Category: Banking Culture

Fitch Ratings downgrades Westpac, ANZ outlook

Credit rating agency Fitch Ratings has changed its outlook on Westpac and ANZ from “stable” to “negative”, following APRA’s update of its capital requirements for the major banks. Via InvestorDaily.

While the additional operational capital requirements should remain manageable for the banks, Fitch said the main driver for the changes were driven by a concern for governance and culture in the institutions. 

Westpac recently released its self-assessment on governance, accountability and culture, admitting significant shortcomings. 

The big four evaluated themselves last year when APRA chair Wayne Byres wrote to the country’s banks, insurers and super licensees after the CBA prudential inquiry. He asked them to determine whether weaknesses uncovered at CBA existed in their companies. 

The result of the self-assessments led APRA last week to increase the minimum capital requirements by $500 million and prompted Westpac to release publicly its self-assessment. 

ANZ is the only bank of the big four which has yet to publish its self-assessment.

“The additional capital requirements should remain manageable and not impair the bank’s ability to meet APRA’s ‘unquestionably strong’ targets starting in 2020, but it indicates material shortcomings in operational risk management, which were not aligned to what Fitch had previously incorporated into its ratings,” Fitch said in its update on Westpac. 

“This has resulted in a downward revision to our score for management and strategy and weaker outlook on earnings and profitability.” 

The rating agency made a similar note on ANZ, saying APRA’s findings indicated deficiencies within both companies’ management of operational and compliance risks, culture and governance.

However, Westpac said Fitch’s affirmation of its rating at AA- meant despite the challenges the bank faces, the credit agency expects it to “maintain its strong company profile in the short term, which in turn supports its strong financial profile.”

Likewise, ANZ was reaffirmed at AA- for both its banking group and New Zealand company. Fitch stated the group “continues to have robust risk and reporting controls around other risks, including credit, market and liquidity risk, as reflected by its conservative underwriting standards and very high degree of asset quality stability.”

Separately, on 9 July S&P Global Ratings affirmed the AA- long-term and A-1+ short-term issuer credit ratings and revised its outlook on the major Australian banks to “stable” from “negative.”

Westpac commented: “This outlook change reflects S&P’s view that the Australian government remains highly supportive of Australia’s systemically important banks based on APRA’s release on loss absorbing capacity.”

RBA On Household Debt And Financial Stress – FOI

The RBA released a freedom of information request today. They say:

Household debt-to-income has drifted up, to 190 per cent (Graph 1 – broad measure, includes debt of unincorporated enterprises, new migrants’ offshore debt, HECS and to non-financials).

More frequently we cite housing debt-to-income which has increased to over 140 per cent (up 23 percentage points over five years) (Graph 2); net of offset accounts this is around 130 per cent (up 16 percentage points over five years).

High income and wealthy households hold a large proportion of household debt (Graph 3). In 2015-16 the top income quintile accounted for about 40 per cent of total debt and the top wealth quintile owed one-third of total debt; this share has been stable over time.

Debt servicing ratios have been broadly steady: falling rates offset rising debt.

Aggregate mortgage prepayments (offsets and redraws) are equivalent to 18 per cent of outstanding mortgages and nearly 3 years of scheduled repayments at current interest rates (Graph 4). One-third have no buffer: many are investors, on fixed-rate or new borrowers. Largest buffers typically: wealthier, higher income and more seasoned mortgages.

The housing non-performing loan (NPL) ratio has increased since the end of 2015 (mostly WA), but remains below the most recent peak in 2011 (Graphs 5 and 6).

NPL ratios for personal loans and credit cards remain high relative to recent history (personal credit is only about 4 per cent of banks’ household lending).

Broad data sources suggest the number of households experiencing financial stress has fallen over the past decade, but there are regional variations. Household Expenditure Survey (2015/16): the number of households experiencing financial stress has fallen steadily since the mid-2000s (Graph 7). HILDA (2016): measures of financial stress are little changed over the decade and are lower than the early 2000s (Graph 8).

ASIC’s recent report on credit cards links problematic debt with multiple credit card usage, corroborating messages from liaison (but overall more households are paying off each month).

Some private surveys point to rising mortgage stress. These surveys are timely but their methodologies often seem to overstate financial stress (e.g. using actual, rather than required mortgage payments, which include prepayments).

Concerns about stress when IO loan converts to a principal-and-interest (P&I) loan. Required repayments are estimated to increase by 30-40 per cent (about $7,000 per year) for a ‘representative interest-only borrower with a $400,000 mortgage converting to P&I.

Based on loans in the Securitisation Dataset, a large share of borrowers should qualify for an IO extension or could refinance with a different lender.

Borrowers that can’t meet new lending standards and are unable to service P&I repayments might sell their properties or default. We estimate this is a small group (eg borrowers with multiple highly leveraged investment properties).

Tighter lending standards are unlikely to bind for borrowers that: undertook a serviceability assessment at loan origination that already took into account the step up in repayments at the end of the interest-only periods (as APRA has required for all such assessments since end 2014); Did not borrow (close to) the maximum loan size available to them; Have experienced income growth since the loan was originated; Have made prepayments on their loans; and/or Were assessed for their original loans at significantly higher interest rates than current assessment rates.

Most borrowers will have positive equity given the rate of housing price growth over the last five years.

The RBA FOI On First Home Loan Deposit Scheme

The RBA just released a FOI relating to the Federal Government’s proposed First Home Loan Deposit Scheme. How many loans might be made?

“the point of the estimates is that the various caps on the scheme (10,000 loan cap, income and house prices) are likely to be the binding constraint on the amount of loans provided rather than the scheme’s equity funding”.

To provide some context:

Based on ABS numbers, in the year to February there were 110,000 loans to first home buyers. The average loan size in February to FHB was $337,412. Usual caveats apply to these data.

Using the average loan size to FHB and assuming the scheme covers 15 per cent, the government will guarantee around $50,000 per loan. If the scheme has $500 million in funding, this implies

– 9,879 loans if the scheme holds reserves covering 100 per cent of its commitments.
– 49,395 loans with 20 per cent reserves.
– 98,790 loans with 10 per cent reserves.
– 197,583 loans with 5 per cent reserves.

Average loan size data are biased downwards, so can use average house prices instead as arguably an upper bound. In the December quarter ABS average house prices were $650,000. 15 per cent of this is $97,500.

– 5,128 loans if the scheme holds reserves covering 100 per cent of its commitments.
– 25,641 loans with 20 per cent reserves.
– 51,282 loans with 10 per cent reserves.
– 102,564 loans with 5 per cent reserves.

RBA flags ‘overhang effect’ of rising mortgage debt

Well, surprise, surprise, the RBA has realised that high mortgage debt reduces household consumption, according to new research they published. Yet they also note the positive economic impact of higher debt, and say the the overall impact is “unclear”! Well, the DFA surveys make it quite clear, many households are “full” of debt” and cannot spend.

This from The Adviser.

New research from the Reserve Bank has highlighted the link between mortgage debt and household spending amid debate over home loan serviceability assessment guidelines.

The Reserve Bank of Australia (RBA) has published new research from its economic research department, which has identified evidence of a link between “high levels of owner-occupier mortgage debt” and a fall in household spending, referred to as the “overhang effect”.

According to The Effect of Mortgage Debt on Consumer Spending report, if mortgage levels remained at “2006 levels”, annual aggregate consumption would have been approximately 0.2 to 0.4 per cent higher.

The RBA added that the negative effect of debt on spending is “pervasive” across households with owner occupied home loans. 

“Our results also suggest that an increase in aggregate owner-occupier mortgage debt can have important implications for aggregate spending, all else constant, and go at least part of the way to resolving the post-crisis ‘puzzle’ of unusually weak household spending in Australia,” the RBA report stated.

The central bank’s research comes amid continue debate over home loan serviceability assessment standards, with the Australian Prudential Regulation Authority (APRA) and the Australian Securities and Investments Commission (ASIC) moving to reform current practices.

ASIC’s proposed update of its responsible lending guidance (RG209) has been met with a renewed call from stakeholders for a revision to the way a borrower’s spending habits are assessed.

The RBA’s research has supported claims from some stakeholders, including Westpac, who have noted that changes in a borrower’s spending behaviour after they assume mortgage debt should be reflected in regulatory guidance.

In its submission to ASIC during the regulator’s first round of consultation, Westpac called for greater flexibility in the assessment of a borrower’s living expenses.

“Adopting a modest lifestyle for a period of time in order to acquire real property has been the means by which many Australians have secured long-term financial security,” Westpac stated.

“Experience shows that many customers are prepared to, and do actually, make lifestyle adjustments after acquiring a home and can then service their home loan obligations without substantial hardship.

“As such, Westpac submits that placing too much emphasis on the customer’s pre-application living expenses when determining suitability, without allowing scope for reasonable lifestyles adjustments (‘belt-tightening’), would have the effect of denying credit to many customers.”

Impact on economy still ‘unclear’

Despite confirming the direct impact of higher mortgage debt on household spending, the RBA has maintained that the impact of the “debt overhang’ on the overall economy remains “unclear’, noting the positive stimulatory contribution of the credit boom. stating that  

“[These] estimates abstract from other stimulatory effects of debt,” the report noted.

“The increase in mortgage debt has likely lifted house prices and by this also supported consumption over this period.

“Our estimates are thus best interpreted as the loss in consumption had all other trends, such as the growth in house prices, occurred even though debt remained constant.”

The RBA concluded: “As a result, the net effect of the increase in debt since the mid-2000s is unclear.”

APRA applies additional capital requirements to ANZ, NAB and Westpac

The Australian Prudential Regulation Authority (APRA) is applying additional capital requirements to three major banks to reflect higher operational risk identified in their risk governance self-assessments.

APRA has written to ANZ, National Australia Bank (NAB) and Westpac advising of an increase in their minimum capital requirements of $500 million each. The capital add-ons will apply until the banks have completed their planned remediation to strengthen risk management, and closed gaps identified in their self-assessments.

The increase in capital requirements follows APRA’s decision in May last year to apply a $1 billion dollar capital add-on to Commonwealth Bank of Australia (CBA) in response to the findings of the APRA-initiated Prudential Inquiry into CBA.

Following the CBA Inquiry’s Final Report, APRA wrote to the boards of 36 of the country’s largest banks, insurers and superannuation licensees asking them to gauge whether the weaknesses uncovered by the Inquiry also existed in their own companies. Although the self-assessments raised no concerns about financial soundness, they confirmed that many of the issues identified in the Inquiry were not unique to CBA. This included the need to strengthen non-financial risk management, ensure accountabilities are clear, cascaded and enforced, address long-standing weaknesses and enhance risk culture.

APRA Chair Wayne Byres said: “Australia’s major banks are well-capitalised and financially sound, but improvements in the management of non-financial risks are needed. This will require a real focus on the root causes of the issues that have been identified, including complexity, unclear accountabilities, weak incentives and cultures that have been too accepting of long-standing gaps.

“The major banks play a vital role in the stability of the entire financial system, and APRA expects them to hold themselves to the highest standards of risk governance. Their self-assessments reveal that they have fallen short in a number of areas, and APRA is therefore raising their regulatory capital requirements until weaknesses have been fully remediated,” Mr Byres said.

APRA supervisors continue to provide tailored feedback to other banks, insurers and superannuation licensees that provided self-assessments to APRA. Where weaknesses have been identified, the level of supervisory scrutiny is being increased as remediation actions are implemented. Where material weaknesses exist, APRA is also considering the need for the application of an additional operational risk capital requirement.

Fed Confirms Easing Bias

In the latest FOMC minutes, the tone suggests a potential easing rate bias, recognising the rising economic risks. Uncertainties have increased they say.

In their discussion of monetary policy for the period ahead, members noted the significant increase in risks and uncertainties attending the economic outlook. There were signs of weakness in U.S. business spending, and foreign economic data were generally disappointing, raising concerns about the strength of global economic growth. While strong labor markets and rising incomes continued to support the outlook for consumer spending, uncertainties and risks regarding the global outlook appeared to be contributing to a deterioration in risk sentiment in financial markets and a decline in business confidence that pointed to a weaker outlook for business investment in the United States. Inflation pressures remained muted and some readings on inflation expectations were at low levels. Although nearly all members agreed to maintain the target range for the federal funds rate at 2-1/4 to 2-1/2 percent at this meeting, they generally agreed that risks and uncertainties surrounding the economic outlook had intensified and many judged that additional policy accommodation would be warranted if they continued to weigh on the economic outlook. One member preferred to lower the target range for the federal funds rate by 25 basis points at this meeting, stating that the Committee should ease policy at this meeting to re-center inflation and inflation expectations at the Committee’s symmetric 2 percent objective.

Members agreed that in determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee would assess realized and expected economic conditions relative to the Committee’s maximum-employment and symmetric 2 percent inflation objectives. They reiterated that this assessment would take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. More generally, members noted that decisions regarding near-term adjustments of the stance of monetary policy would appropriately remain dependent on the implications of incoming information for the economic outlook.

With regard to the postmeeting statement, members agreed to several adjustments in the description of the economic situation, including a revision in the description of market-based measures of inflation compensation to recognize the recent fall in inflation compensation. The Committee retained the characterization of the most likely outcomes as “sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective” but added a clause to emphasize that uncertainties about this outlook had increased. In describing the monetary policy outlook, members agreed to remove the “patient” language and to emphasize instead that, in light of these uncertainties and muted inflation pressures, the Committee would closely monitor the implications of incoming information for the economic outlook and would act as appropriate to sustain the expansion, with a strong labor market and inflation near its symmetric 2 percent objective.

The Council Of Financial Regulators Speaks

The Council just updated their charter, and published their latest minutes. At least there is some minimal disclosure now, though high-level. Note the fact that Treasury is one of the members, alongside the RBA, ASIC and APRA.

The Council of Financial Regulators (the Council) is the coordinating body for Australia’s main financial regulatory agencies. There are four members: the Australian Prudential Regulation Authority (APRA), the Australian Securities and Investments Commission (ASIC), the Australian Treasury and the Reserve Bank of Australia (RBA). The Reserve Bank Governor chairs the Council and the RBA provides secretariat support. It is a non-statutory body, without regulatory or policy decision-making powers. Those powers reside with its members. The Council’s objectives are to promote stability of the Australian financial system and support effective and efficient regulation by Australia’s financial regulatory agencies. In doing so, the Council recognises the benefits of a competitive, efficient and fair financial system. The Council operates as a forum for cooperation and coordination among member agencies. It meets each quarter, or more often if required.

The updates charter says:

The Council of Financial Regulators (CFR) comprises APRA, ASIC, the RBA and Treasury. It aims to facilitate cooperation and collaboration between member agencies, with the ultimate objectives of promoting stability of the Australian financial system and supporting effective and efficient regulation by Australia’s financial regulatory agencies. In doing so, the CFR recognises the benefits of a competitive, efficient and fair financial system.

The CFR provides a forum for:

  • identifying important issues and trends in the financial system, with a focus on those that may impinge upon overall financial stability;
  • exchanging information and views on financial regulation and assisting with coordination where members’ responsibilities overlap;
  • harmonising regulatory and reporting requirements, paying close attention to regulatory costs;
  • ensuring appropriate coordination among the agencies in planning for and responding to instances of financial instability; and
  • coordinating engagement with the work of international institutions, forums and regulators as it relates to financial system stability.

The CFR will draw on the expertise of other non-member government agencies where appropriate for its agenda, and will meet jointly with the ACCC, AUSTRAC and the ATO at least annually to discuss broader financial sector policy.

Their latest minutes:

At its meeting on 5 July 2019, the Council of Financial Regulators (the Council) discussed systemic risks facing the Australian financial system, regulatory issues and developments relevant to its members. The main topics discussed included the following:

  • Financing conditions and the housing market. The Council discussed credit conditions and ongoing adjustment in the housing market. Housing credit growth has stabilised at a relatively low level, with lending to investors remaining weak, particularly from the major banks. Demand for housing credit has been subdued, though there has also been some tightening in credit supply. Business credit growth has weakened recently, with lending to small businesses declining over the past year. Lenders are themselves applying stricter verification of expenses and income to small businesses, and lending may be affected by declining collateral values as housing prices decline.
  • Council members discussed the signs of stabilisation in the Sydney and Melbourne housing markets, evident in both housing prices and auction clearance rates. They observed that the adjustment over the past two years has been sizeable and conditions in most other capital cities continue to be soft. Risks to lenders from housing price falls have to date been limited by the strength of the labour market, low interest rates and the improvement in lending standards in recent years. Housing loan arrears have continued to edge higher, but with significant variation between regions.
  • Members were updated on ASIC’s public consultation on its responsible lending guidance. The responsible provision of credit is a cornerstone of consumer protection and is important to the Australian economy. It was noted that the consultation is not about increasing requirements; but rather, clarifying and updating guidance on existing requirements. For example, ASIC may further clarify areas where the law does not require responsible lending requirements to be applied (e.g. in small business lending). The Council agencies will continue to closely monitor developments in financing and the housing market.
  • ASIC’s product intervention powers. ASIC updated the Council on its proposed approach to the new product intervention power, legislation for which passed in April 2019. This gives ASIC the power to proactively intervene where a financial product has resulted or is likely to result in significant detriment to consumers. ASIC has launched a public consultation on its approach. Council members discussed possible applications of the new power given it is now available for use.
  • Product design and distribution obligations. The Council also discussed the implications of new product design and distribution obligations for retail holdings of bank-issued Additional Tier 1 (AT1) instruments. Members encouraged issuers to review their practices for issuing AT1 instruments ahead of the commencement of the new obligations in April 2021. They noted that APRA would continue to treat all AT1 instruments as regulatory capital, capable of absorbing losses in the unlikely event of a bank failure. Members discussed the importance that all holders of AT1 instruments, particularly retail investors, recognise that AT1 instruments could be written down or converted to equity.
  • Policy developments. Members discussed a number of policy developments, including the implementation of the recommendations of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry. APRA provided an update on its policy work, including changes to its guidance on the minimum interest rate used in serviceability assessments for residential mortgage lending (announced on the morning of the meeting). APRA also updated the Council on its planned increases in the loss-absorbing capacity of ADIs to support orderly resolution. Members discussed proposals by New Zealand authorities to significantly increase Tier 1 capital ratios for banks in New Zealand.
  • Financial market infrastructure (FMI). The Council’s FMI Steering Committee provided an update on the design of a crisis management legislative framework for clearing and settlement facilities. This will ensure the necessary powers to resolve a distressed domestic clearing and settlement facility. A second consultation is now planned for late 2019. The Committee has also considered proposals for enhancements to the agencies’ supervisory powers and other changes to improve the regulatory framework in relation to market infrastructures. The results of the Council’s consultation findings will be provided to Government, to assist with policy design and the drafting of associated legislation (the draft of which would also be consulted on before being introduced to Parliament).
  • Stored-value payment facilities. The Council discussed elements of a potential regulatory framework for payment providers that hold stored value, following a public consultation in 2018. Discussion focused on suitable criteria to determine the regulatory regime that should apply to providers of stored-value facilities, along with the adequacy of consumer protection arrangements. Once completed, the conclusions of this work will be provided to the Government for consideration.
  • Competition in the financial system. Council agencies and the Australian Competition and Consumer Commission (ACCC) are developing an online tool to improve the transparency of the mortgage interest rates paid on new loans. This follows a recommendation of the Productivity Commission’s inquiry into Competition in the Australian Financial System. The tool relies on a new data collection and is expected to be available in 2020.
  • Climate change. Council members noted the work undertaken by regulators to address the implications of the changing climate, and society’s response to those changes, for the Australian financial system.
  • Updated Charter. The Council agreed to adopt an updated Charter, which is being published today. The Charter emphasises the Council’s financial stability objective, while also recognising the benefits of a competitive, efficient and fair financial system. It also highlights the Council’s focus on cooperation and collaboration to support the activities of its member agencies.

In conjunction with the Council meeting, the Council agencies held their annual meeting with other Commonwealth regulators of the financial sector. This included representatives from the ACCC, the Australian Taxation Office and the Australian Transaction Reports and Analysis Centre (AUSTRAC). Topics discussed included enforcement and data initiatives affecting the financial sector.

Westpac to refund 40,000 mortgage customers

The number of Westpac mortgage customers impacted by an error in 2017 has blown out to 40,000 customers despite initial estimates of less than half that number, via InvestorDaily. 

In 2017, Westpac announced that an expected 13,000 owner-occupier customers had been charged excess interest due to what they called a manual “mortgage processing error”.

The bank has now disclosed that the full number of consumers impacted by this error has been pushed up to 40,000, with the total remediation cost increasing with it. 

The processing error impacted those with interest-only loans and happened due to the bank not switching the mortgage holders to principal and interest mortgages at the end of their interest-only period. 

Due to the error, Westpac consumers paid extra interest as their principal did not decrease, despite the interest-only term expiring. 

Westpac’s general manager of home ownership, Will Ranken, said the bank identified the error back in 2017 outlining the issue, following which the bank conducted a full review. 

“Customers who were not ahead of repayments paid excess interest when their home loan did not switch to principal and interest at the correct time had to be remediated. 

“Many of these customers have already been refunded, and we are working hard to complete this remediation program,” he said. 

Mr Rankin said the bank was refunding the excess interest already paid and providing a lump sum to make up for future interest payments on the principal loan amount that had not been reduced. 

“Our approach is to ensure no customer pays more interest over the original loan term as a result of this error,” he said. 

The manual process that resulted in the error has now been switched over to an automated one, confirmed Mr Rankin.

“We apologise to customers impacted and want to assure our customers that we have since introduced an automated switching process to prevent this error occurring again,” he said. 

The bank did not confirm when all customers would be fully remediated but did confirm that affected customers do not need to do anything to get the refund.

Confidence Fades As APRA Caves Again… And Other Stories

A quick round-up of some of today’s news, including the latest falls in unit sales, APRA’s latest climb down, consumer and business confidence and ASIC move to curtail some of the excesses in the short term consumer credit market where people might pay 990%.