Economics and Banking – Page 432 – Digital Finance Analytics (DFA) Blog

ANZ Confirms Loan Reclassification

In a media release (via ASX), ANZ confirmed that they had reclassified data it provides to the regulators. It follows a review of data collection to align more closely management reporting and regulatory reporting.

This review included a reclassification of loan purposes across “owner occupied” and “investment housing”. ANZ says these changes do not impact ANZ’s investor lending growth targets. Their investment loan book was $83.5bn at 30 June 2015.

They say that the changes do not impact ANZ’s overall lending and deposit balances, risk weighted assets, regulatory capital or prior financial reporting disclosures and have no impact on customer facilities. We think this is because there are no differences in the current risk weightings between investment and owner occupied loans.

We identified the change in the APRA monthly banking statistics on Friday.

Credit Traps In A Financial Crisis

The Bank of England recently published a working paper “Bank leverage, credit traps and credit policies” which looks at why, following a financial crisis growth tends to stagnate for a long period and how macroprudential policy tools should be used both before and after a crisis. They look at “credit traps” which arise when shocks to bank equity capital tighten banks’ borrowing constraints, causing them to allocate credit to easily collateralisable but low productivity projects. Low productivity weakens bank capital generation, reinforcing tight borrowing constraints, sustaining the credit trap steady state.

Financial crises tend to have severe negative effects on real activity, and recoveries following crises tend to be weak and slow. In Japan, for example, real GDP remained some 30 per cent below its pre-crisis trend 10 years after the onset of its financial sector distress in 1991. In the UK, the gap between realised real GDP and the level implied by the pre-crisis trend was around 20 per cent five years after the onset of the crisis in 2007. And in the USA, Japan, the UK and the euro-area, the rate of credit growth collapsed around the onset of the crises. In Japan, anaemic credit growth continued for at least a decade.

These consequences have triggered various policy responses. On the one hand, reform of financial regulation continues apace. Across jurisdictions, macroprudential policy authorities have been established and tasked with conducting system-wide prudential policy, including the use of countercyclical bank capital requirements. At the same time, central banks and governments have introduced a range of ‘unconventional’ monetary and credit policies, including asset purchases, policies to support bank funding, and recapitalisation of financial institutions. In light of these sweeping changes to the policy landscape, there is a real need to understand the mechanisms, costs and benefits of these interventions, and the conditions under which they can be effective. This paper enhances the understanding of such ‘credit policies’ – both ex-ante (to avoid credit crises), and ex-post (to escape their consequences) – by presenting a novel, tractable macroeconomic model to understand their effects.

We do this by constructing a simple overlapping generations model featuring financial intermediation and credit frictions, and use it to study the credit policies mentioned above. The key feature of our model that makes it particularly useful for studying these policies is its ability to generate a ‘credit trap’ steady state – that is, a steady state of the economy that features low real activity, low productivity, low bank capital, and weak bank profitability. In our model, the borrowing constraints facing banks depend on the health of the banking system: when the net worth of the banking system is low, banks’ ability to finance productive investment through borrowing is severely constrained. The economy enters a ‘credit trap’ when a large unanticipated shock to bank assets reduces bank capital below a critical threshold, causing banks’ funding conditions to tighten, inducing them to invest in less productive assets that, nonetheless, have higher pledgeability to creditors. Thus, even a temporary shock can have extremely persistent effects if it causes a large reduction in bank capital. And it is the possibility of entering a credit trap that has profound implications for policy that have not been examined by existing work in this area.

Concluding remarks
The recent financial crisis has raised the question of whether there is something fundamentally different about economic recovery following a severe financial crisis and, if so, how macroprudential policy tools should be used both before and after a crisis. Most modern macroeconomic models are unsuitable for addressing this question, with their economies quickly returning to health once a negative shock is unwound. In this context macroprudential policy tools play the role of reducing volatility, rather than avoiding a catastrophe or supporting the recovery from a crisis. By contrast, in this paper we explicitly consider a model in which the economy can become trapped in a steady state featuring permanently lower output, bank credit and productivity following a sufficiently severe financial shock, a confluence of characteristics we call a credit trap.

In this paper we have developed a simple, tractable OLG model for analysing credit traps. We have examined the effectiveness of policy both at preventing a credit trap occurring, and helping the economy to escape (which becomes necessary as it will not recover without intervention). Our analysis shows that a leverage ratio cap is effective in increasing the resilience of the economy against shocks and reducing the probability of a credit trap. However, this comes at the cost of lowering the level of output in the ‘good’ steady state, and hence the policymaker needs to set the cap to trade off these costs and benefits. Relaxing the leverage ratio cap is effective in encouraging faster recovery after a negative productivity shock, provided that the shock is sufficiently small. But if the shock is large enough to tip the economy into a credit trap, then relaxing the leverage ratio cap will not help the economy get out of it. To escape a credit trap other policies are needed, and we consider the efficacy of a set of ‘unconventional’ credit policies: direct lending; bank recapitalisation; and discount window lending. These policies present rich, realistic trade-offs which vary with their relative efficiency costs. Their effectiveness depends on the state of the economy, with all more effective when the economy is weaker.

In future work, it would be interesting to analyse more thoroughly the optimal leverage cap that would be set by a policymaker in advance of a trap. We have shown that the level of the leverage cap that maximises resilience is countercyclical: it would be interesting to analyse numerically if the optimal level of the leverage cap is too, and whether this would vary with the state of the economy in a non-linear way. This would be particularly interesting when the economy is just above the trap threshold, and the policymaker has to trade-off rebuilding the health of the banking system with the possibility of further negative shocks. .

Note: Staff Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. Any views expressed are solely those of the author(s) and so cannot be taken to represent those of the Bank of England or to state Bank of England policy.

Westpac Follows The Herd On Mortgage Repricing

Westpac today announced an increase in interest rates for residential investment property loans, following the introduction of investor lending growth benchmarks set by APRA. They will lift the rates 27 basis points for Westpac brands, and 25 bps for the brands which sit under the St George umbrella, but sooner (21 August), versus 25 September for Westpac.

The standard variable interest rate on Westpac residential investment property loans for new customers will increase by 0.27% to 5.75%, effective 10 August 2015. For existing customers the increase will be effective 25 September, 2015. This timing is to ensure that there is a smooth transition to the differentiated rates structure for the mortgage portfolio.

Fixed rates on residential investment property loans will increase by up to 0.30%, effective 4 August 2015.

Westpac will decrease fixed rates on owner occupier home loans by up to 0.30% effective 4 August 2015.

Consumer Bank Chief Executive, George Frazis, said: “Today’s announcement is an important step in ensuring that Westpac meets APRA’s benchmark that investor credit growth should be no more than 10 per cent.

“We have already introduced a range of initiatives, including increasing the deposit required for investment property loans to 20 per cent as part of our commitment in meeting APRA’s benchmark.

“However, we are pleased to be able to reduce fixed rates on owner occupier loans. We know that the dream of many Australians is to get into their own home and the new lower fixed rates will benefit customers that are looking for security and peace of mind about their loans and monthly repayments.”

The Westpac delay is probably connected with the system changes which will need to be made, as we highlighted in an earlier post.

APRA MBS Says Investment Loans Higher – But Beware!

The APRA monthly banking statistics for the ADI’s to June 2015 were released today. Home investment lending does not show signs of cooling, so this explains the recent more overt pressure being applied by the regulators. We will look at home lending first. The banks grew their lending book by 1.33% in the month to 1.37 trillion. Remember this is the stock of loans. RBA reported total loans were $1,481 bn, the difference being the non-banks.

Within that, owner occupied loans were down 1.24% and investment loans were up 5.99%. Investment loans were worth $507 bn. But this is due to a massive adjustment in the data relating to ANZ. Between May and June, the APRA ANZ data shows their owner occupied loans dropped by $16.2 bn and their investment book grew by $23 bn. We think this helps to explains ANZ’s announcement earlier. Clearly some loans have been reclassified between May and June, so this distorts the overall market picture. APRA’s report on revisions does not really help us. That said, here is the detailed analysis.

CBA has the largest share of owner occupied loans, with 27.36% of the market. Westpac has 30% of all investment property lending. ANZ had 15.12% of owner occupied loans, and 16.46% of investment loans (under the revised data in June).

The portfolio movements May to June show the ANZ swing, and not much else!

The APRA speed bump of 10% is well and truly exceeded this month because of the swing in ANZ. The market grew at an annualised rate of over 15% and many large and small players are well above the threshold – ANZ was at 47% – but this is because of the adjustment. The true growth rate is lower. But, no visible impact of the APRA guidelines so far.

For comparison purposes, here is the data for owner occupied loans – and though no formal speed limit is in place, we have shown the 10% benchmark. The market grew at 4.3% in the past 12 months. The true rate is higher.

Turning to deposits, little change in the month, total deposits were down just a tad to $1.83 trillion. Little movement in relative shares.

On the credit card portfolios, there was a rise of 0.4% in balances outstanding, to $41.5 bn. No significant change in the relative share.

Investment Property Lending Sucking Finance From Business

The latest data form the RBA on credit aggregates to June 2015, tells the continuing story of growing investment property lending, and a relative reduction in lending to business. The data on total loans outstanding (stock) shows there was a fall in lending to business in the month of 0.36%, which translates to a growth of 4.3% for the year to $789 bn. On the other hand, lending for housing rose 0.6% in the month, and 7.3% for the year, (higher than last year at 6.4%) to $1,481 bn. Owner occupied housing rose 0.47% to $945 bn, whilst investment lending grew 1.10% to $536 bn. Other personal lending rose 0.15% to $137 bn.

Total lending to business as a share of all lending fell again to 32.8%, this is not healthy as productive growth comes from business investing in their futures. This is not as strong as we need to sustain the economy.

Looking at the mix of lending for housing, investment lending was up to 36.2%. It has never been higher. This inflates house prices, and banks balance sheets, but the wealth is artificial, and unproductive.

Finally we think there are some funnies in these numbers, which when we have completed the analysis of the APRA monthly banking statistics, we will comment on further. Suffice it to say, it seems maybe some loans were reclassified last month from owner occupied to investor loans, so might be distorting the data.

DFA Survey Shows Property Demand Remains Strong

Following on from yesterdays video blog on the overall results from the latest household surveys, over the next few days, we will dig further into the data. We start with some cross segment observations, before in later posts, we begin to go deeper into segment specific motivations. You can read about our segmentation approach here. Many households still want to get into property – demand is strong, thanks to lower interest rates, despite high home prices and flat incomes. Future capital growth is expected by many in the market, and by those hoping to enter. This despite a fall in household confidence, as measured in our finance confidence index.

We start with savings intentions. Prospective first time buyers are saving the hardest, despite the lower interest being paid on deposits. More than 70% are actively saving to try and get into the market (though we will see later, more are switching to an investment purchase). Portfolio and solo property investors are saving the least – despite the recent changes to LVR’s on loans.

A significant proportion of those saving are actively foregoing other purchases and spending less, so they can top up their deposits. A higher proportion are also looking to the “Bank of Mum and Dad” for help.

Looking next at borrowing intentions over the next 12 months (an indication of future mortgage finance demand), down-traders are slightly less likely to borrow now, compared with a year ago, whilst investors are firmly on the loan path. First time buyers will need to borrow. Refinancers are active, and one motivation we are seeing is the extraction of capital during refinance, onto a lower interest rate.

Many households are still bullish on house price growth. Investors are the most optimistic, whilst down-traders the least. There are significant state differences, with those in the eastern states more positive than those elsewhere.

So, who is most likely to transact? Portfolio investors are most likely, then down-traders, and solo investors. There is also a lift in the number of households looking to refinance, to take advantage of lower interest rates. The recent public announcements by the banks, about tightening lending criteria appears to have encouraged some to bring forward their plans to purchase, in the expectation that later it may be more difficult to get a loan.

The recent tweaks in rates are having no impact on household plans, as the absolute rates are still very low – lower than ever – for many. We conclude that the demand side of the property and mortgage markets are still intact.

Next time we will look in detail at data from first time buyers, and then investors.

Australian Major Banks’ Repricing of Residential Investor Loans Is Credit Positive – Moody’s

From Moody’s.

Over the past week, three major Australian banks increased their lending rates for residential property investment loans and interest-only (IO) loans. Australia and New Zealand Banking Group Limited and Commonwealth Bank of Australia each lifted the standard variable investor rate by 0.27%. National Australia Bank Limited increased the rate it charges for IO loans and line of credit facilities by 0.29% (investors, rather than owner-occupiers, primarily take out IO loans).

Increased lending rates are credit positive for the banks because they re-balance their portfolios away from the higher-risk investor and IO lending toward safer owner-occupied and principal amortizing loans. They also help to preserve net interest margins (NIM) and profitability amid higher capital requirements and increased competition from smaller lenders.

The banks’ moves follow increasing regulatory scrutiny of residential property lending. Investment and IO lending has grown rapidly in the recent past, reaching a record proportion of overall mortgage lending that has contributed to rapid house price appreciation, particularly in the Sydney and Melbourne markets.

In December 2014, the Australian Prudential Regulation Authority (APRA) announced a set of measures designed to ensure residential mortgage underwriting standards remain prudent and to curb growth in investment lending to 10% per year. The major Australian banks have since undertaken a number of initiatives to ensure compliance with APRA’s guidelines. Notably, these include the imposition of higher down payment requirements for investment lending and these most recent pricing changes.

Although investment and IO loans performed well during the global financial crisis of 2007-10, they inherently carry higher default probabilities and severities, and a larger proportion of such loans risks higher delinquencies for Australian banks at times of stress.

Investment loans typically have higher loan-to-value ratios: our data indicates that the average loan-to-value ratio for investment loans is 60.2%, versus 57.8% for owner-occupier loans. In addition, since the underlying properties are not the primary residence, they are more sensitive to changes in house prices and borrower employment status and thus are more likely to default if the borrower’s conditions change. IO loans are more exposed to rising interest rates than principal-and-interest loans.

We see APRA’s and the banks’ efforts to slow the growth in investment lending as an important credit support for the system. We also expect that the remaining major Australian bank, Westpac Banking Corporation will follow the other banks in repricing its investment mortgage book. Over time, these steps are likely to slow investment lending growth rates to below APRA’s 10% cap from current annualized growth rates of 10.6% for ANZ, 9.9% for CBA, 14.1% for NAB and 10.0% for Westpac, according to APRA data.

Curbing investment lending is particularly positive for those banks with significant investment loan portfolios. NAB and Westpac, when it follows suit, are especially well-placed to derive benefits from pricing changes. Westpac has the highest proportion of investment lending in its portfolio (46% of total housing loans), exposing it to a higher-risk segment, and NAB has opted to reprice its IO loans and line of credit facilities (together they constitute 47% of its overall portfolio), allowing it to capture a greater NIM benefit.

ING Direct Tightens Investment Loan Criteria

The AFR is reporting that ING has said new investor borrowers will need to find a 20% deposit, a hurdle which had previously applied only to loans in Sydney. They will also end discounts rates for new investor borrowers and tighten serviceability assessments.

This is further evidence that smaller banks are reacting to the APRA 10% threshold. APRA data shows ING has about $9bn of investment loans but is not growing above the 10% limit. Their move looks like preemptive action to avoid a flood of applications as investors seek loans from smaller players in response to the majors throttling back, or a reduction in focus on mortgages in Australia. Macquarie purchased a mortgage portfolio of $1.5bn from ING in September 2014.

AMP Bank Stops Property Investor Lending and Lifts Rates

In a media release, AMP say that in response to regulator guidelines to limit growth in investor property lending across the market to 10 per cent, AMP Bank will increase variable rates on all existing investor property loans by 0.47 per cent per annum from 7 September 2015.

All investor property loan applications that have been approved will be subject to the 0.47 per cent increase on settlement.

In addition, AMP Bank will not be accepting new or assessing existing investor property lending applications from today. This is expected to last until later in 2015, depending on market conditions.

“We appreciate the position this puts our customers in and will be working with our distribution network to actively communicate with them,” said Michael Lawrence, Managing Director, AMP Bank.

AMP Bank remains committed to helping Australians own their homes and, effective 27 July, reduced interest rates for new owner occupied variable loan rates on the AMP Bank Professional Package to as low as 4.12 per cent per annum.

“Australia’s property market is experiencing high levels of investor property lending growth and we are supportive of the regulator’s intention to slow this growth to appropriate levels,” said Mr Lawrence.

AMP has a small share of the market (around 1%), as shown in the APRA monthly banking statistics, but has been growing its investment loans by well above the 10% APRA guidance rate. Their investment book is worth around $2.9bn, and is half the size of its owner occupied loan book.

As we highlighted, if growth was strong in the first half, and above 10%, then the corollary is that in the second half the growth must be significantly lower to net out at 10%.

Their reduction in rates for new owner occupied loans highlights that the upcoming battleground will be refinancing of owner-occupied loans in substitution of the investment sector.

NZ Monetary policy supporting growth and inflation goal

The NZ Reserve Bank confirmed that at this stage some further monetary policy easing is likely to be required to maintain New Zealand’s economic growth around its potential, and return CPI inflation to its medium-term target level.

Further exchange rate depreciation is necessary, given the weakness in export commodity prices and the projected deterioration in the country’s net external liabilities over the next two years, Governor Graeme Wheeler said.

Speaking to an ExportNZ/Tauranga Chamber of Commerce audience, Mr Wheeler said that in mid-2014, New Zealand’s terms of trade were at a 40-year high, but over the past 15 months the economy has experienced several shocks. Export prices for whole milk powder have fallen 63 percent since February 2014, and oil prices are currently more than 50 percent below their June 2014 level. Net immigration and labour force participation are at historic highs, and the real exchange rate has declined steadily since April 2015.

Over the past two years, annual CPI inflation has been in the lower half of the 1 to 3 percent target band, except for the period since the December quarter 2014 when the fall in oil prices brought CPI inflation to very low levels. The Bank expects annual CPI inflation to be close to the midpoint of the 1 to 3 percent target range by the first half of 2016.

“Under the Bank’s flexible inflation targeting framework, the Policy Targets Agreement specifically recognises that annual CPI inflation will fluctuate around the medium-term trend due to factors such as exceptional movements in commodity prices – like those experienced since mid-2014,” Mr Wheeler said.

“There are, however, several risks and uncertainties around the inflation outlook. These include the future path of the exchange rate, which will be influenced by future commodity prices, and the speed with which the recent depreciation feeds through to higher inflation.”

Mr Wheeler said that, despite recent declines, the exchange rate remains above the level consistent with current economic conditions.

“At current levels of export prices, a more substantial exchange rate depreciation will be required to stabilise the net external liabilities position relative to GDP.”

Mr Wheeler added that there is potential for further downward pressure on global dairy prices. “Also, over coming months, the Federal Reserve and the Bank of England are likely to begin the process of normalising their interest rates, which could assist our currency lower.”

Turning to interest rates, Mr Wheeler said that current monetary policy settings are providing stimulus to the economy at a time when output looks to be growing around 2.5 percent, slightly below potential, and core inflation remains a bit below the mid-point.

He said that some local commentators have predicted large declines in interest rates over coming months that could only be consistent with the economy moving into recession. “We will review our growth forecasts in the September Monetary Policy Statement but, at this point, we believe that several factors are supporting economic growth. These include the easing in monetary conditions, continued high levels of migration and labour force participation, ongoing growth in construction, and continued strength in the services sector.”

Mr Wheeler said that, in returning inflation to the mid-point of the target band, the Bank has to avoid unnecessary volatility in output, interest rates, and the exchange rate.

“Our judgement in the current circumstances is that aiming to return inflation to around its medium-term target level in about nine to 12 months’ time is an appropriate speed of adjustment. This may not always be the appropriate speed of adjustment. Nor does it mean that the Bank will necessarily deliver a precise outcome as the economy is constantly experiencing shocks and disturbances that policy may need to counter or accommodate.

“Having the scope to amend policy settings, however, is a key strength of the monetary policy regime. In response to these developments, the Bank will review and, if necessary, revise its policy settings to meet its price stability objective. The time path of inflation may change as monetary policy is recalibrated, but the overall goal of meeting the specifications of the PTA will remain the central focus of policy.”

Mr Wheeler also noted that the Bank is conscious of the impact that low interest rates can have on housing demand and its potential to feed into higher house price inflation. Lower interest rates risked exacerbating the already extensive housing pressures in Auckland by stimulating housing demand, although, outside of Auckland, nationwide house price inflation is currently running at an annual rate of around 2 percent. However, in the present situation, raising interest rates would be inappropriate as it would put upward pressure on the exchange rate and further dampen CPI inflation.

“The Bank continues to be concerned about the financial stability risks and risks to the broader economy that would be associated with a major correction in Auckland house prices. In the current circumstances, macro prudential policy can be helpful in reducing some of the pressures arising from the Auckland housing market. The proposed LVR measures and the Government’s policy initiatives that it announced in the 2015 Budget should begin to ease the impact of investor activity.

“While a strong supply response over several years is needed to address Auckland’s housing imbalance, macro-prudential policy can help to lower the financial and economic risks while important regulatory and infrastructure issues are addressed and additional investment in new housing takes place.”