Economics and Banking – Page 429 – Digital Finance Analytics (DFA) Blog

Reserve Bank NZ Confirms Tighter Investment Loans Policy

The Reserve Bank today published a summary of submissions and final policy positions in regards to changes in the Loan to Value Ratio restriction rules (LVRs), and the asset classification of residential property investment loans in the Capital Adequacy Framework.

As announced in May, the Reserve Bank is altering existing LVR rules to focus on rental property investors in the Auckland region. The alterations mean that borrowers will generally need a 30 percent deposit for a mortgage loan secured against Auckland rental property.

The new rules will become effective on 1 November 2015. This is one month later than initially proposed, to enable banks to adapt their systems for the new rules.

Restrictions on loans to owner occupiers in Auckland will continue to apply, with banks allowed to make up to 10 percent of their new mortgage lending to such borrowers with LVRs exceeding 80 percent.

Restrictions outside Auckland are being eased after 1 November. Banks will be able to make up to 15 percent of their new mortgage lending to borrowers with LVRs exceeding 80 percent, regardless of whether the borrowers are owner occupiers or residential property investors.

The Reserve Bank received feedback via written submissions, and through meetings and workshops with affected banks. The Reserve Bank has modified its proposals in response to feedback about compliance challenges and special cases. The Reserve Bank’s final policy position adopts a 5 percent speed limit for high-LVR loans to Auckland investors, instead of 2 percent as originally proposed. The Reserve Bank is also introducing an exemption for high LVR lending to finance leaky building remediation and similar cases.

Still Higher Aussie Bank Capital Expected From New Rules – Fitch

A further increase in capital by Australia’s four largest banks is likely over the medium term as regulatory changes stemming from the December 2014 Financial Services Inquiry (FSI) and Basel framework are implemented, says Fitch Ratings. The increase in capital will be supportive of the big banks’ current ratings, though upgrades are not likely given their already high ratings and weaker funding profiles relative to their international peers.

Two of Australia’s “Big 4” banks have announced multi-billion dollar capital raises thus far in August in response to increased regulatory capital requirements. Commonwealth Bank of Australia (CBA) said that it would raise approximately AUD5bn on 12 August while Australia and New Zealand Banking Group (ANZ) declared its own AUD3bn capital raise on 6 August. The additional capital will add 135bp to common equity Tier 1 capital (CET1) for CBA, bringing its CET1 ratio to 10.4% on a pro-forma basis as of end-June. ANZ’s move will add between 65-78bp to CET1 capital, bringing its pro-forma CET1 ratio to 9.2%-9.3%.

The CBA and ANZ announcements come after the Australian Prudential Regulation Authority (APRA) said on 20 July that minimum average mortgage risk-weights for Australian residential portfolios would increase to at least 25% from around 16% currently. Banks have been given until 1 July 2016 to address any capital shortfalls from the higher risk-weights.

Australian banks could have met the increased capital requirement from the APRA decision through internal capital generation given robust profitability. However, Fitch believes that the higher risk-weights are likely to be only the first of a series of new measures to be implemented. In addition to the FSI, the Basel committee is also expected to finalise their proposals for an update to the global framework by end-2015/early-2016. Together, global and domestic regulatory changes are likely to result in yet higher capital requirements.

Fitch believes that the banks’ recent efforts to raise capital in part reflect positioning for a broader range of regulatory changes – in addition to the higher risk-weights announced by APRA – and in anticipation of future growth. National Australia Bank (NAB) had announced plans to raise AUD5.5bn of capital in May, ahead of any regulatory changes. Westpac, too, said in the same month that it would raise an additional AUD2bn in capital through its dividend reinvestment plan (DRP).

The Australian banks are likely to use a combination of retained earnings, discounts on their DRPs, underwritten DRPs, and equity issuance to increase their capital positions.

Interest Only Loan Assessments Falling Short – ASIC

ASIC today released a report that found lenders providing interest-only mortgages need to lift their standards to meet important consumer protection laws. They identified a number of issues relating to bank underwriting practices. We would also make the point that despite the low losses on interest-only loans to date in Australia, in a downturn they are more vulnerable to credit loss.

ASIC’s probe into interest-only home loans was announced in December 2014 and looked at 11 lenders, including the big four banks, to assess how they are complying with responsible lending laws.

As the national regulator for consumer credit and responsible lending, ASIC identified that demand for interest-only loans had grown by around 80% since 2012. ASIC’s review looked at how consumers were assessed for loans by lenders with a focus on the affordability of the loans over the longer term.

The review found that interest-only loans are more popular with investors and those on higher incomes, and that delinquency rates are currently lower for interest-only home loans.

However, ASIC also found that lenders have been falling short of their responsible lending obligations in the provision of interest-only loans. Lenders are often failing to consider whether an interest-only loan will meet a consumer’s needs, particularly in the medium to long-term.

Their key findings from the data review were:

The majority of interest-only home loans were extended to investors; however, a substantial proportion of interest-only home loan approvals (41% in the December 2014 quarter) were for owner-occupiers.
A greater proportion of the total number of interest-only home loans was sold through third-party or broker channels, compared to direct channels
The average value of interest-only home loans was substantially higher than principal-and-interest home loans for both owner-occupiers and investors, and this was especially so for loans provided through direct channels in comparison with third-party channels.
Overall, there was a smaller proportion of interest-only home loans in higher LVR categories when compared to principal-and-interest home loans
A diverse group of consumers tended to take out interest-only home loans. In general, interest-only home loans were more popular with consumers who earned more money, but a substantial proportion (29%) of owner-occupiers with interest-only home loans earned less than $100,000
Consumers with interest-only home loans were, on average, further ahead in reducing the balance of their loan when including funds held in offset accounts related to the home loan, than those with principal-and-interest home loans.

ASIC’s review of more than 140 consumer loan files from bank and non-bank lenders identified:

In 40% of files reviewed, the affordability calculations assumed the borrower had longer to repay the principal on the loan than they actually did
In over 30% of files reviewed, there was no evidence that the lender had considered whether the interest-only loan met the borrower’s requirements
In over 20% of files reviewed, lenders had not considered the borrower’s actual living expenses when approving the loan, but relied instead on expenditure benchmarks.

These practices can expose borrowers to not being able to afford their loan repayments in the future, particularly for interest-only loans, which have much higher repayments after the initial interest-only period ends.

ASIC also issued a survey to the 11 lenders to gain valuable data about the growth of interest-only home loans. The findings are detailed in Report 445, Interest-only home loan review (REP 445).

ASIC Deputy Chair Peter Kell said, ‘Interest-only loans may be a reasonable option for some borrowers. However, lenders must have robust processes in place for assessing a customer’s ability to afford a loan, taking into account the increased repayments once the interest-only period ends. They should lend responsibly, and in a way that does not result in consumers taking on debt that they cannot afford, especially if interest rates rise.’

The report makes a number of recommendations that lenders and brokers should review to ensure they are complying with responsible lending obligations. Following ASIC’s review, all 11 lenders have changed their practices in line with ASIC’s recommendations or have committed to implementing necessary changes in the coming months. The recommendations include ensuring:

loans align with consumers’ requirements and objectives
lenders use a consumers’ actual expenses rather than relying on a benchmark
affordability assessments include buffers for future interest rate rises.

Mr Kell said, ‘We are pleased that the lenders involved in the review have already started implementing changes based on our findings. The rest of the lending industry, including brokers, should now take note and swiftly review the practices they have in place to ensure they comply with their responsible lending obligations.’

As a result of this review, ASIC has commenced follow-up investigations in certain cases which are ongoing. Where necessary, ASIC is considering enforcement action or other regulatory action.

Seven News Does Sydney Property

Seven covered the DFA research in a segment on their evening news tonight in Sydney.

Mortgage Stressed Household Count In Sydney

Continuing our analysis of mortgage stress (one of the drivers of our estimation of the probability of default), we have estimated the actual number of households in each post code who are experiencing stress currently. To recap, Mortgage stress is a poorly defined term. The RBA tends to equate stress with defaults (which remain at low levels on an international basis). A wider definition is 30% of income going on mortgage repayments (not consistently pre-or-post tax). This stems from the guidelines of affordability some banks used in 1980’s and 1990’s, when economic conditions were different from today. This is a blunt instrument. DFA does not think there is a good indicator of mortgage stress, so we use a series of questions to diagnose mortgage stress focusing on owner occupied households. Through these questions we identify two levels of stress – Mild and Severe.

Mild = households maintaining repayments, but by reprioritising expenditure, borrowing more on loans or cards, and refinancing
Severe = households who are behind with their repayments, are trying to sell, are trying to refinance, or who are being foreclosed

We maintain a rolling sample of 26,000 statistically representative households using a custom segment model nationally. Each month we execute omnibus surveys to 2,000 households. Our questions provide a current assessment of mortgage stress. We also model and project likely mortgage stress given the current and expected economic conditions. You can read about the methodology here. The map shows the number of households who are currently in mortgage stress.

This is an interesting view because it shows the absolute estimated number, not the percentage of households. We have not published this view before.

Most striking is the range of master household segments which are represented. An indication that stress is not directly correlated with affluence. We will post data for some of the other regions another time.

The top 100 postcodes at risk of mortgage default

The AFR has done a nice piece on the post code level analysis we completed, and a nice interactive map. Here is the guts of the article, citing DFA.

It’s not just households in Western Sydney and the outer suburbs of Melbourne and Brisbane who are feeling the pressure of paying their monthly mortgage.

A compilation of the top 100 postcodes most at risk of mortgage default by consultancy firm Digital Finance Analytics found a wide geographic spread of suburbs across the country where people could face financial collapse when interest rates start to rise.

The outer suburbs of Canberra, southern Tasmania, Darwin and southern Gippsland in Victoria are some of the regional areas that have been hit by mix of industrial closure, high unemployment and low wages growth, which leaves resident vulnerable to financial collapse.

Digital Finance Analytics principal Martin North said residents of Western Sydney were used to flying close to the wind when it came to household finances.

“There are clearly some western Sydney suburbs and inner-Sydney in the top 200 or 300 postcodes but this is about the probability of default,” Mr North told The Australian Financial Review.

“The probability of default is a complex matrix. It’s not just the lower socio-economic areas [like Western Sydney] because they don’t have big loans and already have more conservative loan criterias.”

Mr North said the postcodes where households are at risk are quite often in regional areas with increasing unemployment – and where they may struggle to find another job.

“The most difficult thing for a mortgage holder is suddenly losing your job because income goes from a certain level to a lower level and it’s quite hard to manage,” he said.

“Events across Australia impacting on employment are probably the best leading indicator of the probability of default.”

Many of those in regional areas are also geographically isolated if they lose their jobs – and don’t have the same employment alternatives that may be on offer for those living in bigger cities such as Sydney, Melbourne and Brisbane.

Two per cent increase poses high risk

In a breakdown of the top 100 postcodes, almost a quarter were in Tasmania (23), followed by Victoria (19), NSW (18), Queensland (16), South Australia (14) and Western Australia (5).

The closure of manufacturing industries in northern Adelaide, the mining downturn in Western Australia, Queensland and in NSW’s Hunter Valley and the public service heartland of Canberra are all mortgage stress hotspots, according to the modelling.

There was also an intergenerational element with most of the households at risk of default including those under 35-years-old who have been lured by record low interest rates.

“My view is these are households that are maxed-up because of the debt they’ve got and with current low interest rates they are just getting by,” Mr North said.

“But if interest rates go up this is where you’ll see the first impact. If interest rates are 2 per cent higher it would create significant pain for households.

“And the risks seem to be higher amongst younger households. I think people have been lured into the market probably sooner than they should have by lower interest rates and rising property values.”

The Canberra postcodes of 2902 (Kambah), 2900 (Tuggeranong, Greenway) and 2903 (Oxley, Wanniassa) top the mortgage stress list, with Tasmanian postcodes in the state’s north and south rounding out the top 10.

Queensland’s mining belt of Mackay (postcode 4721), Brisbane’s outer suburbs (4131), and the outer-suburbs of Melbourne (Essendon, Tullamarine) as well as Hunter Valley’s 2343 scrape into the top 50.

The top 100 postcodes are rounded out by more mining towns (Fitzroy and Blackwater in Queensland), the suburban battlers in south-east Queensland’s Logan (4128), NSW’s Macquarie Fields (2564) and The Ponds (2769).

The typical assumptions about mortgage stress is where more than 30 per cent of household income is spent on home repayments.

But Mr North said this was too simplistic. He also overlays industry employment data as well as information from credit rating agencies about actual defaults.

The National Australia Bank has red-flagged 40 postcodes across the country where business and personal loans are at a higher risk of default, especially when mixed with the stressful combination of rising interest rates and higher unemployment.

In its 40 hotspots, NAB is conducting a more stringent assessment of loan applications, including increasing the amount of equity that borrowers require.

Reserve Bank of Australia assistant governor Christopher Kent last week said the central bank predicted unemployment would remain high until 2017.

RBA Minutes Quite Bullish

The notes from the RBA meeting of 4th August were released today. They seem quite bullish on future economic prospects. Does this mean a rise in the cash rate sooner?

Global economic conditions were expected to continue to be supported by the lower level of oil prices and accommodative global financial conditions. Global industrial production growth had eased further this year, particularly in the Asian region, and this had contributed to lower commodity prices. Growth of Australia’s major trading partners was expected to be around its long-run average over the next two years. Members observed that the downside risks to the outlook for Chinese growth identified over the past year had receded somewhat, although the Government’s policy response to the recent volatility in Chinese equity markets had clouded the medium-term economic outlook. Uncertainties arising from the expected start of monetary policy tightening in the United States had moved into sharper focus.

Domestically, economic activity had generally been more positive over recent months. Very low interest rates were continuing to support strong growth in dwelling investment and consumption, and the further depreciation of the Australian dollar was expected to impart stimulus to the economy through stronger net exports. Although surveys of business investment intentions and non-residential building approvals suggested that non-mining business investment would remain subdued for some time, members noted that non-mining business profits had increased, business conditions were clearly above average and businesses had been hiring more labour, partly encouraged by very low wage growth. As a result, employment had risen as a share of the working age population and the unemployment rate had been relatively stable, in contrast to earlier expectations of a further increase. The recent data on inflation were largely as expected.

Members noted that output growth was expected to pick up gradually from its below-average pace over the past year to exceed 3 per cent in 2017. The forecast for the unemployment rate had been revised lower since the previous forecasts had been presented. The further depreciation of the Australian dollar had resulted in a slight upward revision to the forecast for inflation. Nonetheless, inflation was expected to remain consistent with the target over the forecast period given that domestic cost pressures were likely to remain well contained.

Credit was growing moderately overall, with growth in lending to the housing market broadly steady over recent months. House prices continued to rise strongly in Sydney and Melbourne, but trends had been more varied in a number of other cities. Members observed that recent responses by banks to the suite of measures implemented by APRA in respect of lending to investors in housing, including a tightening in lending conditions, would be expected to reduce the risks relating to the housing market, although it was too early to gauge their full effects.

Members noted that an accommodative monetary policy setting remained appropriate given the forecasts, while observing that the Australian economy had been adjusting to the shift in activity in the resources sector from the investment to the production phase. This shift had been accompanied by significant declines in key commodity prices and was being assisted by the depreciation of the exchange rate over recent months.

In light of these considerations, the Board judged that it was appropriate to leave the cash rate unchanged. New information about economic and financial conditions would continue to inform the Board’s assessment of the outlook and determine whether the current stance of policy remained appropriate to foster sustainable growth and inflation consistent with target.

Loan Probability Of Default By Post Code

DFA’s coverage in the SMH today relating to the probability of default by post code has stimulated significant interest. As part of our household surveys, we capture data on mortgage stress, and when we overlay industry employment data and loan portfolio default data, we can derive a relative risk of default score for each household segment, in each post code. This data covers mortgages only (not business credit or credit cards, which have their own modelling).

Given that income growth is static or falling, house prices and mortgage debt is high, and costs of living rising, (as highlighted in our Household Finance Confidence index released yesterday), pressure on mortgage holders is likely to increase, especially if interest rates were to rise, which we have argued will happen sometime (and perhaps sooner rather than later given the recent RBA commentary on jobs and capacity). In addition, the internal risk models the major banks use, will include a granular lens of risk of default.

So, some borrowers in the higher risk areas may find it more difficult to get a mortgage, without having to jump through some extra screening hoops, and may be required to stump up a larger deposit, or cop a higher rate.

In the CBA results last week we saw some leading indicators of potential higher risks from the lender with the biggest owner occupied portfolio. So no surprise, the banks are aware of potential relative risks, especially if credit decisions are automated. In fact some of the smaller lenders appear to have greater flexibility.

Here is the national map of relative default probability. It shows the relative ranking, with the higher probability ranked 1, and clustered into meaningful groups.

Mortgage price hikes tipped to continue

From Mortgage Business.

A leading market analyst says rising house prices will force the banks to continue raising capital and keep passing on higher home loan rates.

Following last week’s $5 billion capital raising by CBA, Digital Finance Analytics principal Martin North says there is no doubt in his mind that capital will continue to be required.

“We will see more capital raisings,” Mr North told Mortgage Business.

“That means the prices of mortgages will continue to rise irrespective of what happens to interest rates.

“We are in a circle where bigger house prices allow bigger loans to be made, which allows the banks to make more loans and require more capital, like a black hole sucking everything in.”

Earlier this month, ANZ raised $3 billion to meet its CET1 capital ratio requirements. NAB announced a $5.5 billion capital raising in May and Westpac raised $2 billion the same month through its dividend reinvestment plan.

Speaking with Mortgage Business last week, HSBC chief economist Paul Bloxham said more capital raisings are likely as Australia’s banking sector seeks to meet the new, tougher requirements set out by the authorities.

Interest rate hikes on investor home loans came into effect last week with three of the four major banks charging higher rates. NAB raised its interest-only loans by 29 basis points while CBA and ANZ both added 0.27 per cent to their investor loans.

The repricing has been viewed as a response to APRA’s crackdown on credit growth in the investor segment and the need for increased capital.

However, analysts are sceptical whether higher home loan rates actually will cool investor demand.

“Given the momentum in the housing market, it is not clear that the lift in lending rates to investors that has occurred so far will have a significant impact on investor interest in the market,” Mr Bloxham said.

“Further increases in lending rates or a genuine change in direction by the central bank may be required to take the exuberance out of the Sydney and Melbourne housing markets.”

Mr North notes that interest rates are still extremely low and demand for home loans remains “extremely strong”.

“The only thing that will dampen demand is a one or two per cent rise in the official cash rate. Or some other external shock,” he said.

DFA Household Finance Confidence Index For July 2015 Shows Investors Have It

We released the latest DFA Household Finance Confidence today, incorporating results from our household surveys to end July. The overall index recovered a little from its all time low last month, rising to 91. This is still below a neutral setting. The index has been below water since April 2014.

This month we pulled out data from the 26,000 survey responses, segmented by our master property categories. We found that households who are property inactive (those renting, living with parents or friends, or homeless) consistently registered a lower score, at 87 this month, and we see a falling rating since we started this analysis in 2012. On the other hand, those households with investment property consistently rated higher, because of the wealth effects of rising property values, and because their incomes were more stable. Owner occupied households fell between the two extremes, though we noted a kick-up this month, thanks to the prospect of potentially cheaper loans ahead. We also see a subtle fall in the confidence of property investors, who are reacting to recent hikes in interest rates for investment properties. Could this be the first sign of an investment sector slow-down?

Now turning to the All Australia aggregate data, we see that costs of living continue to worry households, with 38% of households saying their costs were rising, up 3% on last month, and a similar fall in those who said there was no change to their costs. Households identified costs relating to council rates, food, fuel and overseas purchases as the main reasons for the rise. Those families burdened with child care costs and health related expenditure also suffered significant increases.

Turning to income, 4% more households this month said their income was falling in real terms, and 40% of households fall into this category. As well as wages being static or falling, households also saw falls in the interest paid on bank deposits. Only 4% said their incomes had risen, these tended to be households receiving dividend income from stocks. Just over 55% of households said their incomes had not changes (though as highlighted above, their costs had), so many are feeling the pinch.

Next, looking at job security, those households who felt more secure in their jobs fell by nearly 1%, to 16% of households. More than 62% of households felt no difference in their level of job security. There were significant state and industry variations however, with those in WA and SA the most concerned, and registering a fall in security, whilst NSW and VIC both registered higher rates of job security.

Looking at household debt (which is very high at the moment), 13% of households were more comfortable at their levels of debt, whilst 26% were less comfortable, and 60% were as comfortable as last time. Low interest rates are allowing households to manage high debt, but of course they are highly leveraged, and would be impacted if interest rates were to rise. Most households expect rates to remain low for the next couple of years.

Turning to savings, 14% of households were more comfortable with the savings they had, little changed from last month, whilst 54% were as comfortable as last month. Households commented on the difficulty of finding a good home for their savings, in the current low interest rate environment, and were concerned that adjusted returns were worth next to nothing. We also noted an increase in those households unable to get access to $2,000 within a week in an emergency. Around 15% of households are in this category, and the majority are those who are property inactive.

Finally, we look at net worth. Those households in the eastern states with property are feeling better off thanks to continued rises in property prices. Those with investment properties were feeling particularly smug. However, those in WA, NT and QLD were more more concerned about the trajectory of house prices, and saw their net worth falling – 62% of households saw their net worth rise, up 2%, whilst 14% saw it fall.

So overall, slowing wage growth and rising costs of living are counterpointed by rises in property prices, and low interest rates. However, bearing in mind that rates are unusually low and house price growth unusually high (for some), we do not see the fundamentals in place for a significant boost to household financial confidence any time soon. Therefore we expect households to spend conservatively, continue to save, and seek higher investment returns from higher risk asset classes.