Martin North – Page 1035 – Digital Finance Analytics (DFA) Blog

Housing Sector Likely To Stall

Reflecting on the ABS data released today, and already covered here, and putting that into context of our household surveys, we think momentum is changing and the housing sector could stall in coming months. Demand for new finance fell 0.8% in May. Whilst refinancing remains quite buoyant, thanks to low rates, investors appear to be slowing, as already foreshadowed in our surveys.

First time buyers are still at low levels,

and they are still priced out of the market.

The current low interest rates and rising prices have together encouraged households to transact sooner than they might otherwise would, pulling transactions forwards, but this won’t last.

So, if future demand is not coming from first time buyers and investors, where will demand come from? Well, we know there are many households who would like to enter the market, but cannot because prices are too high, these property inactives won’t change their tune anytime soon. Will foreign investors keep the property ship afloat? The problem here is there is little good data on overseas investors, and in any case, is this sensible policy? The contribution which SMSF investors might make will hardly move the dial.

We also know that unemployment is up, and likely to continue to trend this way, which directly impacts households and mortgage stress. In addition consumer confidence is not that flash.

We think interest rates may be taken down by the RBA later in the year, but lower rates wont bring more households out of the woodwork because the banks won’t relax their serviceability buffers any further.

Putting all this together, it is likely we are at the top, and both house prices and lending will probably reverse later in the year. This creates a massive problem for the RBA who were banking on housing being the economic bridge between the end of the mining boom and the return to growth from other commercial sectors.

We should have implemented policies to stimulate the commercial sector earlier, rather than inflating house prices and the banks balance sheets with unproductive lending. Lending to business returns growth to the economy, flowing funds to inflated housing does not.

Housing Finance Up To $1.3 Trillion In May – ABS

The ABS released their latest housing statistics today. Total ADI lending now tops $1.3 trillion. Investment lending has reached a new high at 33.8% of all loans. The trend estimate for the total value of dwelling finance commitments excluding alterations and additions rose 0.2%. Investment housing commitments rose 0.3% and owner occupied housing commitments rose 0.2%. However, In seasonally adjusted terms, the total value of dwelling finance commitments excluding alterations and additions fell 0.8%.
There were some state variations in owner occupation loans, but in percentage terms there is more noise in the data from the smaller states. NSW, QLD and SA were up from the previous month, whilst VIC and TAS fell month on month.

The proportion of fixed rate loans remain elevated, but off its 20% high in 2013.

First time buyers were slightly higher in May, but still lower than average and close to all time lows.

Investment lending is still a significant factor, with close of 33.8% of lending for investment purposes. This is an all time record for investment lending.

The banks have a greater proportion of investment lending …

compared with credit unions or building societies.

The stock of total ADI housing lending is now above $1.3 trillion in original terms.

Finally, note there is an investigation into the first time buyer data. The ABS advise that in collecting this information, lenders are asked to report all loans to first home buyers. Concerns have been raised that under-reporting could occur if some lenders were only able to accurately report on those buyers receiving a first home buyer grant. Most data on first home buyers are collected by the Australian Prudential Regulation Authority (APRA) under the Financial Sector (Collection of Data) Act 2001. APRA is contacting lenders on behalf of the ABS to investigate whether lenders experience any difficulties reporting on loans to first home buyers. The outcomes from the investigation will be published on the ABS website.

UK Rates Kept at 0.5%; QE Continues

Today the Bank of England announced that it would maintain Bank Rate at 0.5% and the size of the Asset Purchase Programme at £375 billion.

The previous change in Bank Rate was a reduction of 0.5 percentage points to 0.5% on 5 March 2009. A programme of asset purchases financed by the issuance of central bank reserves was initiated on 5 March 2009. The previous change in the size of that programme was an increase of £50 billion to a total of £375 billion on 5 July 2012.

In March 2009, the Monetary Policy Committee (MPC) announced that it would reduce Bank Rate to 0.5%. The Committee also judged that Bank Rate could not practically be reduced below that level, and in order to give a further monetary stimulus to the economy, it decided to undertake a series of asset purchases.

Quantitative Easing Explained

Between March and November 2009, the MPC authorised the purchase of £200 billion worth of assets, mostly UK Government debt or “gilts”. The MPC voted to begin further purchases of £75 billion in October 2011 and, subsequently, at its meeting in February 2012 the Committee decided to buy an additional £50 bn. In July the MPC announced the purchase of a further £50bn to bring total assets purchases to £375 bn. The purpose of the purchases was and is to inject money directly into the economy in order to boost nominal demand. Despite this different means of implementing monetary policy, the objective remained unchanged – to meet the inflation target of 2 per cent on the CPI measure of consumer prices. Without that extra spending in the economy, the MPC thought that inflation would be more likely in the medium term to undershoot the target.

This policy of asset purchases is often known as ‘Quantitative Easing’. It does not involve printing more banknotes. Furthermore, the asset purchase programme is not about giving money to banks. Rather, the policy is designed to circumvent the banking system. The Bank of England electronically creates new money and uses it to purchase gilts from private investors such as pension funds and insurance companies. These investors typically do not want to hold on to this money, because it yields a low return. So they tend to use it to purchase other assets, such as corporate bonds and shares. That lowers longer-term borrowing costs and encourages the issuance of new equities and bonds to stimulate spending and keep inflation on track to meet the government’s target.

The Bank will continue to offer to purchase high-quality private sector assets on behalf of the Treasury, financed by the issue of Treasury bills.

A video on Quantitative Easing is available.

Unemployment Up In June, Slightly.

The ABS released their Labour Force statistics for June 2014 today. Australia’s seasonally adjusted unemployment rate increased by 0.1 percentage points to 6.0 per cent in June 2014

The seasonally adjusted labour force participation rate increased by 0.1 percentage points to 64.7 per cent in June 2014. The number of people employed increased by 15,900 to 11,578,200 in June 2014 (seasonally adjusted). The increase in total employment was due to increased female employment (both full-time and part-time) and increased male part-time employment, offset by a fall in male full-time employment. Part-time employment increased by 19,700 people to 3,515,700 and full-time employment decreased by 3,800 people to 8,062,500.

The ABS monthly seasonally adjusted aggregate hours worked series increased in June 2014, up 15.1 million hours (0.9 per cent) to 1,629.1 million hours. The seasonally adjusted number of people unemployed increased by 20,300 to 741,700 in June 2014.

There are still considerable state variations, with unemployment lowest in the ACT (3.3%) and WA (4.9%), and highest in TAS (7.3%) and SA (6.8%).

As unemployment creeps higher, more households with large mortgages will be under pressure. We will be updating our mortgage stress modelling shortly.

ASIC Warns On Super And Managed Investment Fees

ASIC today released a report into fee disclosure practices for super and managed investments. The intention of the fee and cost disclosure requirements is to promote comparability of products. However, ASIC’s review of industry practices indicates that there is significant variation in the disclosure of fees and costs. A key driver of this variation is the frequent complexity of the operational and investment structures of funds. In addition, data quality and differences in the interpretation of the fee and cost disclosure requirements can also lead to variations in disclosed fees. As a result, DFA’s take on the report is that investors need to be very careful when comparing products. ASIC makes a number of significant observations. Remember this is a $2,338.8bn industry, and fees have a profound impact on the overall returns from an investment.

The reporting of fees and costs in underlying investment vehicles has been an area of significant concern. The fees and costs that are generally disclosed in a fund-of-funds arrangement are the fees and costs of the fund-of-funds manager, and not the fees and costs associated with the underlying funds. As a result, fees and costs may be understated by as much as 0.20%–0.40% annually.
The disclosure of indirect costs provides investors with a more accurate representation of the overall fee burden associated with each product and allows for increased comparability across funds.
Whilst difficult, APRA expects trustees to make all reasonable efforts to obtain information about their investments beyond the first non-connected entity.
The disclosure of management costs is an area of significant concern for ASIC. Anecdotally, it has been alleged that there are instances of costs being manipulated to present investors with a product that appears to be more financially attractive than it really is.
These disclosure practices can be fundamentally misleading because they reduce the amount disclosed as management costs and do not accurately portray the cost of individual products. They also prevent investors from being able to accurately compare superannuation or managed investment products against each other.
There is also a lack of clarity in the industry regarding how future performance fees should be determined and disclosed. Currently, a number of alternative methods are used to determine future performance fees, and this can result in significantly different projections across superannuation funds. One common practice is for superannuation funds to disclose the previous year’s performance fees as a reflection of what will occur in the current year. ASIC considers the adoption of this practice may lead to misleading results because it implies that past performance fees are indicative of future performance fees.
Inconsistency in the disclosure of fees in relation to the treatment of tax undermines the purpose of the Stronger Super reforms because it prevents investors from accurately and confidently comparing fee structures between superannuation funds.
The disclosure of fees net of income tax assumes that all investors receiving the PDS will be entitled to a share of the reduction in income tax resulting from the costs that the fees pay for. However, only investors who have received taxable income during the year into their superannuation account—such as positive investment returns or taxable contributions (e.g. employer contributions)—are entitled to a reduction in income tax. ASIC considers the disclosure of fees net of income tax to be misleading to investors who are not entitled to a reduction in income tax.
ASIC encourages industry to develop industry standards for good practice in fee and cost disclosure for superannuation funds and managed investment products.

We discussed the questions of fees in the light of FOFA recently. The ASIC report provides further evidence that improvements need to be made.

Increasing Competition In Banking – Lessons From The UK

The UK Prudential Regulation Authority (PRA) and Financial Conduct Authority (FCA) have today published a review of the changes introduced last year which were put in place to reduce the barriers to entry for new financial institutions. The purpose of the measures was to enable increased competition in the banking industry, to the benefit of customers. The changes focussed on two key areas: reforms to and a simplification of the authorisation process for new banks; and a major shift in the prudential regulation, such as capital requirements, for new entrants.

The two areas of focus were:

A new ‘mobilisation’ option where authorisation is granted when a firm has met key essential elements but with a restriction on their activities due to some areas still requiring completion.
Capital and liquidity requirements for new entrants are now lower than before, but are set against a requirement for a firm to show the regulators that it has a clear recovery and resolution plan in place in the event of it getting into difficulty in the future.

In the twelve months following the changes, the PRA authorised five new banks and there has been a substantial increase in the number of firms discussing the possibility of becoming a bank with the regulators. In the twelve months to 31 March 2014 the regulators held pre-application meetings with over 25 potential applicants. These firms have a range of different business models from retail and wholesale banking to FCA-regulated Payment Services firms who are looking to enter the banking market and offer deposits and lending to their current client base (including small SMEs) and others who are proposing to offer a mixture of SME or mortgage lending funded by retail and SME deposits.

The minimum amount of initial capital required by a new entrant bank is £1m compared to £5m under the previous regime. The on-ramp strategies have been helpful for applicant firms that may previously have faced challenges in raising capital or investing in expensive IT systems without the certainty of being authorised.

The PRA intends to publish statistics regarding banking authorisation annually.

In the Australian context, we know from recent client work that potential new entrants face a stiff climb to gain access to the local market. Consideration should be given to given to emulate the UK approach, because we need greater competitive tension in Australian banking.

Why FOFA Matters So Much

Last week, the Future of Financial Advice regulations were tabled in Parliament, following the recently published Senate review. As currently incarnated they have the potential to drive a coach and horses through the original intentions of the FOFA reforms. Today we explore why this is so, and highlight some of the consequences for both the managed funds industry and investors.

First, we need to remember that according to the ABS, as at 31 March 2014, the managed funds industry had $2,338.8bn funds under management, an increase of $31.3bn (1%) on the December quarter 2013 figure of $2,307.5bn. This is the marked to market value of the overall portfolio, helped by the facts that S&P/ASX 200 increased 0.8%; the price of foreign shares, as represented by the MSCI World Index excluding Australia, increased 0.6% and the A$ appreciated 3.1% against the US$. Here is the trend chart from the ABS series.

Looking at the splits by type, superannuation is the largest contributing element, with 74% of the total, or $1.706.1bn. This is not surprising seeing as we have a forced savings scheme for households.

The ABS also show the industry flows in their report. Local Investment Managers have $1,520 bn invested, whilst $828.6 bn are invested with managers overseas, or directly into the market.

There has been considerable consolidation in the managed funds industry, looking at the managers themselves, the financial planners, and the wealth management platforms. The big banks are estimated to have about 80% of the financial planners, and are behind the bulk of the wealth management platforms and fund managers. This significant industry concentration is bad for competition, households and savers. We discussed this at length in our earlier series on superannuation. This is part of a wider consolidation within financial services, and should not have been allowed to happen, because such value chain consolidation allows a small number of players to control the industry, reduce competition and keep fees high. We recently covered the question of wealth management fees, those in Australia are significantly higher than elsewhere, despite the higher savings per capita. There have also been reports of poor or fraudulent advice to investors, where advisors recommended their own solutions, even if they were not the best for the investor concerned. Of course the original FOFA proposals was a response to this. We covered the history of FOFA up to the recent Senate Inquiry here.

So, now lets look at the latest regulated changes. On 30 June 2014, the Government registered the Corporations Amendment (Streamlining Future of Financial Advice) Regulation 2014. These changes to the FoFA laws were effective from 1 July 2014, and note they are yet to be tested in the Senate, maybe the regulatory amendment approach was seen as a way to avoid scrutiny. The changes are

to remove the Opt-In requirement;
to require Fee Disclosure Statements (FDS) to apply prospectively – for new clients from 1 July 2013 only;
to remove the requirement to satisfy section 961B(2)(g) (the ‘catch-all’ provision) from the best interests duty;
to allow for scaled advice;
to amend the grandfathering regulations in order to remove the current restrictions on trade for financial planners who may change employers/licensees, and enable fair market competition for financial planners selling their business;
to ban commissions on investment and superannuation products, and eliminate the possibility of a re-introduction of these commissions through the previously proposed general advice exemption.

The Governments position is that financial planners will continue to provide advice in the best interests of their clients, without the catch-all provision, and that as commissions have been banned for providing general advice, (despite the fact that advisors may receive other remuneration options and bonuses), they will not be conflicted. Therefore, the changes will reduce the costs of advice, and provide greater access to potential investors.

We are not convinced. In fact, we think that the latest adjustments will lead to confusion in the industry, enable the large banks to continue their consolidation and control of the industry, and will lead to investors potentially being given poor advice.

First, it will be easy to get round the ban of commissions. The original FOFA would have outlawed financial planners working in the banks to receive any reward for suggesting their own products. In addition, any fees or commissions would have had to be disclosed. Now, planners can provide general product advice, and get rewarded. In addtion, bank tellers, and other bank employees are now able to receive bonuses for selling products under general advice, provided they have an appropriate “target” and it is not called a commission. This creates a conflict.

Second, the original FOFA did not really separate specific advice (where a planner takes the history and needs of a client, to work out what their best investment strategy might be) and general product advice, or splitting advice from product sales. Product sales were overlaid with considerable obligations and requirements, more befitting advisors. In addition, people selling products could not be rewarded for achieving sales (as happens in most sales environments). What should have happened was a clear distinction between sales and advice, with sales able to be remunerated, but advisors not. Advisors would never sell products, so could not be conflicted.

The proposed changes which the Senate Inquiry considered were to allow planners to receive a proportion of their income from product sales, with the caveat that it should be in the best interests of the client. However, now in the regulated clauses, this best interest element has gone missing. Because the best interest clause has been removed, financial planners are now able to point potential investors to their own bank products, provided they meet their savings requirements, even if they are not the best products. So, a planner has no obligation to point to the best product in the market, even if that is with a competitor.

So, the amendments as currently in the regulations, work in favour of the big banks, means that planners can remain conflicted, tellers can sell products, and the potential to release real competitive tension into the market as products would have be compared cross market (with an bias towards cheaper?) are all gone.

We can only hope the new Senate will have the chance to review and change the regulations. The really interesting question, is whether the latest round of changes reflect a poor understanding of how the wealth management industry works, or whether the big banks, protecting their own highly profitable enterprises have lobbied successfully. Remember wealth management fees in Australia are three times higher than they should be!

Whilst Bank Margins Improve Significantly, Most Households Do Not Benefit

Using the updated RBA chart pack data, we can see the movements in deposits, lending and funding, all elements impacting bank profitability and their customers. We see that funding costs are down, deposit returns are down, whilst headline lending rates are static. This is creating an opportunity for banks to discount selectively to attract target housing lending. Looking in more detail, margins on personal loans have increased, with no change to the average rate since 2012, despite the fall in funding costs and the target rate since then. Average mortgage rates have not changed since September 2013, again despite falls in funding costs. Deposit rates have been falling recently as can be seen from the chart. Small business lending rates are still very high. This is creating significant profit for the banks.

In addition, wholesale bank funding costs are lower than they have been since 2007, and we are even seeing improvements in the costs of securitisation, as well as debt based funding. We recently published an update to our series on mortgage discounting, and we highlight again the wide range of margins available depending on the particular transaction involved. Large home loans, and investment property loans appear to attract the biggest discounts. Small business on the other hand find it hard to get any reduction in interest rates.

Those with the capacity to switch have the potential to negotiate quite a discount, but those unwilling or unable to switch are unable to take advantage of the lower rates, so continue to be locked into high rates, which flow direct to the bank’s bottom line. And remember, according to the BIS, we have some of the most profitable banks in the western world. Clearly competitive tension is insufficient to drive down margins for most households. I will be interested to see if the current Financial Sector Inquiry discusses the question of completion in banking as it looks to me to be a major issue, which is costing Australia Inc, dear. Banks were quick to put their rates up when needed, but the reverse is not true.

Banco Santander to refer small UK businesses to peer-to-peer lender

Further evidence of the continued importance of peer to peer lending is highlighted by the news that Spanish based bank, Banco Santander will start referring small UK businesses to peer-to-peer lending service Funding Circle as part of a new partnership between the two firms. As we highlighted in our recent review of the development of peer to peer lending, Funding Circle is an online marketplace for business loans aimed at small companies. Funding Circle, as a quid pro quo will point customers to Santander for day-to-day banking services such as advice, cash management or expertise.

“SMEs need access to multiple sources of finance, and Santander’s partnership with Funding Circle is a good example of how traditional and alternative finance can work together to help the nation’s SMEs prosper,” said Santander UK CEO Ana Botin. “Peer-to-peer financing is also a useful way to introduce people to the concept of investing in entrepreneurs; an important element in a healthy enterprise economy.”

So far Funding Circle has lent £306m to more than 5,000 businesses. The company says the opportunity is still massive, citing research estimating that some 250,000 businesses could qualify for alternative funding in the UK each year. The model has piqued the UK government’s attention, with the British Business Bank, which it backs, investing GBP60m (USD101m) to fund 10% of all business loans made on Funding Circle. This offers an alternative channel to funding to businesses which find it difficult to obtain financing through traditional channels. The traditional British banks seem unwilling to provide sufficient credit to small and medium-sized enterprises (SMEs) and the UK government is considering making it compulsory for them to direct failed loan applicants to alternative institutions, such as peer-to-peer lenders.

Funding Circle include the following facts on their web site (correct as at 1 May 2014):

~30,000 active investors registered with Funding Circle
The average amount an active investor has in their account is £6,000
Average net return is 6.1%* after fees and bad debt but before tax
Investors recently exceeded a total lending of £270 million
£130 million of this total was lent in 2013 alone
4,000+ businesses have borrowed via Funding Circle
More than £20 million lent to small businesses every month

Average loan amount is approximately £60,000
Approximately 1.4% bad debt ratio
The peer-to-peer lending industry is tripling in size each year, and has the potential to become worth over £12 billion per year within a decade according to independent research by Nesta
The top three platforms alone have already completed almost £1 billion of lending to date and will help lend another £1 billion over the next 12 months

Detailed Funding Circle Statistics are available here.

Will The Next Rate Movement Be Down?

Today Glen Stevens spoke at The Econometric Society Australasian Meeting and the Australian Conference of Economists in Hobart. He gave an economic update, and included a number of messages which when taken with economic data from the ABS today, suggests that interest rates may be cut later in the year.

Here are a few of his points:

“the most recent set of GDP figures, while certainly encouraging, probably overstate somewhat the true ongoing pace of growth in the economy. The Bank’s forecasts from early May, which we have not materially changed, embody ongoing growth but, in the near term, probably a little below trend”.

“The cash rate measured in ‘real’ terms is approximately zero. In either nominal or real terms the cash rate is well below ‘normal’ levels, and comfortably below even the mooted lower ‘new normal’ levels. Moreover, we still have ‘ammunition’ on interest rates – we have not got close to the zero lower bound that has afflicted some other countries”.

“Now, the terms of trade are falling, and the investment part of the boom has peaked. Mining investment, as a share of GDP, has probably already declined by about 1 percentage point, and is expected to fall by another 3 or 4 percentage points over the next few years”.

“Consumer demand has been rising moderately, even if recently perhaps a little more slowly than it did over the summer. Residential construction is moving up strongly, and intentions to invest outside the resources sector have started to improve, from very subdued levels. The labour market has also shown some early indications of mild improvement. But these signs remain early ones”.

“the exchange rate remains high by historical standards. There is little doubt that significant parts of the trade-exposed sectors still find it quite ‘uncomfortable’: it continues to exert acute pressure for cost containment, productivity improvement and business model change. When judged against current and likely future trends in the terms of trade, and Australia’s still high costs of production relative to those elsewhere in the world, most measurements would say it is overvalued.”

” if we think there is a need for higher construction, which we do, an environment of declining prices is probably not conducive to that outcome. Some pick-up in housing prices as a result of lower interest rates was to be expected; it shows that monetary policy is working and is part of the normal transmission process”.

“investors should take care in the Sydney market, which is the main area where a large increase in borrowing has been occurring. The total value of credit approvals for investor loans in New South Wales as a whole is about 130 per cent higher than in 2008, and it is in the investor segment where there has been evidence of some increase in lending with loan-to-value ratios above 80 per cent in the past couple of quarters”.

“in forming expectations about future price gains and deciding their financing structure, people should not assume that prices always rise. They don’t; sometimes they fall”.

“banks and other lenders need to maintain strong lending standards. APRA has helpfully been reinforcing this point directly with bank boards, as well as stressing the importance of having adequate, higher, interest rate buffers in place, given the current very low level of rates in the market.”

“Overall, the Bank has not seen developments in the housing market as warranting higher interest rates than the ones we have had, in the current circumstances.”

So the bank is happy with the housing market, concerned about the exchange rate, and thinks growth will be below trend. The ABS data today showed Retail spending down a tad, and building approvals were down in current terms. Given the comment that there is room to cut further, a reduction in the benchmark rate looks quite likely.

But then the BIS Annual Report contained a waning that ultra low interest rates are not necessarily effective, and may themselves lay the foundations on the next global financial crisis. If rates were to be cut further, the case for deploying macroeconomic measures to control house prices would become even stronger.