Another massive week of finance and property news, much of it centred on households and their finances, as the regulators home in on the risks in the mortgage market. But is it too little too late?
We start our review of this week’s finance and property news with the RBA’s Financial Stability report. This quarterly report, which ran to 62 pages said that International economic conditions, and local business confidence are on the improve while banks now hold more capital, have tightened lending standards, and shadow banking is under control. But, they say, Australian household balance sheets and the housing market remain a core area of interest, and from a financial stability perspective, this is the key risk. They showed that one third of mortgage holders have less than one months’ buffer, and their key concern is the negative impact on future growth as households hunker down; so nothing new really, apart from some new “Top Down” stress testing.
And nothing to answer the IMF’s downgraded Australian growth forecast. Given the first half result in 2017 was 1.2% a second half forecast at circa 1% is hardly stellar; and the sudden rebound to 3% next year, some might say, appears courageous. The IMF also revised up the unemployment rate, suggesting it will remain at 5.6%, rather than falling to 5.3% as estimated last time. This plus slow wage growth highlights the issues underlying the economy. They also warned about risks from high debt saying growth in household debt relative to GDP is associated with a greater probability of a banking crisis. And Australia is right up there!
On the same day, the ABS released their latest Housing and Occupancy Costs data. The average household with an owner occupied mortgage is paying around $450 a week, slightly lower than the peak a couple of years ago. This equates to around 16% of gross household income. But of course, the true story is interest rates have fallen to all-time lows, allowing people to borrow more, as prices rise. As a result, should interest rates start to bite, this will cause real pain. Plus, we have recent flat wage growth, in real terms, in the past couple of years. Finally, households have a bigger mortgage held for longer, which is great for the banks, but not helpful from a household perspective, as it erodes savings into retirement and means that more older Australians are still borrowing as they transition from the work force.
Earlier in the week, the ABS also released their latest housing finance data which showed that ADI lending rose 0.6% in trend terms in August, or 2.1% seasonally adjusted. Within that, lending for owner occupied housing rose 0.9%, or 2.1% seasonally adjusted and investor loans rose 0.2% in trend terms, or a massive 4.3% in seasonally adjusted terms. So lending growth is apparent, and signals more household debt ahead. First time buyers continue to extend their reach, despite the fact we are seeing “Peak Price” for property at the moment. In original terms, the number of first home buyer commitments as a percentage of total owner occupied housing finance commitments rose to 17.2% in August 2017 from 16.6% in July.
AFG’s latest mortgage index, shows that property investor appetite is falling, while first time buyers, and property upgraders are more active. First time buyers are reacting to the recent incentives put in place in VIC and NSW, they said.
Citi published a 54-page report on the highly topical subject of interest only (IO) loans, and we provided data from our Core Market Model to assist their research. Even after recent regulatory tightening, they say that underwriting standards in Australia are still more generous than some other countries, at 5.3 times income, compared with 3.7 times in the UK, 4.4 times in Canada and 4.9 times in New Zealand. They conclude that there are vulnerabilities in the IO sector, both from property investors and owner occupied IO loan holders. Overall this is, we estimate, more than $680 billion of the $1.6 trillion mortgage book. They say that tighter lending criteria and rising house prices has meant investors increasingly face net negative cash flows and investors face a growing household cash flow gap and reducing capital gains expectations. The large levels of debt outstanding by borrowers aged in their 50’s and 60’s means many investors will need to sell property to discharge their debts. Owner Occupied IO borrowers are more susceptible to interest rate rises given higher average borrowing levels and higher average loan to value ratios. They concluded “Given the widespread use of IO finance and the reduced prospects of discharging debt via means other than liquidation of portfolio holdings, banks must face an increased risk of mis-selling claims in future years. Mining towns serve as a microcosm of this threat”.
ASIC updated their work on IO loans finding that Australia’s major banks have cut back their interest-only lending by $4.5 billion over the past year. However, other lenders have partially offset this decline by increasing their share of interest-only lending. They say that borrowers who used brokers were more likely to obtain an interest-only loan compared to those who went directly to a lender and borrowers approaching retirement age continue to be provided with a significant number of interest-only owner-occupier loans. Now ASIC will examine individual loan files to ensure that lenders are providing interest-only home loans in appropriate circumstances, to ensure that consumers are not paying for more expensive products that are unsuitable, under the responsible lending provisions.
In this light, it was interesting to listen to some of the Big Bank’s CEO’s in front of the House of Representatives Standing Committee on Economics. Westpac CEO said half of his $400 billion mortgage portfolio was interest only. The other banks were closer to 40%. While both Westpac and ANZ said “we don’t lend to people who can’t pay it back. It doesn’t make sense for us to do so”, the underwriting standards are, we think, way too lose, as the recent regulatory tightening highlights, but it’s probably too late, especially for IO loans which now would fail even the current still generous standards. In an excellent The Conversation article, Richard Holden, Professor of Economics, UNSW rightly highlighted the “Spooky” parallels between our current situation, and the US mortgage market prior to the GFC. “Australia’s large proportion of five-year interest-only loans – turbocharged by an out-of-control negative-gearing regime – looks spookily similar. It’s one thing for borrowers to do silly things. When it becomes dangerous is when lenders not only facilitate that stupidity, but encourage it. That seems to be what has happened in Australia”.
Smaller lenders are still feeling the pressure, as illustrated by the Bank of Queensland results, which came out this week. While the headline profit was up, underlying growth was lower, and mortgage lending was the key. Net interest margin fell to 1.87%, but was better in 2H. Interest only loans were 40% in 2H16, and 39% in 1H17, but trending down, they say! 8% of loans are higher than 90% LVR on a portfolio basis, and 19% in the 81-90% band.
During their hearing, the big banks also confirmed they had repriced their mortgage back book, especially for interest only and investment loans, but weirdly denied this was to increase profitability. The quote of the week for me was one CEO saying that people should switch from IO loans to P&I loans “because they were cheaper” – which may be true from a headline interest rate perspective, but the monthly repayments when switching are significantly higher, so in reality, it is not cheaper in cash flow terms!
There was conflicting data relating to Foreign Property Investors, especially from China, with Credit Suisse saying they estimate, based on stamp duty records, that foreign buyers are acquiring the equivalent of 25% of new housing supply in NSW, 17% in Victoria and 8% in Queensland. If they are correct, this may put a floor on home prices, and they suggest that crackdowns on capital outflows by Chinese authorities appear not have slowed China’s appetite for Australian property.
On the other hand, while the NAB Residential Property Index rose 6 points in Q3, they highlighted lower foreign buying activity in new property markets, VIC saw the share fall to 14.4% (from 20.8% in Q2) and NSW down to 7.8% from 12% in Q2. In contrast, QLD saw a rise to 11.4%, up from 8.6% last quarter. NAB also revised its national house price forecasts, predicting an increase of 3.4% in 2018 (previously 4.3%) and easing to 2.5% in 2019. Unit prices are forecast to rise 0.5% in 2018 (-0.3% previously), with a modest fall expected in 2019.
Our data suggests that Chinese buyers are indeed still active, with a focus on certain postcodes where high-rise units are being built, and often offered direct to overseas buyers. We also see evidence of some high rollers buying larger houses. But overall this is not enough to support home prices into next year.
We published the September update of the Digital Finance Analytics Household Finance Security Index, which underscored the growing gap between employment, which remains relatively strong, and the Financial Security of households. The Index fell from 98.6 in August to 97.5 in September. The state by state view highlights a fall in NSW, while VIC holds higher, and there was a rise in WA from February 2017 lows. This highlights the fact the households across the national are under different levels of pressure. Tracking by age bands we find younger households are significantly less confident, compared with those aged 50-60 years. But across the board, the general trend is lower.
Similar findings were contained in the latest AlphaWise survey conducted by Morgan Stanley. Income growth has not recovered, ‘cost of living’ inflation is re-accelerating and ‘macro-prudential’-related tightening of credit conditions is extending from housing into consumer finance. They say Australian households are in a vulnerable financial position, especially those who have taken out a mortgage. And in an era of weak incomes growth, soaring energy prices and high levels of indebtedness, with the prospect of higher interest rates on the way, many intend to cut discretionary spending in anticipation of even tighter household budgets. That’s bad news, not only Australia’s retail sector, but also the broader economy. They forecast discretionary consumption volumes will slow to just 0.2% in 2018, dragging overall consumption growth down to 1.1% and well below consensus of 2.5%.
So, in summary the evidence is building that we are entering a concerning episode where growth is likely to be lower, households will remain under pressure, and risks in the system are considerably higher than the RBA is willing to concede. The mystery though is why the regulators are still allowing mortgage lending to grow way faster than inflation, and wages. This surely must be slowed, and soon. Once again, too little too late.
So that’s the Property Imperative Weekly to 14th October. If you found this useful, do leave a comment below, subscribe to receive future updates and check back next week.