The combined capital city preliminary clearance rate rose to 76.9 per cent this week, increasing from last week, when final results saw the clearance rate fall to 69.8 per cent after 10 consecutive weeks remaining in the mid-70 per cent range. The rebound in the preliminary clearance rate has occurred against a backdrop of higher auction volumes, with 2,347 properties taken to auction across the combined capital cities, up from last week’s 1,751, however lower than one year ago (2,675). The higher clearance rate and increase in volumes this week were attributable to stronger results across the two larger auction markets of Melbourne and Sydney, with performance across the remaining capitals remaining varied over the week.
Considering the slowdown in auction markets over previous weeks as well as widespread speculation that the housing market is moving through its peak, the final auction clearance rate, published by CoreLogic on Thursday, will be an important follow up to this strong preliminary result.
The New Zealand Reserve Bank has announced it is undertaking a comprehensive review of the capital adequacy framework applying to locally incorporated registered banks over 2017/18. The aim of the review is to identify the most appropriate framework for setting capital requirements for New Zealand banks, taking into account how the current framework has operated and international developments in bank capital requirements.
The Capital Review will focus on the three key components of the current framework:
The definition of eligible capital instruments
The measurement of risk
The minimum capital ratios and buffers
The purpose of this Issues Paper is to provide stakeholders with an outline of the areas of the capital adequacy framework that the Reserve Bank intends to cover in the Capital Review, and invite stakeholders to provide initial feedback on the intended scope of the review, and issues that might warrant particular attention. As feedback is received and decisions are made, some of these issues might fall away or be given a lower priority.
Detailed consultation documents on policy proposals and options for each of the three components will be released later in 2017, with a view to concluding the review by the first quarter of 2018.
Basis and framework for capital regulation
The Reserve Bank has powers under the Reserve Bank Act 1989 to impose capital requirements on registered banks. The Reserve Bank exercises these powers to promote the maintenance of a sound and efficient financial system, and to avoid significant damage to the financial system that could result from the failure of a registered bank.
The capital adequacy framework for locally incorporated registered banks is set out mainly in documents BS2A and BS2B of the Reserve Bank’s Banking Supervision Handbook. The framework is based on, but not identical to, an international set of standards produced by the Basel Committee on Banking Supervision.
The framework imposes minimum capital ratios. These are ratios of eligible capital to loans and other exposures. Exposures are adjusted (risk-weighted) so that more capital is required to meet the minimum requirement if the bank has riskier exposures.
The high-level policy options raised in this Issues Paper have the potential to result in reasonably significant changes to the New Zealand capital framework. It is expected, however, that any changes are likely to occur within a Basel-like framework.
The Reserve Bank invites submissions on this Issues Paper by 5pm on 9 June 2017
APRA’s latest curb on interest-only loans aims to reduce risk in the mortgage market, but several leading brokers have told The Adviser that all is not what it seems.
When the Australian Prudential Regulation Authority (APRA) announced in March that it expected banks to limit the flow of new interest-only loans to 30 per cent of total new mortgage lending and place limits on LVRs above 80 per cent, several brokers wrote to The Adviser about their thoughts on the new supervisory measures.
Some brokers opined that there is still a place for interest-only (IO) loans, as long as the reasons behind putting a customer in such a loan are sound.
There is place for IO loans
Chris Foster-Ramsay of Foster Ramsay Finance, said: “I think there is a place for IO loans for true IO purposes, but for cash flow purposes, which it has become, no, there’s not.”
His thoughts echo those of Brett Halliwell, general manager of Advantedge Financial Services, who said: “There is absolutely a part for [IO loans] in the market already and all sorts of brokers recommend it for different circumstances.
“[But], if I look at the regulators’ role (i.e. APRA and ASIC both together), it’s their role to be really ‘glass half empty’ a lot of the time, and while we are looking at the positives to the customer and why IO might make sense, there are negatives. And, when you look at the fact that we’ve had a really good run in Australia in economic conditions, that, at some stage, will turn.
“So, I don’t think that the regulator is saying that [IO loans] are necessarily bad, they’re saying there is a place for it, there needs to be different standards for it.”
Mr Foster-Ramsay added that he thought the changes had already “created a different direction in the market”, and predicted that “it won’t be too long before there is up to a 120-basis-point difference between an owner-occupier P&I loan and an IO investment loan”.
He continued: “I think the ability to get an IO facility will also become increasingly difficult… I’d go as far as to say that the IO facilities for 10 to 15 years are gone but we may see an IO facility for five years with a loading for the P&I for 25 years.”
Notably, some brokers have taken to The Adviser website to highlight several scenarios where they thought IO loans would be suitable (such as for customers buying a home to live in that could transfer into an investment property or for self-employed customers with lumpy income flow), but said that the crackdown has made them reluctant to advise clients to take out IO loans, even when they are suitable.
‘Precautionary not reactionary’
Other brokers said that they were not surprised by the new measures, with Aaron Christie-David, director at Atelier Wealth, stating that he had been recommending principal and interest (P&I) loans to his clients for the past year, in anticipation of the changes coming in.
He told The Adviser: “We were telling our clients last year that we would put them on P&I investment loans, because we could anticipate these changes were coming. Some brokers have been up in arms about it but they should not have been surprised that IO loans came under the microscope, it was a matter of time.
“If you have the cash you should be paying off debt as quickly as possible. That’s what the banks are telling people and that has been backed up by APRA and ASIC,” he said.
“If rates go up and you roll off an IO period in five years’ time, when rates probably would have risen, and you maybe have a child or have lost a job, that’s a recipe for disaster. Especially if no one will refinance them — your repayments could go up 30-40 per cent. That’s where I get concerned.”
He added: “People think these are reactionary measures in the market, but they’re almost precautionary measures for the future.”
Specialist lending broker Peter Ellis from Lending Mate said he thought the changes should have actually come in sooner, stating: “With property prices rising, and the speed at which they have been selling, something was bound to occur. More concerning, though, is how debt as a percentage of household disposable income is at 187 per cent (according to Reserve Bank figures)… if this was left unchecked we may have well seen a wider raft of changes instigated.
“The regulators have a hard job to do and no matter what move they make someone will always be unhappy. But, in the interests of the nation, some controls had to be put in place to stop property becoming a commodity. Personally, I think change was needed sooner, but better late than never.”
Others, such as Daiman McIntyre of Ruahine Finance voiced the opinion that different levers, other than speed limits, should have been put in place to reduce risk.
The Victoria-based broker said: “APRA (and ASIC) clearly have concerns in regards to residential investments, and are using the tools they have, which are industry wide and sledgehammer like, to implement a task that really needs much finer and delicate management that government tax policy might better address.
“Ideally government should be targeting negative gearing, and creating limitations on properties to produce a better, long-term result without restricting some segments of lending. Industry doesn’t buy equipment to lose money, so why is it almost encouraged in residential property?”
A key issue raised by Small Business and Family Enterprise Ombudsman Kate Carnell in her Small Business Loan Inquiry has caused the major banks to amend their SME loan contracts.
During the inquiry, Carnell spoke of her concern around non-monetary default clauses such as financial indicator covenants which linked defaults to aspects such as loan-to-valuation ratios.
For loans below $5m, banks must not default a loan if the small business customer has complied with loan payment requirements and has acted lawfully, she said. She also pressed banks to remove conditions that allowed them to invoke financial covenants or catch-all ‘material adverse change’ clauses. These changes would have to be made by 1 July.
Commonwealth Bank of Australia
The Commonwealth Bank of Australia (CBA) has said it will amend its small business lending contracts to address the issues raised by Carnell.
“We are simplifying our small business loan terms and conditions to make it easier for our customers. For almost all of our small business loans, financial indicator covenants will no longer be included in loan contracts and therefore will no longer be a possible cause of default,” said CBA business and private banking group executive, Adam Bennett.
“Even though we very rarely used these covenants as a reason to foreclose a loan, this means that we will be removing all references to them in our small business loan contracts where our exposure to the customer is below a value of $3m. We are doing this for all new and existing qualifying customers to provide greater transparency and certainty for small business.”
These changes will affect 95% of CBA’s small business customers and will advise all affected existing customers of the amended contracts.
Australia & New Zealand Banking Group
The Australia & New Zealand Banking Group (ANZ) has also reaffirmed its commitment to these changes especially around small business lending contracts.
“As we outlined before the Parliamentary Committee last month, ANZ will implement all 11 banking recommendations. This includes simplified contracts for new loans to small business customers being those with total business lending of less than $3m,” said ANZ general manager of small business banking Kate Gibson.
There will be no more financial indicator covenants for over 95% of the bank’s small business customers, she said. These conditions will remain in place for borrowers seeking complex business lending products.
“We are simplifying the contracts for our small business customers to make it easier for them to understand their loan terms, so they can be clear up front about their obligations for the life of their loan. We are working to implement all these changes by the end of the year.”
ANZ’s new contracts will also remove all general material adverse clauses while clearly outlining the reduced number of specific event clauses which could result in bank enforcement action if a breach occurs.
National Australia Bank
National Australia Bank (NAB) has also stepped up to say it will follow Carnell’s recommendations around SME lending.
The bank will remove all non-monetary covenants on loans for new and existing small business customers with total lending of less than $3m. This will improve transparency for 98% of all the bank’s customers.
NAB has also promised to rewrite its small business contracts in plain English by the end of the year.
“We’ve been working constructively with the industry to address concerns raised in the Small Business and Family Enterprise Ombudsman Kate Carnell’s Small Business Loans Inquiry report. We are proud to be helping lead the charge on this – including taking measures beyond the Ombudsman’s recommendation, by applying the measures to all new and existing loans,” said NAB executive manager of business direct and small business Leigh O’Neill.
The threshold of $3m is just right as it benefits the vast major of the bank’s business customers, she added, as loans above this amount are more complex and require a greater level of management.
Last Wednesday, the US House of Representatives’ Financial Services Committee held a hearing on the Financial CHOICE Act of 2017, which was introduced on 19 April and aims to provide banks relief from various provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act enacted in 2010.
The proposed legislation envisions a broad reduction in regulatory and supervisory requirements that would be negative for banks’ creditworthiness, increasing the potential asset risk in the banking system and the likelihood of a disorderly unwinding of a failed systemically important bank.
Increased likelihood of a disorderly bank resolution.
Among the CHOICE Act’s most notable provisions is the repeal of Title II of Dodd-Frank, including the orderly liquidation authority (OLA) to resolve highly interconnected, systemically important banks. Although the bill calls for a new section of the bankruptcy code to accommodate the failure of large, complex financial institutions, we believe that dismantling the OLA increases the likelihood of a disorderly wind-down of a failed systemically important bank with greater losses to creditors. Additionally, although the aim of repealing Title II is to end “too big to fail,” without the enactment of a credible replacement bank resolution framework, the actual effect could be the opposite.
A credible operational resolution regime (ORR) to replace OLA would require provisions specifically intended to facilitate the orderly resolution of failed banks and would provide clarity around the effect of a bank failure on its depositors and other creditors, its branches and affiliates.
The intent of OLA is to resolve failed banks as going concerns, preserving bank franchise value so as to limit losses to bank creditors and counterparties. If, under the new legislation, failed banks are liquidated instead of being resolved as going concerns, loss rates suffered by creditors would increase.
A disorderly resolution would also have greater repercussions for the broader financial markets and the economy. This suggests that although the intent of eliminating OLA may be to reduce the likelihood of future bank bailouts, absent an ORR we believe that the likelihood of a US government bailout of a systemically important US bank could actually increase.
A return to greater risk-taking, only partly offset by improved profitability prospects. The CHOICE Act would also ease restrictions on risk-taking by eliminating the Volcker Rule and rolling back the supervisory function of the US Consumer Financial Protection Bureau (CFPB), limiting it instead to the enforcement of specific consumer protection laws. Eliminating the Volcker Rule restrictions on proprietary trading could reverse the decline in banks’ trading inventories and private equity and hedge fund investments since the financial crisis. That decline in trading inventories has contributed to a decline in risk measures such as value at risk. How far inventories rebound and proprietary trading pick up will take time to become evident, but increased risk seems likely. Changes to the CFPB could also add risk by lifting the regulatory scrutiny that has caused banks to scale back or eliminate some riskier consumer lending products (such as payday advances).
The CHOICE Act also imposes a variety of restrictions and requirements on US banking regulators that could erode the robustness of US banking regulation. More generally, weakened supervision and oversight create the potential for increased asset risk in the banking system. From a credit risk standpoint, the resulting uptick in credit costs and tail risks from increased risk-taking would outweigh the potential boost to bank profitability from reduced compliance expenses and new revenue opportunities.
Less robust capital supervision and stress-testing.
The CHOICE Act calls for a reduction in the frequency of regulatory stress testing, and an exemption from enhanced US Federal Reserve supervision, including stress-testing, for banks with a Basel III supplementary leverage ratio of at least 10%. These measures would undermine the post-crisis Dodd-Frank Act Stress Test (DFAST) and Comprehensive Capital Analysis and Review (CCAR) regimes, which have driven both an increase in capital ratios and a more conservative approach to capital management.
We believe that DFAST and CCAR have been successful tools in reducing the risk of bank failures, not only improving capital and placing beneficial restrictions on shareholder distributions but, more importantly, stimulating vast improvements in banks’ internal risk management and capital planning processes. The DFAST and CCAR results are a useful, independent and public tool to analyze banks’ stress capital resilience over time. The public disclosures from these exercises are an important data point for creditors, the market and our own stress-testing analysis, and provide a strong incentive for bank management teams to closely manage and fully resource their stress-testing and capital-planning processes.
The federal government may be poised to unveil a special savings account and tax breaks for first home buyers in next week’s budget, despite government ministers refusing to confirm leaked reports in the media at the weekend.
With the housing affordability crisis close to the top of voter concerns, the federal Treasurer last week appeared to change focus from the housing sector to infrastructure, but those hoping to get into the housing market will be encouraged to hear the issue may be tackled, if in limited form only.
Reports suggested that Treasurer Scott Morrison’s upcoming budget would feature a provision allowing aspiring first home buyers to salary sacrifice in order to raise their needed deposits.
If that is true, it will be a case of back to the future, as a similar measure was introduced during Kevin Rudd’s first turn as prime minister before being scrapped by the Abbott government.
While Resources Minister Matt Canavan would not deal in specifics during a Sky News interview on Sunday, he stressed that home ownership would be a key theme of the upcoming budget.
“We are focused on making sure Australians can afford a home,” he said. “It is a fundamental principal.”
Under the Labor scheme, First Home Saver Accounts saw the government make co-contributions of up to $1020 (or 17 per cent) on the first $6000 that account holders deposited each year.
While there were tax concessions associated with the accounts, there were also restrictions around access to the funds, including that they were only to be used towards payment for first homes.
That scheme proved to be something of a disappointment. While Labor treasurer Wayne Swan predicted as many as 750,000 accounts would be established, only 46,000 had been opened when his successor, Abbott-era treasurer Joe Hockey, wound it up six years later in 2014.
And there was no shortage of critics, including the consumer group CHOICE, which complained in a submission to Treasury that it provided disproportionate assistance to high-income earners while doing little to help those who genuinely needed it.
“We are unaware of any evidence to suggest that sufficient savings are more difficult to achieve for higher-income earners,” CHOICE noted sarcastically.
Another criticism came from Treasury itself, which warned that the scheme as initially conceived would be complex to administer while not benefitting those on low incomes.
If the Turnbull government is indeed planning to revive home-saver accounts or something similar, the one near-certainty is that government contributions and associated tax breaks will need to be far more substantial if they are to have a positive impact than under Labor, when house prices were substantially less.
Despite First Home Saver Accounts being in effect for six years, Labor frontbencher Mark Butler insisted on Sunday that they had not had time to work – and, if something similar were to be re-introduced, it wouldn’t do much good anyway.
“The critical message is this,” he told the ABC’s Insiders, “you cannot deal with housing affordability in Australia without dealing with negative gearing.”
Greens senator Sarah Hanson-Young also rejected the notion that salary sacrificing would have a major effect.
“We have to bring the pressure down, not just give people more money to go straight into the hands of property investors.”
There’s been quite a bit of speculation over whether Australia has a property market bubble – where house prices are over-inflated compared to a benchmark – and when it might burst. According to housing experts, there’s at least four scenarios where this could happen.
Australia could see a property bubble burst due to:
Lending tightening, interest rate hikes and mortgage stress
Underemployment and unemployment creating a slow deflation
Government intervention failure and market repair
Global crisis
These four scenarios focus on different tension points in Australia’s and the global economy. One scenario focuses on the balance of actions between regulators like APRA and the Reserve Bank, combined with household mortgage stress. Another envisions the affect that unemployment might have in certain areas.
Some of the factors we may see play out, such as the federal and state government trying to intervene to “fix” problems in the market, as happens in one scenario. But other factors may be out of the government’s control, for example, where a global crisis pushes up risk premiums.
All of these scenarios highlight just how complicated and interrelated the steps that lead to a property bubble burst could be.
Lending tightening, interest rate hikes and mortgage stress
Associate Professor Harry Scheule, UTS Business School
Following increases in interest rates in the US and Europe, as those markets recover, the Australian dollar begins to decline – forcing the Reserve Bank of Australia (RBA) to increase interest rates.
Higher interest rates lead to higher monthly repayments, as most of Australia’s home loans are adjustable. Interest only loans are the most exposed. Higher interest rates also lead to more mortgage delinquencies.
The banks tighten bank lending standards in response to the increase in delinquencies. This further constrains interest-only borrowers seeking to refinance after the end of the interest-only terms. This means more mortgage stress, as many had expected to roll over the interest-only period indefinitely, but now they are forced to make principal repayments next to interest payments.
The cycle between delinquencies and tightening bank lending standards continues and as a result there’s a noticeable drop in loan supply and a fall in house prices.
Underemployment and unemployment create a slow deflation
Danika Wright, Lecturer in Finance, University of Sydney
Unemployment and underemployment – workers who want to work more but can’t – increase. As the apartment development boom dies down, and without a mining boom to replace it, construction industry workers are at high risk.
Households with a lot of mortgage debt are forced to limit their spending, particularly on discretionary items. This in turn affects companies that employ retail workers, reducing hours and employment.
Employment opportunities are a major component of house price amenity, in part because demand for housing is pushed higher by inbound work-related migration. So, as there are less jobs nearby, the amenity value of some areas decreases.
The amount of people at risk of defaulting on their mortgage increases in areas where there is a loss of employment or reduced income. In 2008, arguably the last time Sydney house prices went through a correction, the incidence of mortgage defaults and property price declines was geographically localised.
Borrowers who have the least amount of equity in their homes (typically the least wealthy, younger and newer entrants to housing market) are the hardest hit by falling property values. They are more likely to end up “underwater” – that is, owing more than the property is now worth – and face the prospect of a distressed sale. This in turn contributes to the downward spiral in house prices.
Australia has tighter lending criteria than regulators enforced before the global financial crisis in the United States. But concerns by regulators, including APRA, over current lending practices and potentially fraudulent activities raise questions over the real quality of mortgages and the ability of borrowers to repay them.
Government intervention failure and market repair
Professors of Economics, Jason Potts and Sinclair Davidson, RMIT
A combination of low interest rates and low growth in new housing stock drive up Australian housing prices, a situation compounded by poor policy choices by state and federal governments and high demand from foreign residential property investors.
As a result housing is misallocated in the Australian market, across demographic and especially age groups. This produces demographic pressures, as millennials delay leaving home, delay starting families. This leads to political pressure on governments – increases the urge to intervene.
The federal government intervenes, blaming the secondary drivers (particularly the non-voting group: foreign investors). They increase restrictions on foreign investment in residential housing stock.
The federal government also lobbies APRA to increase rules on financial products, while promoting a scheme to subsidise and promote first home ownership.
Because none of these previous measures from the federal government affect the primary drivers of the misallocation of housing, domestic interest rates don’t change, and state governments do not act to release new stock. As a result housing prices continue to grow.
Increasingly alarmed that house prices continue to rise, the federal government starts to panic, threatening ever further regulation and starts to blame the financial system. This triggers the RBA to finally act, raising interest rates.
As interest rates rise, this causes mortgage stress, resulting in default among investors with high amounts of debt, pushing these properties onto the market. These distressed sales finally cause prices to fall.
Global crisis
Timo Henckel, Research Associate, Centre for Applied Macroeconomic Analysis, ANU
International crisis (whether it be political, military, economic) leads to an increase in global risk premiums.
Borrowing costs for Australian banks rise because of this and supply of global capital falls, pushing up mortgage rates in Australia.
The most vulnerable mortgagees can no longer afford their mortgages and are forced to sell their homes.
House prices fall which, coupled with rising interest rates, adds further distress to households’ balance sheets, leading to more selling of houses and so on.
Authors: Jenni Henderson, Editor, Business and Economy, The Conversation; Wes Mountain, Deputy Multimedia Editor, The Conversation
Interviewed: Danika Wright, Lecturer in Finance, University of Sydney; Harry Scheule, Associate Professor, Finance, UTS Business School, University of Technology Sydney; Jason Potts, Professor of Economics, RMIT University; Sinclair Davidson, Professor of Institutional Economics, RMIT University; Timo Henckel, Lecturer, Research School of Economics, and Research Associate, Centre for Applied Macroeconomic Analysis, Australian National University.
