Martin North – Page 1045 – Digital Finance Analytics (DFA) Blog

APRA Hoses Down Macroprudential

The Australian Prudential Regulation Authority (APRA) has published the opening statement given to the Senate Standing Committee on Economics by Wayne Byres today. He appears to deflect focus from macro prudential intervention.

Recent comments in the Reserve Bank’s Financial Stability Review about emerging imbalances within the housing market, and the need to reinforce sound lending practices, has been interpreted in many instances as Australia being on the verge of macroprudential interventions of the type that have been instituted in a number of other jurisdictions around the world, such as hard limits on certain types of loans, or minimum deposit requirements for borrowers. While we are very much still in the investigation stage, and have not yet decided what further action we might need to take, I would like to make two points in response to the general commentary currently taking place:

First, within our regulatory framework APRA generally seeks to avoid outright prohibitions on activities where possible: instead, our regulatory philosophy is to focus on institutions’ setting their own appetite for risk. We also use the regulatory capital framework to create incentives for prudent lending and ensure that, while institutions remain free to decide their lending parameters, those undertaking higher risk activities do so with commensurately higher capital requirements. That is not to say that we would never use the sorts of tools being employed elsewhere, but they are unlikely to be the first ones we reach for.

That brings me to my second point responding to potential risks in the housing market in this way is not new. We see it as standard supervision. In the period from 2002 to 2004, for example, there was a similarly strong run-up in house prices, and similar concerns about higher risk lending and emerging imbalances. We’re doing now what we did then: collecting additional information, counselling the more aggressive lenders, and seeking assurances from Boards of our lenders that they are actively monitoring lending standards. We’re about to finalise guidance on what we see as sound mortgage lending practice, and we’ve conducted a comprehensive stress test of the largest lenders. The sources of risk are different this time around – last time we were focussed on low doc and no doc lending – but the response of higher supervisory intensity and regulatory requirements in the face of higher risk activity is not new. It is APRA doing its job.

We have already highlighted the potential to adjust capital risk weightings as a mechanism to control risk, and it may be that the upcoming G20 will decide on lifting capital weights. However, we believe there is a role for targetted macroprudential measures in the investment housing sector as the argument is not just about risk per se, rather it is the fact that in the current low rate environment too much lending is going into unproductive establishing housing investment, rather than lending for productive growth. This point was well made in the speech yesterday by Philip Lowe, RBA Deputy Governor in an address to the Commonwealth Bank of Australia’s 7th Annual Australasian Fixed Income Conference in Sydney – Investing in a Low Interest Rate World. He concluded:

Very low global interest rates have been with us for some time. And it is likely that they will stay with us for some time yet.

Fundamentally, this reflects the low appetite for real investment relative to the appetite for saving.

These low rates are encouraging investors to buy existing assets as they seek alternatives to bank deposits earning very low or zero rates. Asset prices have increased in response.

Some of this is, of course, desirable and, indeed, intended. But the longer it runs on without a pickup in the appetite for real investment, the greater is the potential for new risks to develop. During this period, while we wait for the investment environment to improve, we need to be cognisant of potential risks of asset prices running too far ahead of real activity. This is true in Australia, as it is elsewhere around the world.

The underlying solution is for an improvement in the investment climate. Monetary policy can, and is, playing an important role here. But ultimately, monetary policy cannot drive the higher ongoing expected returns on capital that are required for sustained economic growth and for reasonable long-term returns to savers. It is instead government policy – including in some countries, increased spending on infrastructure – that has perhaps the more important role to play here.

RBA Still On The Low Rate Trip

The RBA minutes of the 7th October meeting are out. The themes are familiar, and they continue to signal an ongoing period of low interest rates, and the importance of lending standards.

Growth in the global economy was continuing at a moderate pace. Commodity prices, in particular iron ore prices, had declined over the past month. This was consistent with both the ongoing increase in iron ore supply and further weakening of the Chinese property market, which is an important source of demand for steel. Global financial conditions remained very accommodative and the Australian dollar had depreciated somewhat, largely reflecting a broad-based appreciation of the US dollar.

As expected, the domestic economy had grown moderately in the June quarter, following a strong March quarter result. The outcome was supported by strong growth in dwelling investment and steady consumption growth. Members noted that more timely indicators suggested that moderate growth overall had continued into the September quarter.

Faced with volatility in the labour force survey results, members based their assessment of the labour market on a range of indicators. These suggested that conditions in the labour market remained subdued but had stabilised somewhat this year. While forward-looking indicators pointed to modest employment growth in the months ahead, there was a degree of spare capacity in the labour market and it would probably be some time before the unemployment rate declined consistently. Wage growth was expected to remain relatively slow in the near term, which should help to maintain inflation consistent with the target even with lower levels of the exchange rate.

Members noted that the current setting of monetary policy was accommodative, with lending rates remaining very low and continuing to edge lower over recent months as competition to lend had increased. In this context, members discussed the importance of lenders maintaining strong lending standards and the ongoing dialogue between the Bank and APRA on the matter.

Continued accommodative monetary policy was expected to support demand and help growth to strengthen over time. To date, this had been most apparent in the housing market, where dwelling investment had picked up and was expected to remain strong following the rapid rise in housing prices and high levels of approvals. Credit growth had remained moderate overall, but in recent months there had been a further pick-up in lending to investors in housing. Despite the easing in financial conditions associated with the depreciation of the Australian dollar, the exchange rate remained high by historical standards – particularly given recent declines in key commodity prices – and was offering less assistance than would normally be expected in achieving balanced growth in the economy.

Given the information available, the Board’s judgement was that the current stance of monetary policy continued to be appropriate for fostering sustainable growth in demand and inflation outcomes consistent with the target over the period ahead. Members considered that the most prudent course was likely to be a period of stability in interest rates.

Looks like rates will remain on hold for a few months more yet, and macroprudential controls on investment lending appear likely.

ASIC’s “Motherhood and Apple Pie” Strategic Outlook

ASIC has just released their Strategic Outlook. “Our Strategic Outlook sets out the trends shaping our regulatory focus and examples of our responses to key risks we see in 2014–15. Next financial year, we will build on this initiative and publish a detailed Risk Outlook and Strategic Plan.”

There is an interesting set of issues highlighted. For example, a statement about the potential for Digital disruption.

Traditional business models in financial services and markets are being disrupted by new digital strategies at an accelerating pace. In financial services, crowdfunding and peer-to-peer lending platforms are disrupting traditional ways of accessing capital. In our markets, we see digital disruption in high-frequency trading and dark liquidity. These strategies offer investors and financial consumers additional ways of interacting with our financial services and markets, create competition, and raise new challenges for firms and regulators. We expect continuing developments to create additional opportunities for digital disruption, including:

more advances and take-up in the use of mobile technology for financial transactions, online investment advice, and peer-to-peer platforms that connect investors and businesses seeking finance

increased use of ‘big data’ by financial services providers to customise their marketing, and

increased opportunities to engage and empower consumers through interactive data innovations, such as calculators and product comparison tools.

The potential of digitisation in the financial system is yet to be fully realised. Firms and regulators need to continue to work together to harvest the opportunities from digital disruption, while mitigating the risks – in particular, we need to think about how we achieve outcomes in an increasingly digital world.

They also highlight the main areas of potential risk, using a simple framework.

Poor conduct of some gatekeepers, companies, principals and intermediaries can jeopardise market integrity and investor outcomes

Weak compliance systems, poor cultures, unsustainable business models and conflicted distribution may result in poor advice, mis-selling and investor loss, especially in managed investments

Poor retail product design and disclosure and misleading marketing may disadvantage consumers, particularly at retirement

Innovation and complexity in product distribution and financial markets through new technology can deliver mixed outcomes for retail investors, financial consumers and issuers

Globalisation and cross-border businesses, services and transactions may lead to compromised market outcomes

Different expectations and uncertainty about outcomes in the regulatory settings can undermine confidence and behaviour

Whilst we cannot quarrel with these statements, DFA’s perspective is they are high-level and the devil will be in the detail. Given their critical market conduct role, it is important they get it right. Some recent events suggest they need to be more proactive. We also see contention between the various stakeholders they are required to consider.

The UK’s “Twin Peaks”

Speaking at the Kenilworth Chamber of Trade business breakfast event Andrew Haldane, the Chief Economist of the Bank of England, discussed developments in the labour market, and the implications for monetary policy in the United Kingdom. His perspective is important and relevant in the Australian context.

The main messages of Andrew’s speech are:

In June, as he made clear in a speech, he put even weight on moving interest rates sooner (which he termed being ‘on the front foot’) and moving interest rates later (being on the back foot). Three months on, the statistics now appear to favour the back foot.
Recent evidence, in the UK and globally, has shifted Andrew’s views about the likelihood of weaker outcomes. That reflects markdowns in global growth prospects and weak pipeline inflationary pressures, both from wages and prices internally, and energy and commodity prices externally. He is gloomier about demand and sees inflationary forces weakening in the near term. This implies that interest rates could remain lower for longer than he had expected three months ago, without endangering the inflation target.
Turning to the performance of the UK economy, Andrew notes various reasons to be cheerful: ‘growth at the top of the G7 league table’ and ‘well balanced between consumption and investment’; ‘borrowing costs at exceptionally low levels’; ‘employment up 1.8 million since its trough’ and unemployment falling from 8.4% to 6%, and expected to fall further. The combination of GDP growth, inflation and unemployment suggests that the economy is in ‘fine fettle’ and has only been bettered in 5 of the last 44 years.
But looking at a different set of indicators suggests ‘reasons to be fearful’. ‘Growth in real wages has been negative for all bar three of the last 74 months’. ‘The level of productivity is no higher than it was six years ago’. And real interest rates are around zero. This combination of poor economic outcomes is ‘virtually unprecedented going back to the late 1800s, with the exception of the aftermath of the world wars and the early 1970s.’
Andrew concludes that the economy appears to be ‘writhing in both agony and ecstasy. It is twin peaked’.
Looking forward he suggests that the key issue is which of these twin forces will win out. The Monetary Policy Committee’s forecast suggests that by 2017, ‘productivity growth and real wage growth are back to around 2% and real household deposit rates are in positive territory’ or in other words ‘the sun will come out tomorrow’. But Andrew notes that such forecast have been confounded in the past, and he also notes that the low level of expected real interest rates implied in the UK’s yield curve may reflect pessimistic assumptions about future growth prospects.
Turning to the labour market he finds more evidence of polarising patterns: ‘the upper peak of the labour market is clearly thriving in both employment and wage terms. The mid-tier is languishing in both employment and real wage terms. And for the lower skilled, employment is up at the cost of lower real wages for the group as a whole’.
Turning to the implications for interest rates, he suggests that financial market participants must weigh up the likelihood of the UK taking a strong path or a weak path – the twin peaks he has been discussing. ‘Over the past few months, the implied path for interest rates has shifted down’. ‘One interpretation of that move is the market now assigning a somewhat higher probability to the lower peak’. That is also his own assessment of how the balance of risks has shifted.

Refinancing; An Important Driver Of Housing Finance

We have been looking in detail at recent trends in housing refinance, by using a combination of the recently released ABS data and results from the DFA surveys. There is an interesting story to tell here. So today we explore the refinancing landscape. First the ABS data shows us that refinancing value has been increasing to a record $5.9bn in July 2014, and represents more than 30% of all owner occupied lending, and about 17% of all housing lending.

We also see that the state distribution is centered on NSW and VIC.

However, looking in percentage terms, there is only a small rise in NSW, and a fall in QLD.

Turning to our surveys, about 17.5% of refinacing are to fixed loans, the rest variable, either principal and interest or interest only. A considerable proportion of refinance deals are via brokers, with a record 74% in September.

Households with loans between $250k and 500k are likely to refinance, though those with larger loans are more likely to refinance their loan, compared with those with below $100k balances.

Turning to the loan type, the majority are refinancing to a principal and interest loans (P&I), though we note that those with larger balances are more likely to consider an interest only loan.

Looking in more detail, we see that brokers are more likely to initiate a conversation with a household on refinancing if the loan is larger. Many are driven by the need to reset the term (this relates to the industry practice of having a nominal 30 year term, with five year reviews, plus fixed term loans maturing). We also see a concern to reduce monthly payments, especially in the loans between 250k and 500k, and to release cash in the case of larger loans, especially above $750k, where we assume the capital appreciation in the property is most significant.

In the survey detail, we found that some were releasing capital to assist in the purchase of an investment property, or to assist others to purchase a property. Refer to the recent post on the Bank of Mum and Dad. Most households who were concerned about rates have already locked into fixed products, though many still preferred the variable rate product. We also found that more than 50% of households considering a refinance were ahead of schedule on their nominal monthly repayments. Those in the range 250k – 500k were least likely to be ahead.

Overall then, refinancing is a significant element in the property owning household sector, and yet there has been little discussion of this facet of the market, compared with first time buyers and investors.

Foreign Property Buyers Are Market Significant – nab

The results from the National Australia Bank’s latest residential property survey shows that foreign buyers are flocking to buy Australian property, snapping up one out of every six new homes – and that number is set to get higher.

Foreign buyers were more prevalent in new housing markets in Q3. Foreign buyers accounted for 16.8% of total demand (about 1 in 6 of all buyers), and this share is tipped to rise further next year (17.3%). Foreign buyers were more active in all states, especially VIC where they accounted for an estimated 24.8% of demand (or 1 in 4 sales). In contrast, local investors were less active in Q3, with their share of national demand falling to 27% (32.5% in Q2). Local investors accounted for a smaller share of demand in all states.

Foreign buyers were slightly more active in established property markets in Q3, with their share of total national demand rising to 8.2% (7.2% in Q2). Foreign buyer demand for established property increased in all states except NSW. VIC led the way, with foreigners accounting for a record high 11.5% of established property demand.

NAB chief economist Alan Oster said first-home buyers were not competing with foreign investors for property, because foreign buyers opt for high-end apartments – “they’re not buying cheap stuff”. It’s local investors creating the most difficulty for first-timers, he said, spurred on by low interest rates, superannuation changes and a tax system that encourages property investment.

While there are restrictions on what properties foreign investors can buy, the Foreign Investment Review Board has been criticised for failing to enforce those rules and a parliamentary inquiry into foreign investment in residential real estate is due to deliver its recommendations in November.

First Time Buyers Get The Investment Bug – Big Time

The most recent ABS data continues to underscore the fact that Owner Occupied First Time Buyers are sitting out of the market. In original terms, the number of first home buyer commitments as a percentage of total owner occupied housing finance commitments fell to 11.8% in August 2014 from 12.2% in July 2014.

However, this is not telling us the full story. We have been tracking the rise and rise of first time buyers who are going direct to investment property. The chart below shows the state of play, and the significant rise in the number of first time buyers going to the investment sector, especially in Sydney and Melbourne.

Another way to look at the data is the percentage of FTB who went for investment housing. In the latest data we estimate that around 30% of potential first time buyers went for the investment option. These are not identified in the official figures. I would also add that the small sample sizes prior to 2012 may impact the trend data, but the DFA samples, into 2013 and beyond are large enough to be meaningful and significant.

From our surveys, we found that:

1. Most first time buyers were unable to afford to purchase a property to live in, in an area that made sense to them and were being priced out of the market.

2. However, many were anxious they were missing out on recent property gains, so decided to buy a less expensive property (often a unit) as an investment, thanks to negative gearing, they could afford it. They often continue to live at home meantime, hoping that the growth in capital could later be converted into a deposit for their own home – in other words, the investment property is an interim hedge into property, not a long term play. Some are also teaming up with friends to jointly purchase an investment, so spreading the costs.

3. About one third who purchased were assisted by the Bank of Mum and Dad, see our earlier post. More would consider an investment property by accessing their superannuation for property investment purposes, a bad idea in our view.

Given the heady state of property prices at the moment, this growth in investment property by prospective first time buyers is on one hand logical, on the other quite concerning. We would also warn against increasing first time buyer incentives, as we discussed before.

Our analysis also highlights a deficiency in the ABS reporting, who are currently investigating the first time buyer statistics (because in some banks, first time buyers are identified by their application for a first owner grant alone). They should be tracking all first time buyer activity, not just those in the owner occupation category.

Payments Competition To Increase

The Treasury just released a consultation relating to Banking Amendment (Credit Card) Regulation 2014. Opening up access to non-ADIs is likely to increase competition and innovation in card issuing and acquiring, resulting in downward pressure on fees and charges, and better service to merchants and end users (which include consumers, business and government). Non-ADIs would also not be subject to the ongoing costs associated with supervision by the Australian Prudential Regulation Authority. We discussed the payments revolution recently. This is likley to put the existing players, namly the major banks under increased pressure.

The changes take effect on 1 January 2015. Implementation of the new regulatory framework will require the Payments System Board of the RBA to vary the Credit Card Access Regimes to provide for reporting requirements and disclosure of eligibility and assessment criteria for Scheme membership. The Australian Payments Clearing Association will also need to vary related Bulk Electronic Clearing System rules to allow certain non-ADIs to continue to participate in the system after the removal of the SCCI framework.

The exposure draft legislation would amend the Banking Regulations 1966 (the Regulations) to open up credit card issuing and acquiring to non authorised-deposit-taking institutions (ADIs). The reforms will allow non-ADIs to become credit card issuers and card acquirers in the Visa and MasterCard credit card schemes.

The exposure draft will revoke Regulation 4 of the Regulations, which provides that credit card acquiring and issuing is ‘banking business’ and triggers supervisory requirements of the Australian Prudential Regulation Authority. The exposure draft also makes a number of consequential amendments to the Regulations as a result of the revocation of Regulation 4.

All new entrants will need to meet the same consumer credit regulations that currently apply to banks (including specialist credit card institutions) under the National Consumer Credit Protection Act 2009. The proposed credit card access reforms will not alter these general consumer credit protections. The card schemes will be responsible for determining which entities may become card issuers or acquirers under their schemes, subject to a risk management framework imposed by the Reserve Bank of Australia (RBA).