We have released the June 2018 edition of our household financial confidence index, which draws information from our rolling household surveys. In June the overall index fell once again to 89.7, well below the 100 neutral setting down from 90.2 last month.
Looking at the results across the states, we see further falls in New South Wales and Victoria, a small fall in Western Australia, but small rises in Queensland and South Australia.
Looking across our property segments, those who are renting or living with families or friends returned a small rise, reflecting expected tax changes and increments on some wages for the new financial year. However, those owning or investing in property were significantly less bullish (drowning out any benefit from the tax changes etc.). Property Investors are getting very nervous as prices decline, interest rates are expected to rise, and rental streams are crimped. We noted a rise in vacancy rates in a number of areas. Owner occupied (OO) households are more positive, relatively speaking, although they have dipped below the neutral setting in April.
Across the age bands, older households are more bullish, with those over 60 years and 50-60 years a little more positive on the back of the recent tax changes from 1 July 2018. On the other hand, younger households are consistently less positive, especially those who purchased property in the past couple of years. Those aged thirty to forty years are under most pressure. Those with savings in the banks remain concerned.
We can examine the drivers across the dimensions in our survey. In terms of job security there was a small rise last month, with those feeling more secure up 0.65% to 11.8%. On the other hand, those less secure also rose by 0.78% to 27.9%, with a consistent theme of limited hours being to the fore. We continue to see a rise in households managing multiple concurrent part time jobs to make ends meet.
Turning to income, there was no indication of significant income rises before the new financial year, next month may be different. 52.7% said their incomes had fallen in real terms over the past year, and 44% reported no change. Once again we see evidence of limited hours driving underemployment higher, so on a gross income there is no light at the end of the tunnel, yet.
Costs of living continue to rise with 81.3% seeing their expenditure rising, thanks to the usual suspects, including electricity, child care, school fees and health insurance costs. There were also signs of pressure from food costs and council rates. Only 2.2% reported said their costs have fallen over the past 12 months. The reported CPI rates appear to be disconnected from reality.
Debt remains a major issue, with mortgages being the front line. Households remain highly leveraged. Some households with lower Loan to Value ratios have been able to switch to other, cheaper loans, but more than 40% of households seeking to refinance have been knocked back in the past 3 months, up from 5% a year ago. A hallmark of the current lending environment. We also continue to see many households adding to their overall debt via credit cards, or other loans. The new positive credit environment which commenced 1 July 2018 will change the game ahead. Credit may become harder to source for some.
On the other hand, households continue to dip into their savings to maintain lifestyle and budgets. 46% of households are less comfortable with the level of their savings compared with a year ago. Many responses highlighted the recent collapse in bank deposit rates as ADI’s try to manage their margins. Around the same, 46% of household reported no change. Significantly more than one third of households with an owner occupied mortgage had savings LESS than the equivalent of one months mortgage repayment. The other two thirds had significantly larger resources which would insulate them in a down turn, at least for a time.
Finally, we see that more households are reporting a fall in net worth – total assets less loans and other liabilities, with 23% now saying they are worth less (up 0.95% on the month). 28% reported no change over the past year, and 46% reported growth in net worth, helped by the still significant run up in home prices in recent years (now correcting) and rises in stocks in recent months.
Generally those with more assets are still seeing rises compared with an average Australian household, highlighting the two-speed story across the country, depending on affluence.
But we also continue to see a tranche of highly leveraged high net-worth households having to cope with financial pressures as home prices and rentals move against them and the impact of switching from interest only to principal and interest loans hits home.
We would expect a small bounce in the index next month as some incomes rise in the new tax year and other changes take effect. But the impact of the fading property sector, and cash flow constraints are likely to dwarf this impact. The only “get out of jail card” will be income growth above inflation, and as yet there is little evidence of this occurring. Thus we expect the long grind to continue.
Finally, we see a number of attractor rates from the banks in an attempt to keep mortgage volumes up, but many households cannot access them in the new tighter lending environment. In addition the reduction in rates on some deposit accounts is also hitting the hip pockets of many who rely on income from them. We noted in the survey that a number of households were actively seeking alternative savings vehicles as property and bank deposits look less interesting. We will have to see whether these alternatives are as attractive (in terms of risk-return) as some are claiming. We have our doubts. But then risk is relative.
By way of background, these results are derived from our household surveys, averaged across Australia. We have 52,000 households in our sample at any one time. We include detailed questions covering various aspects of a household’s financial footprint. The index measures how households are feeling about their financial health. To calculate the index we ask questions which cover a number of different dimensions. We start by asking households how confident they are feeling about their job security, whether their real income has risen or fallen in the past year, their view on their costs of living over the same period, whether they have increased their loans and other outstanding debts including credit cards and whether they are saving more than last year. Finally we ask about their overall change in net worth over the past 12 months – by net worth we mean net assets less outstanding debts.
Back in January I decided to start more regular content creation for YouTube. Last week we passed 3,000 subscribers, and the number continues to grow. Thanks for your support. And judging by your comments, you appreciate the straightforward data driven approach. Our podcast subscriber base is also expanding nicely too.
Since that time, we have built the arguments using data to highlight around the growing pressures from higher levels of debt, sliding home prices sliding and higher interest rates.
Now one question keeps recurring in the community discussion. I see the problem, but what should I do to protect myself in these uncertain times? This is an excellent question, and one I want to take further. Because the answer is, it depends.
It depends on where you believe the economy is headed. It depends whether you are seeking to protect the value of existing assets and savings, are seeking to exploit the uncertainty, or something else.
So in response, I am going to commence today the first in a series of posts which I have called Financial Resilience 101.
Resilience is defined as “the capacity to recover quickly from difficulties; toughness”.
And we start our journey with a quick recap based on some of the most relevant posts I have already created. If you missed them, now is a good time to catch up.
The first post “Four Potential Finance and Property Scenarios” discusses the range of potential outcomes over the next couple of years, because you will need to decide where to place your bets.
If you are holding to a mild correction and more of the same, you will adopt one set of strategies for resilience, whereas if you are at the other end of the spectrum and looking at global events similar to the GFC a decade ago you will go a different way. Thinking about scenarios is useful if not easy to do. We will update our scenarios again in a future post, but they generally still holding true.
The next post discussed whether now is a good time to buy property “Should I Buy”and here we explored the reasons to buy and not to buy.
Again it partly depends on your view, but also whether you are thinking of property as a place to live or an investment.
The other side of the coin is should I sell now, and we discussed this too in our post “Should I Sell Now?” and we look at the reasons why you might decide to sell, or not.
Again this varies depending on whether you are an owner occupier or a property investor.
Then we went on to explore options beyond property, accepting that things may get shaky. In our post “What Should I Do” we go through the options, from stocks, shares, bonds, commodities and crypto and draw some comparisons with the UK a decade ago via Northern Rock.
Now once you have gone through these sessions you will have a good set of foundations from which to build a Financial Resilience Strategy. Next time we will then go further into what to do next.
And a warning, this is not financial advice, as I cannot take account of individual circumstances, and am not qualified to give such advice. That said, there are some general principles which I think are useful, based on my own experience. And if you find these useful then that is a good outcome. But you will have to make your own decisions.
Two final points, first generally diversification is goodness, as it spreads the risks, and second there are no silver bullets, no simply answers. If there were, I would not be making these videos, I would be going after that solution! Neither Gold, nor Silver nor Crypto are without significant risks. You can easily jump from the frying pan into the fire. Things are decidedly tricky at the moment, so you need to do the work, and make your own choices. No silver (or other metal) bullets here!
Welcome to the Property Imperative weekly to 7th July 2018, our digest of the latest finance and property news with a distinctively Australian flavour. By the way if you value the content we produce please do consider joining our Patreon programme, where you can support our ability to continue to make great content. Here is the link.
Watch the video, listen to the podcast, or read the transcript.
This week the RBA left the cash rate on hold once again at 1.5% and continued the trend of doing nothing. In fact, reading the release from Tuesday, it is worth noting two things. First they are being very gentle in referring to home price falls, saying “Nationwide measures of housing prices are little changed over the past six months. Conditions in the Sydney and Melbourne housing markets have eased, with prices declining in both markets. Housing credit growth has declined, with investor demand having slowed noticeably. Lending standards are tighter than they were a few years ago”. Second, we think they would like to lift rates to more normal levels, but cannot thanks to high debt, and downside risks. They are stuck. I believe the next move will be down as the economy weakens (dragged down by the fading property market, rising interest rates internationally, and concerns about China’ economic dynamo). But not yet.
Now compare this with a BIS report also out this week. The BIS is worried by the current low interest rate environment, and in a new report by a committee chaired by Philip Lowe, warn of the impact on financial stability across the financial services sector, with pressures on banks via net interest margins, and on insurers and super funds. They warn that especially in competitive markets, risks rise in this scenario. Low interest rates may trigger a search for yield by banks, partly in response to declining profits, exacerbating financial vulnerabilities. In addition, keeping rates low for longer may create the need to lift rates sharper later with the risks of rising debt costs and the broader economic shock which follows. A salutatory warning! We discussed this in more detail in our post “To “Bail-In” Or To “Bail-Out”, That Is Indeed The Question”.
The contrast between the theoretical macro policy position, and the local situation here in Australia, must at very least be giving Mr Lowe a bit of a headache!
The trajectory of global rates is upwards as we will discuss later. The latest from the FED is that further rate rises are required, and expected. So the FED is doing what the BIS report suggested. But the net result is pressure on Bank funding here, remember that around 30% of bank funding comes from overseas and the BBSW is higher still.
Two points to make here. First as credit availability is the strongest influence of home prices, the easy access to international capital markets the banks have had in recent years meant they could lend more, up to 30% more, hence disastrously higher home prices. Second the weight of evidence is that more banks will lift rates. Citigroup for example, forecasts that the rising cost of funding will prompt Australia’s four major banks to increase their mortgage interest rates independently of the RBA, with the banks tipped to begin lifting their mortgage rates by an average of eight basis points by September. Citigroup adds that the rise in banks’ short-term funding costs since early 2018 is likely to be sustained. And in effect the tenor of the RBA minutes signals to the banks they can go ahead and lift rates.
As rates have fallen, households have leveraged up, supported by lose lending policy and driving home prices to massive multiples of household income as data from IFM Investors showed this week.
And even small rate rises will hurt, as we showed in our latest Mortgage Stress release for June, which was out this week. Mortgage stress continues to rise. Across Australia, more than 970,000 households are estimated to be now in mortgage stress (last month 966,000). This equates to 30.3% of owner occupied borrowing households. In addition, more than 22,000 of these are in severe stress. We estimate that more than 57,100 households risk 30-day default in the next 12 months. We expect bank portfolio losses to be around 2.8 basis points, though losses in WA are higher at 5.2 basis points. We continue to see the impact of flat wages growth, rising living costs and higher real mortgage rates. We discussed this in our post “The Debt Pips Are Squeaking”, in which we also discussed the latest anaemic retail sales figures, and the latest household debt to income ratio from the RBA which are now at a record 190.1. We are literally drowning in debt. And its structural.
The Australian Institute of Health & Welfare released a new report showing that home ownership is out of reach to growing numbers of Australians, thanks to high prices and poor affordability. They say that over the last 20 or so years Australia has seen a shift from outright ownership to owning with a mortgage, and a shift from overall home ownership to private rental Between 1995 and 2015, the proportion of outright owner-occupied households fell from 41.8% to 30.4%. Comparatively, the proportion of households owning with a mortgage has increased, from 29.6% to 37.1%, over the same period. Overall, the proportion of households in home ownership fell from 71.4% to 67.5%. There has also been an increase in the proportion of households renting privately (from 18.4% to 25.3%), and a decline in the proportion of households renting through state and territory housing programs (from 5.5% to 3.5%). Equally telling is home ownership rates between 1971 and 2016, by selected 5-year age groups. The home ownership rate of 30–34 year olds was 64%, and 50% for 25–29 year olds, in 1971. Forty-five years later these rates have decreased notably, with the home ownership rate of 30–34 year olds falling 14 percentage points to 50%. Similarly, that of 25–29 year olds fell 13 percentage points (to 37%). While declines are evident for other age groups they are much less marked. So fewer Australians are tending to own their home at retirement. For Australians nearing retirement, for example, age groups 50–54, 55–59, and 60–64, home ownership rates peaked in 1996 at 80%, 82% and 83%, respectively Since 1996 however, there has been a gradual decline in home ownership rates, most notably in the 50–54 age group which has seen a 6.6 percentage point fall over these 20 years (from 80.3% to 73.7%). This is one reason why we are watching closely our “Down Trader” segment – people seeking to sell and release capital. There are 1.2 million in this state, compared with around 600,000 up Traders, and 150,000 first time buyers. So on simple supply demand logic, more people selling than buying means prices will fall further.
And on that note, CoreLogic said that the weighted average clearance rate has tracked below 60 per cent for 8 consecutive weeks now, while over the same 8-week period last year clearance rates were tracking within the low 70 to high 60 per cent range. Last week Melbourne’s final auction clearance rate fell to 57.2 per cent across a lower volume of auctions week-on-week with 791 held, down on the 941 auctions over the week prior when a higher 59.9 per cent cleared. In Sydney, less than half of the homes taken to auction sold last week. The city returned a final auction clearance rate of 49.7 per cent, down slightly on the 50.1 per cent the previous week, with volumes across the city remaining relatively steady over the week with a total of 634 held. All of the remaining auction markets saw a lower volume of auctions last week, with the final clearance rate across each market also falling week-on-week. There were also a large number of passed in auctions.
Gerard Minack from Minack Advisors said this week that the housing market looks ‘thin’, hinting that prices may be unusually sensitive to a change in demand. Historically housing market turnover tracked price growth. However, turnover has been soft relative to price gains over the past 3-4 years, and in the March 2018 quarter turnover fell to the lowest level since the 1990 recession.
There are still many economists talking of just a small slide in prices over the next few months, but we suspect they are underestimating the impact of tighter credit. For example, Macquarie suggested from their annual mystery shopping survey mortgage power – the amount people could get when applying for a mortgage had not dropped that much at all. But in fact, it seems the non-banks, those not under so much scrutiny from APRA is where the bigger loans reside.
Whereas UBS, the arch property bears, suggest that credit tightening will continue, as lending flows ease, saying one of the key recommendations of the Royal Commission is likely to be a stricter interpretation of Responsible Lending. In particular “reasonable steps” required to verify customers’ financial positions. This is likely to require credit licensees (banks and non banks) to verify living expenses from customers’ transaction banking and credit card data over a period of around 12 months. They go to say that as ANZ stated in its submission to the Royal Commission, verifying living expenses from transaction accounts and credit cards is operationally complex and will likely require substantial investment in technology to automate this process. So UBS believes that while the major banks will be able to absorb these costs, such technological investments may be prohibitive for many of the smaller players. Therefore, they believe that any potential regulatory mismatch benefiting the smaller banks and non-banks is unlikely to be sustainable. In other words, credit will be tighter soon, driving prices lower.
The Corelogic’s Housing Index showed that prices slipped again last week in Sydney, down 0.13%, Melbourne down 0.11%, Adelaide down 0.01% and Perth down 0.07%. Brisbane rose 0.02%. On a 12 month basis, Sydney on average has dropped 4.69%, while Perth has fallen 2.08%. The other centres have risen just a little. But it is worth remembering that Sydney prices are still 66% from the last trough, Melbourne 56%, Brisbane 21% and Adelaide 19%. Perth is only 0.4% higher, thanks to the prevailing weak economic conditions in the West. This weakness also has translated into rental rates, with Perth seeing just a 3% rise over the past 10 years for houses, and a small fall for units. Compare this with a national rise in rentals over the same period of 25.7%. At the other end of spectrum rentals rose 53.8% for Hobart houses, and 44.7% for units, highlighting the housing cost pressure there.
Despite the falls in property values, and the expected future further falls, the AFR said Labor has shrugged off suggestions from the property industry that its planned changes to negative gearing rules should be scrapped because of market conditions. They reported that Shadow treasurer Chris Bowen told a Property Council of Australia forum in June the changes were about making long-term structural adjustments, rather than addressing the short-term cycle. The policy was a once in a generation reform. We think he is right.
The Royal Commission in Darwin this week heard about the thousands of Aboriginal people who are sold unsuitable financial products and vulnerable consumers are targeted by instant cash loan machines because the financial landscape supports predatory practices. Insurance agents were able to exploit and target Aboriginal people because the industry isn’t fully regulated. An excellent The Conversation Article made the point that the cultural, economic and political arrangements that allow this to happen are called “practice architectures”. They include the complex language used to deceive consumers into buying unsuitable products, incentivised high pressures sales tactics, and a lack of care and concern for vulnerable consumers. All of these aspects are within the scope of financial regulators. The funeral insurance industry can push dodgy products because no one is watching. Predatory financial practices will continue until governments and/or regulators do something about it.
More evidence of regulators not doing their job, and the financial sector simply exploiting their customers to make a quick buck.
We heard this week that ASIC has accepted court enforceable undertakings from the Commonwealth Bank of Australia and Australia and New Zealand Banking Group under which the banks have agreed to change the way they distribute superannuation products to their customers. ASIC investigated CBA’s distribution of its Essential Super product and ANZ’s distribution of its Smart Choice Super and Pension product through bank branches. ASIC found a common practice of offering those products to customers at the conclusion of a fact-finding process about customers’ overall banking arrangements. ASIC was concerned that customers may have thought, due to the proximity of the fact-finding process to the offer of Essential Super or Smart Choice Super, that the CBA branch staff or the ANZ branch staff were considering risks specific to the customer when this was not the case. These court enforceable undertakings prevent CBA from distributing Essential Super in conjunction with a Financial Health Check and ANZ from distributing Smart Choice Super in conjunction with an A-Z Review. They also require CBA and ANZ to each make a $1.25 million community benefit payment. If there is a breach of the undertaking ASIC can, under the ASIC Act, apply for orders from the court to enforce compliance. But whilst individuals risk being sent to prison as one Perth finance broker, did this week, or permanently banned from the finance industry for loan fraud, the asymmetric penalties between the small guys and the big firms is – well shameful. It seems to me regulators are going for the easy targets who cannot fight back, whilst imposing mild penalties on the big guys, for fear of court proceedings. The balance is just wrong.
Finally, looking across the markets, shares in Australia started the new financial year well, with most banking stocks going higher. Bendigo Bank was up 1.72%, Suncorp up 0.54% and even the languishing Bank of Queensland rose 0.77%. Westpac was up 0.85%, ANZ up 1.97% on its buybacks, NAB up 1.6% and CBA up 1.2%, though still below its peak in 2017 when it was above $82. So risks in the mortgage book are clearly not worrying investors that much just now. This despite the 90-Day mortgage default rates going higher as reported in the S&P Ratings SPIN Index. Macquarie, who has more business offshore than on shore rose 0.42%, at 122.96, just off its all-time highs, The ASX 200 ended higher up 0.91% to 6,272, a solid rise. The Aussie Dollar did a little better too against the US Dollar settling at 74 cents, up 0.57% and against the Chinese Yuan up 0.7% to $4.94.
Now back to global debt. Deutsche Bank published a chart which showed that of the $50 trillion global bond market, about $8 Trillion of these bonds are now trading at negative interest rates, thanks to changes in interest rates across the market. Within the $50 trillion, the amount of nonfinancial corporate bonds has increased 2.7 times over the past decade to $11.7 trillion, according to Mckinsey. Debt in China has outgrown that in the USA, based on GDP, with non-financial corporate debt in China sitting at 160% of GDP, compared with 97% in the USA, according to JP Morgan. The China credit boom, is well, booming…
This all signals more trouble ahead, given that the US 3 Month bond rate and LIBOR are sitting at highs, and the 10 Year US Bond Rate remains elevated, reflecting the expectation of more FED rate hikes ahead. And the latest from the FED is that further rate rises are required, and expected.
U.S. stocks finished the week mostly higher, thanks mainly to low-volumes of buyers on Friday. The S&P 500 finished the week up about 1.5% and the Dow ended about 0.8% higher for the week. The big winner was the tech-heavy NASDAQ Composite, which closed up about 2.4% for the week. The DOW ended the week up 0.41% to 24,456 after light holiday trading.
US employment data showed still-solid growth in payrolls, but lower-than-expected wages, which eased inflation concerns. Nonfarm payrolls rose by 213,000 in June. That was higher than the consensus estimates of 200,000. The jobless rate unexpectedly rose to 4.0% from 3.8%, missing consensus expectations for it to remain unchanged as more people entered the labor force. Average hourly earnings advanced 0.2% month-on-month in June, below expectations. The data still suggests the Federal Reserve will gradually raise interest rates. The markets are still pricing in two more rate hikes this year.
The real unknown though is the U.S, China Trade Battle which is now officially underway. The U.S. has put tariffs in place on $34 billion worth of Chinese goods and the Chinese hit right back with tariffs on $34 billion on U.S. goods going into effect. China said the U.S. had “launched the largest trade war in economic history to date.” And the U.S. administration is already looking at ramping up the amount of tariffed goods, threatening another 16 billion dollars in two weeks, and then more later. No one knows where this will lead. But there are risks for Australia and other countries getting caught in the cross-fire.
The U.S. dollar endured a tough week that was not helped by the mixed jobs numbers that offered little encouragement for traders looking for faster Fed hikes. The dollar index, which compares the greenback to a basket of six currencies, was down about 0.7% for the week. The dollar also faced pressure from the euro during the week. German Chancellor Angela Merkel resolved an immigration battle and with her interior minister that had threatened the future of her coalition government.
Oil continued higher through the week, as supply limits kicked in, up 1.33% to 73.91, and Gold fell again, down 0.23% as risks abated.
And finally, Bitcoin recovered a little to 6,615 but remains volatile, while the broader VIX index sits slightly above the lows seen last year, but below the peak of a few months back.
So it seems that investors are banking on the debt elastic not snapping back anytime soon, but we will be watching for further signs of stress given the massive amount owing out there as rates rise. Meantime banks are making hay, despite the levels of uncertainly out there. As the BIS report put it “A key takeaway is that, while a low-for-long scenario presents considerable solvency risk for insurance companies and pension funds and limited risk for banks, a snapback would alter the balance of vulnerabilities,”. We have been warned.
Before I sign off, mark your diary. On the 17th July at 8 PM Sydney time I will be running our next live streaming session, where you can discuss in real time the issues in play. Judging by the previous session, it will be a lively event. I will schedule it shortly on our YouTube channel.
Digital Finance Analytics (DFA) has released the June 2018 mortgage stress and default analysis update.
The latest RBA data on household debt to income to March reached a new high of 190.1 [1] …
… so no surprise to see mortgage stress continuing to rise. Across Australia, more than 970,000 households are estimated to be now in mortgage stress (last month 966,000). This equates to 30.3% of owner occupied borrowing households. In addition, more than 22,000 of these are in severe stress. We estimate that more than 57,100 households risk 30-day default in the next 12 months. We expect bank portfolio losses to be around 2.8 basis points, though losses in WA are higher at 5.2 basis points. We continue to see the impact of flat wages growth, rising living costs and higher real mortgage rates.
The latest S&P Ratings data shows a rise in 90 day plus delinquencies in the SPIN series for April, from the major banks. So despite the fact it only covers MBS mortgages the trend is consistent with our stress analysis!
The inevitable result of too lose lending standards and easy loans is creating an intractable problem for many households given the continued low income growth, high cost environment. This also means risks to lenders continue to rise.
Our surveys show that more households are keeping their wallets firmly in their pockets as they try to manage ever tighter cash flows. This is an economically significant issue and will be a drag anchor on future growth. The RBA’s bet on sustained household consumption looks pretty crook. Even now, household debt continues to climb to new record levels, mortgage lending is still growing at an unsustainable two to three times income. Falling home prices just adds extra picante to the problem.
We continue to see households having to cope with rising living costs – notably child care, school fees and fuel – whilst real incomes continue to fall and underemployment remains high. Households have larger mortgages, thanks to the strong rise in home prices, especially in the main eastern state centres, and now prices are slipping. While mortgage interest rates remain quite low for owner occupied borrowers, those with interest only loans or investment loans have seen significant rises. Rate pressure will only increase as higher Bank Bill Swap Rates (BBSW) will force more lenders to lift their mortgage rates, as a number of smaller players already have done.
Our analysis uses the DFA core market model which combines information from our 52,000 household surveys, public data from the RBA, ABS and APRA; and private data from lenders and aggregators. The data is current to end June 2018. We analyse household cash flow based on real incomes, outgoings and mortgage repayments, rather than using an arbitrary 30% of income.
Households are defined as “stressed” when net income (or cash flow) does not cover ongoing costs. They may or may not have access to other available assets, and some have paid ahead, but households in mild stress have little leeway in their cash flows, whereas those in severe stress are unable to meet repayments from current income. In both cases, households manage this deficit by cutting back on spending, putting more on credit cards and seeking to refinance, restructure or sell their home. Those in severe stress are more likely to be seeking hardship assistance and are often forced to sell.
Probability of default extends our mortgage stress analysis by overlaying economic indicators such as employment, future wage growth and cpi changes. Our Core Market Model also examines the potential of portfolio risk of loss in basis point and value terms. Losses are likely to be higher among more affluent households, contrary to the popular belief that affluent households are well protected.
Stress by The Numbers.
Regional analysis shows that NSW has 264,737 households in stress (264,344 last month), VIC 266,958 (271,744 last month), QLD 172,088 (164,795 last month) and WA has 129,741. The probability of default over the next 12 months rose, with around 10,953 in WA, around 10,526 in QLD, 14,207 in VIC and 15,200 in NSW.
The largest financial losses relating to bank write-offs reside in NSW ($1.3 billion) from Owner Occupied borrowers) and VIC ($927 million) from Owner Occupied Borrowers, which equates to 2.10 and 2.76 basis points respectively. Losses are likely to be highest in WA at 5.2 basis points, which equates to $761 million from Owner Occupied borrowers.
A fuller regional breakdown is set out below.
Here are the top 20 postcodes sorted by number of households in mortgage stress.
Some Important Context
The rise in mortgage stress does not occur in a vacuum. The revelations from the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (the Commission) have highlighted deep issues in the regulatory environment that have contributed to the household debt “stress bomb”. The most significant area of law discussed by the Commission has been responsible lending. Yet most of the commentary on the regulatory framework has been superficial or poorly informed. For example, several commentators have strongly criticised the Australian Securities and Investments Commission (ASIC) for not doing enough but have failed to explain what ASIC has in fact done, and what it ought to have done. Gill North, Professor of law at Deakin and a Principal of DFA suggests that” APRA (and not ASIC) should be the primary focus of regulatory criticism. APRA has failed to adequately prepare Australia for future financial system instability and its prudential supervision of home lending standards and practices over the last 5 years has been woeful”.
North has published widely on responsible lending law, standards and practices over the last 3-4 years, and continues to do so. Her latest work (which is co-authored with Therese Wilson from Griffith University) outlines and critiques the responsible lending actions taken ASIC from the beginning of 2014 until the end of June 2017. This paper will be published by the Federal Law Review, a top ranked law journal later this month.
The responsible lending study by North and Wilson found that ASIC proactively engaged with lenders, encouraged tighter lending standards, and sought or imposed severe penalties for egregious conduct. Further, ASIC strategically targeted credit products commonly acknowledged as the riskiest or most material from a borrower’s perspective, such as small amount credit contracts (commonly referred to as payday loans), interest only home loans, and car loans. North suggests “ASIC deserves commendation for these efforts but could (and should) have done more given the very high levels of household debt. The area of lending of most concern, and that ASIC should have targeted more robustly and systematically, is home mortgages (including investment and owner occupier loans).”
Reported concerns regarding actions taken by the other major regulator of the finance sector, the Australian Prudential Regulation Authority (APRA), have been muted so far. However, an upcoming paper by North and Wilson suggests APRA (rather than ASIC) should be the primary focus of criticism. This paper concludes that “APRA failed to reasonably prevent or mitigate the accumulation of major systemic risks across the financial system and its regulatory approach was light touch at best.”
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[1] RBA E2 Household Finances – Selected Ratios March 2018
The RBA updated their E2 Household Finances – Selected Ratios to end March, released at the end of June. So they are yet to reflect the latest downturn in home prices and rising debt. But the trajectory is clear and should be ringing alarm bells.
First the ratio of household debt to housing assets and total assets is going up, reflecting mainly falls in property prices. The rate is accelerating, confirming that while debt is still rising, values are not. Expect more ahead.
The ratios of assets to income are falling, having been rising for year, again reflecting falls in home prices. So while incomes are flat in real terms, asset values are falling faster.
And finally, the killer, the household debt to income ratios continues higher, this despite the greater focus on lending quality, and reduced “mortgage power”. The household debt to income ratio is now at 190.1, the housing debt in income 140.1, and the owner occupied housing debt to income is 106.7. In fact this is moving up more sharply as lenders have focused on owner occupied lending.
Combined this shows the problems in the household sector. No surprise then that mortgage stress is going higher. We release the June data tomorrow.
Remember that the debt to GDP ratio is highest in Australia compared with other countries.
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We ran some custom analysis for Nine, looking at mortgage stress in and around Sydney. Here is a map showing the relative number of households now in stress – based on their cash flows. This is data to end May, we will run the June update in early July.
Today we walk through the worst postcodes for mortgage stress and add movement and colour with supporting demographic and financial data.
Yesterday we released the May 2018 mortgage stress and default analysis update. Across Australia, more than 966,000 households are estimated to be now in mortgage stress (last month 963,000). This equates to 30.2% of owner occupied borrowing households.
Our analysis uses the DFA core market model which combines information from our 52,000 household surveys, public data from the RBA, ABS and APRA; and private data from lenders and aggregators. Households are defined as “stressed” when net income (or cash flow) does not cover ongoing costs. Probability of default extends our mortgage stress analysis by overlaying economic indicators such as employment, future wage growth and cpi changes. Our Core Market Model also examines the potential of portfolio risk of loss in basis point and value terms.
So now we are going to look in more detail, at the most stressed post codes across the country, by counting down to the most stressed area in the country. In each case we will dive into the vital statistics for each location, including population, income mortgage and loan to income ratios, as well as the number of households in stress.
Just outside the top 10 is Victorian post code, 3810, Packenham, with around 4,310 households now in mortgage stress. It is some 54 kms south east of Melbourne. The average home price is around $502,000 compared with $290,000 in 2010. According to the latest census the average age is 32 years and there are more than 12,600 families in the district. The average monthly household income is $5,900, which is below the average in the state as well as nationally. 46% of homes have a mortgage, compared with the Victorian average of 35%. The average monthly mortgage repayment is $1,700, or more than 28% of their average incomes. But 11% are paying more than 30% of their income each month to service their mortgages.
In tenth place is 3029, another Victorian postcode which includes Hoopers Crossing and Tarneit, around 25 kms from Melbourne CBD. There are about 24,600 households in the district, and the average household income is $6,840 a month. The average mortgage repayment is $1,730 or around 26% of the monthly budget although 12.5% are paying more than 30% of their income on repayments. More than 80% of the dwellings are separate houses and a further 15% are townhouses. Nearly 51% of all properties in the area are mortgaged compared with the VIC average of 35%. The average home price is currently around $545,000 for a house and $378,500 for a unit, compared with $462,000 and $330,000 a year ago.
Next we go to WA, 6030 which includes Clarkson, Merriawa and Tamala Park, 34 kms north of Perth. There are 4,597 households in mortgage stress in the area, which is home for around 11,000 households. The average age is 34 years. 86% of the properties here are separate houses, and 14% town houses. 51% of the properties are mortgaged, well above the WA average of 40%. The average income each month is and the average mortgage repayment is 2,000. The average proportion of income going on the mortgage is more than 28% but more than 12% have repayments requiring more than 30% of income.
Next in eighth place is yet another Victorian post code 3350, which includes Ballarat and the surrounding area, It’s about 100 kilometres from Melbourne. In this region there are 4,746 households in mortgage stress. The average property value is $315,000, compared with $281,000 in 2010. There are more than 14,500 families in the area and the average age is 37, line ball with the average across the state. The average monthly income is $5,300, well below the national and state averages. Around 33% of households have a mortgage and the average repayment is $1,408 a month, with an average loan to income ratio of 26.5%, though 5% are above 30%.
In Seventh place we go to Queensland 4350, around Drayton and Toowoomba, about 100 kilometres from Brisbane. There are about 27,000 households in the region and the average age is 37. 77% of the properties here are standalone houses, and a further 15% are townhouses. We estimate 5,054 households are in mortgage stress. The average home price is $470,000, compared with $382,000 in 2010. The average income is $5,300 a month. Around 30% have a mortgage and the average mortgage repayment is $1,510 giving an average loan to income of 25%. Just 4% have mortgage commitment above 30% of income.
Next, sixth is 3037, which includes areas around Delahey, Hillside and Sydenham; around 20 kms north west of Melbourne. Here around 5,317 households are in mortgage stress. Of the 13,000 households in the district, more than half have a mortgage and the average age is 33. The average home price is around $570,000, up from $365,000 in 2010. 80% of properties are standalone houses and a further 18% are townhouses. The average monthly income is around $7,200 and the average mortgage repayment is $1,730, with an average loan to income of 24%. But 13% require more than 30% of their income to service their mortgage.
In fifth place is another Victorian suburb, 3806, Berwick and Harkaway which is around 40 kilometres south east of Melbourne, with 5,461 households in mortgage stress. The average home price is $700,000 compared with $451,000 in 2010. There are around 13,000 families in the area, with an average age of 36. 88% of the properties in the area are standalone houses. More than 47% of households here have a mortgage and the average repayment is $1,850 compared with the average income of $7,600 making the average loan to income about 24%. However, more than 9% are committed to pay more than 30% of their income each month.
In fourth place we go back to VIC again, to 3805, which includes Narre Warren and Fountain Gate, This area is around 38 kilometres south east of Melbourne. Here 5,900 households are in mortgage stress. The average home price is $620,000 compared with $366,000 in 2010. There are more than 15,000 families in the area, and the average age is 34 years. The average household income is just over $7,000 a month, which is higher than the national average. 54% of homes are mortgaged and the average monthly repayment is $1,700 slightly below the national average of $1,755. The average loan to income ratio is around 25%, but 12% are paying more than 30% of their income on the mortgage each month.
Coming third we cross the Nullarbor to WA to 6065. This is the area around Wanneroo, including Tapping, Hocking and Landsdale and is located about 25 kilometres north of Perth. It is an area of high population growth and residential construction mainly on smallish lots. There are more than 6,340 households in mortgage stress in the region. The average home price is $420,000 compared with $529,000 in 2010, and down from a peak of $813,000 in 2014. There are about 17,000 households in the district, with an average age of 33. The average income is $8,300 a month, and 58% have a mortgage with average repayments of $2,170, well above the WA and national averages. The average loan to income ratio is around 26%, but more than 13% are paying over 30% of their incomes on the mortgage each month.
In second spot is the area around Campbelltown in NSW, 2560, which is around 43 kilometres inland from Sydney. Here 6,381 households are in mortgage stress. The average home price is $640,000, up from $320,000 in 2010. Around 20,000 households live in the area with an average age of 34 years. 80% of properties are standalone houses. The average income is $6,100 a month. 37% have a mortgage and the average repayment is higher than the national average at $1,800, or 29% of income. But 13% are paying more than 30% of their income on the mortgage.
So to the post code with the highest count of stressed households, is NSW post code 2170, the area around Liverpool, Warwick Farm and Chipping Norton, which is around 27 kilometres west of Sydney. There are around 27,000 families in the area, with an average age of 34. There are 6,974 households in mortgage stress here. The average home price is $805,000 compared with $385,000 in 2010. 64% of properties are standalone houses, while 22% are flats or apartments. The average income here is $5,950. 36% have a mortgage, which is above the NSW average of 32% and the average repayment is about $2,000 each month, so the average proportion of income paid on the mortgage is more than 33%.
So it’s clear from this analysis that stress is residing among households who are relatively affluent, but highly leveraged, and include a number of newly built high-growth suburbs on the edges of our larger cities. Many are typified by high density standalone houses, or townhouses crammed into small plots. We are seeing a rotation of stress towards some of the Victorian post codes in recent months, but there are concerning rises in both NSW and VIC. However, WA remains the more immediate trouble spot, as can be demonstrated by the higher levels of default there – perhaps close to double the national average.
We will continue to monitor mortgage stress, and will update our core market model next at the end of the year.
As before, I think it is worth repeating that many households in stress do not have a robust household budget, and creating this is an important first step to getting to grips with stress. Whilst putting more on credit cards and refinancing may seem superficially attractive mitigation steps, our analysis shows that these are often only temporary fixes. Getting to grips with where the money is going is an important first step to tackling the problem. Remember too that banks have an obligation to assist in cases of hardship, so if households are in difficulty, they should talk to their lenders, rather than hoping things will work out. Given flat incomes and rising prices, this is unlikely.
Digital Finance Analytics (DFA) has released the May 2018 mortgage stress and default analysis update. Across Australia, more than 966,000 households are estimated to be now in mortgage stress (last month 963,000). This equates to 30.2% of owner occupied borrowing households. In addition, more than 22,600 of these are in severe stress, up 1,000 from last month. We estimate that more than 56,700 households risk 30-day default in the next 12 months. We expect bank portfolio losses to be around 2.7 basis points, though losses in WA are higher at 5 basis points. We continue to see the impact of flat wages growth, rising living costs and higher real mortgage rates.
Martin North, Principal of Digital Finance Analytics says “the pressure on households in a low income growth, high cost, highly leveraged environment means that overall, risks in the system continue to rise, and while recent strengthening of lending standards will help protect new borrowers, there are many households currently holding loans which would not now be approved. The recent Royal Commission laid bare some of the industry practices which help to explain why stress is so high. This is a significant sleeping problem and the risks in the system remain higher than many recognise”.
“We continue to see the number of households rising, and the quantum is now economically significant. Even now, household debt continues to climb to new record levels. Mortgage lending is still growing at two to three times income. This is not sustainable and we are expecting lending growth to continue to moderate in the months ahead as underwriting standards are tightened and home prices fall further”. The latest household debt to income ratio is now at a record 188.6.[1]
The forces which are lifting mortgage stress levels remain largely the same. In cash flow terms, we see households having to cope with rising living costs – notably child care, school fees and fuel – whilst real incomes continue to fall and underemployment remains high. Households have larger mortgages, thanks to the strong rise in home prices, especially in the main eastern state centres, and now prices are slipping. While mortgage interest rates remain quite low for owner occupied borrowers, those with interest only loans or investment loans have seen significant rises. We expect some upward pressure on real mortgage rates in coming months as international funding pressures mount, a potential for local rate rises and margin pressure on the banks thanks to a higher Bank Bill Swap Rate (BBSW). The potential for a 20-25 basis point hike by the banks is increasing, and this would lift the number of households in mortgage stress higher again.
Our analysis uses the DFA core market model which combines information from our 52,000 household surveys, public data from the RBA, ABS and APRA; and private data from lenders and aggregators. The data is current to end May 2018. We analyse household cash flow based on real incomes, outgoings and mortgage repayments, rather than using an arbitrary 30% of income.
Households are defined as “stressed” when net income (or cash flow) does not cover ongoing costs. They may or may not have access to other available assets, and some have paid ahead, but households in mild stress have little leeway in their cash flows, whereas those in severe stress are unable to meet repayments from current income. In both cases, households manage this deficit by cutting back on spending, putting more on credit cards and seeking to refinance, restructure or sell their home. Those in severe stress are more likely to be seeking hardship assistance and are often forced to sell.
Probability of default extends our mortgage stress analysis by overlaying economic indicators such as employment, future wage growth and cpi changes. Our Core Market Model also examines the potential of portfolio risk of loss in basis point and value terms. Losses are likely to be higher among more affluent households, contrary to the popular belief that affluent households are well protected.
Stress by The Numbers.
Regional analysis shows that NSW has 264,344 households in stress (262,577 last month), VIC 271,744 (256,353 last month), QLD 164,795 (175,960 last month) and WA has 129,064. The probability of default over the next 12 months rose, with around 10,656 in WA, around 10,468 in QLD, 14,268 in VIC and 15,049 in NSW.
The largest financial losses relating to bank write-offs reside in NSW ($1.3 billion) from Owner Occupied borrowers) and VIC ($951 million) from Owner Occupied Borrowers, which equates to 2.10 and 2.73 basis points respectively. Losses are likely to be highest in WA at 5 basis points, which equates to $718 million from Owner Occupied borrowers.
A fuller regional breakdown is set out below.
Here are the top 20 postcodes sorted by number of households in mortgage stress.
[1] RBA E2 Household Finances – Selected Ratios December 2017 (Revised 3rd April 2018).
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According to the latest from The St.Louis Fed On The Economy Blog, individuals who were in financial distress five years ago were about twice as likely to be in financial distress today when compared with an average individual.
Many households have experienced financial distress at least one time in their life. In these situations, households miss payments for different reasons (unemployment, sickness, etc.) and eventually file bankruptcy to discharge those obligations.
In a recent working paper, I (Juan) and my co-authors Kartik Athreya and José Mustre-del-Río argued that financial distress is not only quite widespread but is also very persistent. Using Federal Reserve Bank of New York Consumer Credit Panel/Equifax data, we reported that individuals who were in financial distress five years ago were about twice as likely to be in financial distress today when compared with an average individual.1
Consumer Bankruptcy
In this post, we focus our attention on a very extreme form of financial distress: consumer bankruptcy. We obtained financial distress data from the Survey of Consumer Finances (SCF), conducted by the Board of Governors. The data span from 1998 to 2016 with triennial frequency, and the respondents who are younger than 25 or older than 65 have been trimmed.2
We first measured the share of households that had previously experienced an episode of financial distress by looking at people who filed for bankruptcy five or more years ago.3 The figure below shows that the share of households with past financial distress increased from approximately 6.6 percent in 1998 to 12.2 percent in 2016.
We then measured current financial distress by computing the share of households that delayed their loan payment on the year the survey was conducted.4 (We recognize that this measure is less extreme, as only a share of households that are late making payments will end up in bankruptcy.)5
The figure below shows that while there are minor fluctuations in the share of households with late payments throughout the sample period, the numbers remained around 8 percent.
Finally, we created a ratio to measure the persistence of financial distress. It compares the share of households with late payments among households that declared bankruptcy five or more years ago to the share of households with late payments the year the SCF was conducted.
If financial distress was not persistent at all, both shares would be equal, and the ratio would be one. Thus, a value greater than one indicates the persistence of financial distress. The figure below shows the evolution of the persistence of financial distress over the years.
The ratio fluctuates around 1.5, implying that the households that have encountered an episode of financial distress in the past are 1.5 times more likely to delay payment today, compared to average households.
Looking across our property segments, those who are renting or living with families or friends returned a small rise, reflecting expected tax changes and increments on some wages for the new financial year. However, those owning or investing in property were significantly less bullish (drowning out any benefit from the tax changes etc.). Property Investors are getting very nervous as prices decline, interest rates are expected to rise, and rental streams are crimped. We noted a rise in vacancy rates in a number of areas. Owner occupied (OO) households are more positive, relatively speaking, although they have dipped below the neutral setting in April.
Across the age bands, older households are more bullish, with those over 60 years and 50-60 years a little more positive on the back of the recent tax changes from 1 July 2018. On the other hand, younger households are consistently less positive, especially those who purchased property in the past couple of years. Those aged thirty to forty years are under most pressure. Those with savings in the banks remain concerned.
We can examine the drivers across the dimensions in our survey. In terms of job security there was a small rise last month, with those feeling more secure up 0.65% to 11.8%. On the other hand, those less secure also rose by 0.78% to 27.9%, with a consistent theme of limited hours being to the fore. We continue to see a rise in households managing multiple concurrent part time jobs to make ends meet.
Turning to income, there was no indication of significant income rises before the new financial year, next month may be different. 52.7% said their incomes had fallen in real terms over the past year, and 44% reported no change. Once again we see evidence of limited hours driving underemployment higher, so on a gross income there is no light at the end of the tunnel, yet.
Costs of living continue to rise with 81.3% seeing their expenditure rising, thanks to the usual suspects, including electricity, child care, school fees and health insurance costs. There were also signs of pressure from food costs and council rates. Only 2.2% reported said their costs have fallen over the past 12 months. The reported CPI rates appear to be disconnected from reality.
Debt remains a major issue, with mortgages being the front line. Households remain highly leveraged. Some households with lower Loan to Value ratios have been able to switch to other, cheaper loans, but more than 40% of households seeking to refinance have been knocked back in the past 3 months, up from 5% a year ago. A hallmark of the current lending environment. We also continue to see many households adding to their overall debt via credit cards, or other loans. The new positive credit environment which commenced 1 July 2018 will change the game ahead. Credit may become harder to source for some.
On the other hand, households continue to dip into their savings to maintain lifestyle and budgets. 46% of households are less comfortable with the level of their savings compared with a year ago. Many responses highlighted the recent collapse in bank deposit rates as ADI’s try to manage their margins. Around the same, 46% of household reported no change. Significantly more than one third of households with an owner occupied mortgage had savings LESS than the equivalent of one months mortgage repayment. The other two thirds had significantly larger resources which would insulate them in a down turn, at least for a time.
Finally, we see that more households are reporting a fall in net worth – total assets less loans and other liabilities, with 23% now saying they are worth less (up 0.95% on the month). 28% reported no change over the past year, and 46% reported growth in net worth, helped by the still significant run up in home prices in recent years (now correcting) and rises in stocks in recent months.
We would expect a small bounce in the index next month as some incomes rise in the new tax year and other changes take effect. But the impact of the fading property sector, and cash flow constraints are likely to dwarf this impact. The only “get out of jail card” will be income growth above inflation, and as yet there is little evidence of this occurring. Thus we expect the long grind to continue.
