Category: Economics and Banking

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.

MoodyAug24-1In 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

MoodyAug24-2 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.

Current-Stress-Count-Melbourne

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.

Melbourne-Stress-CountWe 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:

  1.  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.
  2. A greater proportion of the total number of interest-only home loans was sold through third-party or broker channels, compared to direct channels
  3. 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.
  4. Overall, there was a smaller proportion of interest-only home loans in higher LVR categories when compared to principal-and-interest home loans
  5. 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
  6. 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.

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.

Current-Stress-Count-SydneyThis is an interesting view because it shows the absolute estimated number, not the percentage of households. We have not published this view before.

Sydney-Stress-CountMost 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.