Economics and Banking – Page 431 – Digital Finance Analytics (DFA) Blog

ADI Property Exposures to June 2015 – Up and Away!

APRA released their latest quarterly ADI property exposure data today. The publication contains information on ADIs’ commercial property exposures, residential property exposures and new housing loan approvals. Detailed statistics on residential property exposures and new housing loan approvals are included for ADIs with greater than $1 billion in housing loans.

ADIs’ commercial property exposures were $233.7 billion, an increase of $9.9 billion (4.4 per cent) over the year to 30 June 2015. Commercial property exposures within Australia were $194.0 billion, equivalent to 83.0 per cent of all commercial property exposures.

ADIs’ total domestic housing loans were $1.3 trillion, an increase of $97.1 billion (7.9 per cent) over the year. There were 5.4 million housing loans outstanding with an average balance of $243,000.

ADIs with greater than $1 billion in housing loans approved $96.0 billion of new loans, an increase of $10.5 billion (12.2 per cent) on the quarter ending 30 June 2014. Of these new loan approvals, $55.1 billion (57.4 per cent) were owner-occupied loans and $41.0 billion (42.6 per cent) were investment loans.

Looking at the housing related data in detail, we see major banks wrote about 80% of all home loans, other banks had about 13% of the market, the rest covered by building societies, credit unions and foreign banks.

Looking at the relative value of loans, major banks still have the lion’s share, and we see the continued growth in investment lending

Looking at the LVR’s of new loans, we see that major banks have upped the proportion in the 60-80% range, and there is a slight reduction in loans over 90%. Clearly lending criteria have been tightened.

Building societies are writing more than 10% of loans over 90%, significantly more than credit unions.

Other banks (excluding majors) also dialled back higher LVR loans but grew then past quarter and also grew their relative mix of 60-80% LVR loans.

Foreign banks new high LVR loans fell. Once again we see growth in the 60-80% LVR range.

New investment loans grew with the majors (ANZ reclassified loans in the quarter), other banks investment loans fell slightly

There was significant growth in interest only loans, foreign banks were strongly up.

Overall about 46% of all new loans were written via third party channels. We see the majors continuing to grow their broker origination, whilst credit unions and foreign banks use of brokers fell.

Overall, the proportion of out of serviceability criteria fell, but overall about 4% of new loans were approved outside normal criteria.

Loans with offset facilities continued to rise, with credit unions leading the way.

Finally, low documentation loans continue to languish.

Who Benefits from High House Prices?

Most would accept that house prices in the major Australian centres are too high. Whether you use a measure of price to income, loan value to income, or price to GDP; they are all above long term trends. Indeed, in Sydney and Melbourne, they are arguably more than 30% higher than they should be. The latest DFA Video Blog discusses the issue and identifies the winners and losers, together with a transcript.

Ultra-low interest rates currently make large loans affordable for many households, yet overall household debt is as high as it has ever been and mortgage stress, even at these low interest rates is quite high. Banking regulators are concerned about systemic risks from overgenerous underwriting criteria and they have been lifting capital ratios to try to improve financial stability, with a focus on the fast growing investment sector. In many countries around the world, house prices are also high, so from New Zealand to UK, regulators are taking steps to try limit systemic risks. These rises are partly being driven by global movements of capital, ultra-low interest rates and quantitative easing.

However, let’s think about who benefits from high and rising prices. First anyone who currently holds property (and that is two-thirds of all households in Australia) will like the on-paper capital gains. This flows through to becoming an important element in building future wealth. In addition, refinancing is up currently, and we see some households crystalising some of the on-paper gains for holidays, a new car or other purposes, stimulating retail activity. A recent RBA research paper, suggests that low-income households have a higher propensity to purchase a new vehicle following a rise in housing wealth than high-income households.

Those holding investment property also enjoy tax-concessions on interest and other costs; and on capital appreciation. Rising wealth generally supports the feel-good factor, and consumer confidence – though currently this is a bit wonky.

Higher values stimulates more transactions, which creates more momentum.

Now, the one-third of households who are not property active, consist of those renting and those living with family, friends or in other arrangements. Their confidence levels are lower and they are not gaining from rising house prices. A relatively small proportion of these are actively seeking to buy, and they are finding the gradient becoming ever more challenging, as saving for a deposit is becoming harder, lending criteria are tightening and income growth is slowing. We have noted previously that a rising number of first time buyers have switched directly to the investment sector to get into the market. Generally younger households are yet to get on the housing escalator, whilst older generations have clearly benefited from sustained house price growth. This has the potential to become a significant inter-generational issue.

But overall, the wealth effect of rising property is an umbrella which spreads widely. The sheer weight of numbers indicates that there are more winners than losers. No surprise then that many politicians will seek to bathe in the reflected glory of rising values, whilst paying lip-service to housing affordability issues.

There are other winners too. For states where property stamp-duty exists, the larger the transaction value and volume, the higher the income. For example, in NSW, in January and February nearly $1bn was added to coffers thanks to this tax and the state is well on track to achieve the $6.1 billion of stamp duty forecast in the 2014-15 budget papers. The higher the price the larger the income. The tax-take funds locally provided services so ultimately residents benefit.

The banks also benefit because rising house prices gives them the capacity to lend larger loans (which in turn allows house prices to run higher again). They have benefited from relatively benign capital requirements and funding, thus growing their balance sheet and shareholder returns. Whilst recent returns have been pretty impressive, future returns may be lower thanks to changes in capital ratios and especially if housing lending moderates. On the other hand, their appetite to lend to productive business and commercial sectors is tempered by higher risks and more demanding capital requirements. The relative priority of debt to housing as opposed to productive lending to business is an important issue and whilst higher house prices can flow through to real economic growth, it is mostly illusory.

Finally, building companies can benefit from land banks they hold, and development projects, despite high local authority charges. We also note that some banks are now winding back their willingness to lend to the construction industry (because of potentially rising risks). The real estate sector of course benefits, thanks to high transaction volumes and larger commissions. Mortgage brokers also enjoy volume and transaction related income. Even retailers with a focus on home furnishings and fittings are buoyant.

So standing back, almost everyone appears to benefit from higher prices. But is it really a free-kick? Well, for as long as the music continues to play, it almost is. The question becomes what happens if (or when) prices were to fall (remember that during the GFC, northern hemisphere prices fell in some places up to 40%, though since then prices in the US, Ireland and the UK have started to recover). Given our exposure to housing, there would be profound impacts on households, banks and the broader economy if values fell significantly.

But underlying all this, we have moved away from seeing housing as something which provides shelter and somewhere to live; to seeing it as just another investment asset class. This is probably an irreversible process, and part of the “financialisation” of society, given the perceived benefits to the economy and households, but we question whether the consequences are fully understood.

RBNZ – Investor LVR limits to reduce financial system risk

The Reserve Bank New Zealand expects new lending limits for Auckland property investors will reduce heightened financial system risk, and help moderate the Auckland housing market cycle, Deputy Governor Grant Spencer said today.

Speaking to the Northern Club in Auckland, Mr Spencer said that the resurgence in Auckland house prices over the past year has increased the Bank’s concerns about financial stability risks.

Mr Spencer said that Auckland prices have risen a further 24 percent over the past year, compared to 3 percent for the rest of the country.

“This has stretched the price-to-income ratio for the Auckland region to 9, double the ratio for the rest of New Zealand, and places Auckland among the world’s most expensive cities.

“New housing supply has been growing, but nowhere near fast enough to make a dent in the existing housing shortage. In the meantime, net migration is at record levels, and investors continue to expand their influence in the Auckland market.”

Mr Spencer said that investors are now accounting for 41 percent of Auckland house purchases, up 8 percentage points since late 2013. “We have seen a particular increase in purchases by smaller investors and investors reliant on credit. Half of the new lending to investors is being written at loan-to-value ratios of over 70 percent.

“This trend is increasing the risk inherent in the Auckland market. The increasing investor presence is likely to amplify the housing cycle, and worsen the potential damage from a downturn, both to the financial system and the broader economy.”

Mr Spencer said that macro-prudential policy can assist in moderating the risks to the financial sector and broader economy associated with Auckland’s housing market.

“A sharp fall in house prices has the potential to accentuate weakness in the macro-economy, particularly if banks tighten lending conditions excessively, leading to greater declines in asset markets and larger loan losses for the banks. A key goal of macro-prudential policy is to ensure that the banking system maintains sufficient prudential buffers to avoid this sort of contractionary behaviour in a downturn.

“Modifications to the Reserve Bank’s LVR policy, announced in May, are targeted specifically at Auckland residential investors. The speed limit has been eased for the rest of the country where housing markets are not subject to the same pressures.”

Mr Spencer said that the Bank recognises that low interest rates are contributing to housing demand pressures, and this is a factor the Bank takes into consideration when setting monetary policy. “However, the current weakness in export prices, economic activity and CPI inflation means that interest rate increases are likely to be off the table for some time,” he said.

He noted that the Bank’s macro-prudential policy is one of many measures aimed at reducing the imbalances in the Auckland housing market.

“Much more rapid progress in producing new housing is needed in order to get on top of this issue. Tax policy is also an important driver, and we welcome the changes announced in the 2015 Budget, including the two year bright-line test, the proposed non-resident withholding tax and the requirement for tax numbers to be provided by house purchasers.”

Massive Capital Injection to Chinese Banks is Credit Positive – Moody’s

In a research note Moody’s says that last Tuesday, China’s official Xinhua News Agency reported that the People’s Bank of China (PBOC) had injected $48 billion of equity capital into China Development Bank Corporation and $45 billion into The Export-Import Bank of China (CEXIM).

The injections were made through Wutongshu Investment Platform Co. Ltd., an entity that invests China’s foreign currency reserves. The massive equity infusions are credit positive for CDB and CEXIM. CDB’s capital adequacy ratio rises to about 11.8% from 9.1% under Basel III at year-end 2014, while CEXIM’s capital adequacy ratio, which it does not disclose, rises significantly. The injections also add to both banks’ loss-absorption capacity. Against the backdrop of heightened asset-quality risks at domestic banks, we think the enhanced loss-absorption implies that regulators are likely to impose minimum capital requirements on the banks.

The capital infusions are consistent with the Chinese government’s goal to strengthen Chinese policy lenders’ capital positions. After the injections, both banks’ ratios of tangible common equity to tangible assets compare well with those of the rated Chinese large and national joint-stock commercial banks.

In the past several years, CDB and CEXIM have taken on key roles as policy-driven banks in financing priority projects and supporting the growth of Chinese corporates expanding overseas. For 2013-14, CDB’s compound annual asset growth rate was 17.1% and CEXIM’s 23.2%, compared with an average 13.6% rate for the Chinese banking industry during the same period

The capital injections demonstrate the Chinese government’s strong commitment to support the two lenders, whose policy roles are increasingly important for stimulating domestic economic growth. CDB and CEXIM are likely to take on greater credit exposure and their lending may have a greater strategic rationale rather than an economic one. For instance, the additional capital should facilitate CDB and CEXIM financing of overseas projects that are part of China’s One Belt, One Road initiative to boost infrastructure and economic connectivity across Eurasia.

Our assumption of a very high level of government support for CDB and CEXIM’s reflects strong government backing to offset their greater risks, given the two banks’ strategic importance as agents of the Chinese government in the implementation of development initiatives.

Zombie loans and a £300bn cushion: inside the Bank of England rates dilemma

From The Conversation.

When the men and women of the committee which sets UK interest rates get together these days, they are dealing with a deceptively simple question. Rates will go up, but how far and how fast? Their answer will decide the fate of a fragile recovery.

The UK economy is getting back to normal. Output has overtaken its peak of 2007 and is growing at close to the average pre-crisis rate; unemployment is low, employment is increasing. Real wages and investment have finally begun to improve. There are even signs of a return to productivity growth.

You might well argue that the financial crisis was unnecessary; that the imposition of austerity meant that recovery was slower than it needed to be and that the burden of adjustment was unfairly shared. But notwithstanding this, the economy is recovering.

This means that interest rates also have to get back to normal. The most recent meeting of the Bank of England’s Monetary Policy Committee left things as they were – at a historic low of 0.5%, where it has remained since February 2008. It is both the lowest rate ever and the longest period without a change in rates. This cannot go on for much longer. We will get another rate decision on September 10 and even members of the committee who usually argue for lower rates, such as David Miles, are openly discussing the moment when the rate will start to rise.

Spent force?

But why do interest rates have to rise? Well, consider the choice between spending now or delaying expenditure into the future. In an economic downturn, the benefits of increasing spending in the present outweigh the costs of reducing it in the future. This is why low interest rates, which encourage spending right now, were a useful policy response to the financial crisis.

Notes and queries. How far and how fast? nataliej, CC BY-NC

But in more normal times, low interest rates encourage levels of expenditure which may exceed the productive capacity of the economy and so cause rising inflation. They may also lead to excessive borrowing and so risk another financial crisis. Higher interest rates, which encourage saving that can be channelled into productive investment, are then more appropriate.

So, if interest rates have to go up in order to manage the transition to another kind of economy, how quickly will they rise? Here, policymakers face two major risks. The first is within the banking system.

Risk factors

Banks are holding more than £300 billion in reserves at the Bank of England. This has been a useful cushion in turbulent times (reserves increased recently during the latest Greek crisis) but going forward, the economy needs banks to make loans rather than accumulate cash.

As a first step, the Bank of England has to stop paying interest on these reserves. This will encourage banks to run down reserves and increase lending. But reducing bank reserves by, say, £200 billion will increase lending by roughly £2 trillion (economists call this the “money multiplier”: historically the multiplier has been around 10). Doing this too quickly risks destabilising the economy. So this suggests we will see a modest and gradual increase in interest rates.

Zombies in our midst. The loans that bit back. Follow, CC BY-NC-ND

The second risk lies with households and firms. Low interest rates have enabled some individuals to stave off bankruptcy by managing to keep up loan repayments. This will no longer be possible once interest rates start to rise. These are the so-called “zombie loans” that stalk the economy, and no one knows how many of these are out there, or at which point in the interest rate cycle they will become a serious danger. Caution again suggest a modest and gradual increase until the scale of the problem becomes clearer.

Level up

Finally, let’s consider how high interest rates will eventually rise.

Policymakers have suggested that the pre-crisis average of 5% may be too high. Why? First, it is not clear how much of the damage caused by the financial crisis is permanent. If the economy has sustained serious damage to its productive capacity, interest rates will need to stay low for a protracted period, until investment has rebuilt capacity.

Second, it has been argued that there are now fewer investment opportunities than there were before the crisis, as the wave of productive investments opened up by the rapid spread of globalisation and new technology has ebbed away, robbing us of opportunities to generate growth and support a robust recovery. This “secular stagnation” hypothesis argues for lower interest rates into the future.

Of course, these arguments are all about successfully managing the recovery of the domestic economy – and we know only too well that external factors, such as US sub-prime mortgages, can have devastating effects across the world. It will be a useful by-product of the expected modest and gradual rate rises from the Bank of England that if and when the next crisis strikes from out of the blue, then there remains the room to bring rates straight back down again.

Author: Chris Martin, Professor of Economics at University of Bath

Mortgage Stressed Household Count In Melbourne

Continuing our series of the number of households experiencing mortgage stress by post code, today we look at Melbourne. Here is the geo-map showing the relative number of households in each post code district. We have not shown this distribution before.

The areas with the highest count are listed below. Note the DFA segment distribution represented in each one. Whilst many are young families, or disadvantaged, many are more wealthy, and these have had access to larger loans, and more valuable property. But as a result they are more exposed, especially as incomes are static and costs are rising. Some are also getting squeezed by lower returns from savings and deposits with the banks.

We will post Brisbane next time.

Battle Shifts Further Towards Owner Occupied Home Lending

As we predicted, the banks have upped the ante on their owner occupied loans, for new customers, as the regulatory enforced slow-down on investment lending starts to bite. As well as hefty discounts, rebates are on offer, paid for by the hike in interest rates to new and existing investment loan borrowers. The changes to capital for advanced IRB banks, not due until next year, is a convenient alibi. The truth is, banks need the home lending fix to keep growing.

For example, according to Australian Broker:

A major bank has announced it will be running a home loan rebate campaign, which could save consumers over $1,000 on new owner-occupied loans.

From Monday 24 August, Westpac will be running its home loan rebate campaign to celebrate the popular Chinese Mid-Autumn Festival, which falls on Sunday 27th September.

As a part of this promotion, eligible customers will be entitled to receive a $1,088 rebate after applying for a new owner-occupied home loan with the major bank’s Premiere Advantage Package. Customers must receive conditional approval by Wednesday 30 September 2015.

The rebate figure of $1,088 was chosen because the number 8 is a lucky number in Chinese culture. According to Westpac, auction numbers on the 8th of August – the eighth day of the eighth month –were up 51% in Melbourne when compared to the same weekend last year.

With Chinese foreign buyers now accounting for about one in six new properties sold in NSW and VIC, Westpac general manager of third party distribution, Tony MacRae says this is an opportunity for the major bank to celebrate cultural diversity and the Australian Chinese community.

“Undoubtedly the Chinese community is the largest Asian migrant segment in Australia and we pride ourselves in supporting this key segment,” he said.

“Promoting cultural celebrations such as the Mid-Autumn Moon festival helps Westpac to deepen relationships with brokers supporting our Chinese and migrant customers.”

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.