market Model, reach out, and we will endeavour to assist.

Here is the table of contents.

1	EXECUTIVE SUMMARY
2	TABLE OF CONTENTS
3.	OUR RESEARCH APPROACH
4.	THE DFA SEGMENTATION MODEL
5	PROFILING THE PROPERTY MARKET
5.1	Current Property Prices
5.2	Property Transfer Volumes Are Down
5.3	Clearance Rates Are Easing
5.4	But Can We Believe the Auction Statistics Anyway?
6	MORTGAGE LENDING TRENDS
6.1	Total Housing Credit Is Up
6.2	ADI Lending Trends
6.3	Housing Finance Flows – Bye-Bye Property Investors
6.4	The Rise of the Bank of Mum and Dad
6.5	Lending Standards Are Tightening
6.6	How Low Will Borrowing Power Go?
6.7	The Portfolio Mix Is Changing
6.8	Funding Costs Are Higher
6.9	The Interest Only Loan Problem
7	HOUSEHOLD FINANCES AND RISKS
7.1	Households’ Demand for Property
7.2	Property Active and Inactive Households
7.3	Cross Segment Comparisons
7.4	Property Investors
7.5	How Many Properties Do Investors Have?
7.6	SMSF Property Investors
7.7	First Time Buyers.
7.8	Want to Buys
7.9	Up Traders and Down Traders
7.10	Household Financial Confidence Continues to Fall
7.11	Mortgage Stress Is Still Rising
7.12	But The RBA Is Unperturbed
7.13	Latest Household Debt Figures a Worry
8	THE CURRENT INQUIRIES
8.1	Productivity Commission
8.2	The ACCC Mortgage Pricing Review
8.3	The Royal Commission into Misconduct in Finance Services
8.4	Merge Financial Advice and Mortgage Brokering Regulation
9	AN ALTERNATIVE FINANCIAL NARRATIVE
9.1	Popping The Housing Affordability Myth
9.2	The Chicago Plan
10	FOUR SCENARIOS
11	FINAL OBSERVATIONS
12	ABOUT DFA
13	COPYRIGHT AND TERMS OF USE

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