Economics and Banking – Page 461 – Digital Finance Analytics (DFA) Blog

National Australia Bank CRE Sale

National Australia Bank (NAB) is to sell an additional £1.2 billion parcel of higher risk loans from its UK Commercial Real Estate (CRE) portfolio to an affiliate of Cerberus Global Investors (Cerberus). As a result of the sale, a small gain is expected to be recognised in the March 2015 half year accounts, and an estimated £127 million of capital will be released for the NAB Group when the transaction is settled. Following the sale, the balance of the portfolio will be reduced to £836 million, compared to the original balance of £5.6 billion in October 2012 when the run-off portfolio was first established. The loans being sold are mainly defaulted, watch and high loan-to-value loans, with the sale reducing the higher risk loans in the portfolio by 93%.

NAB Group Chief Executive Andrew Thorburn said NAB had accelerated the run-off of theNAB UK CRE portfolio, with the great majority of the remaining non-performing loans being sold. “This is an important step forward, effectively bringing closure to one of our legacy positions. The sale of these higher risk loans in the NAB UK CRE portfolio is another important milestone in our strategy of reducing our low returning legacy assets and sharpening our focus on our core Australian and New Zealand franchises,” Mr Thorburn said. “Pleasingly the remaining NAB UK CRE loans are largely strong performing loans, and we will look at other options to manage this small remaining portfolio.”

NAB and Cerberus will work together on a smooth transition for impacted customers. This work will include appropriate advance notice to enable customers to understand and plan for the transfer. Given the significant risk reduction in the portfolio over the last 2 years, the NAB UK CRE business segment will no longer be reported as a separate line of business in the NAB accounts and going forward will be reported as part of Corporate Functions and Other. The NAB UK CRE collective provision overlay will be separately assessed as part of the usual half year accounts close process, including the requirements of AASB9. The transaction is not subject to regulatory or other external approvals, and the assets will immediately be derecognised from the NAB Group’s balance sheet.

UK Macroprudential Update

The Bank of England just released their latest Financial Stability report. Within the document there is a section on the implementation of macroprudential measures relating to mortgage lending. This makes an interesting contrast with the Australian Regulatory framework.

Mortgage affordability test – Implemented: When assessing affordability, mortgage lenders should apply an interest rate stress test that assesses whether borrowers could still afford their mortgages if, at any point over the first five years of the loan, Bank Rate were to be 3 percentage
points higher than the prevailing rate at origination.

Loan to income limit – Implemented: The PRA and the FCA should ensure that mortgage lenders do not extend more than 15% of their total number of new residential mortgages at loan to income ratios at or greater than 4.5. This Recommendation applies to all lenders which
extend residential mortgage lending in excess of £100 million per annum.

Powers of Direction over leverage ratio – Action under way: The FPC recommends that HM Treasury exercise its statutory power to enable the FPC to direct, if necessary to protect and enhance financial stability, the PRA to set leverage ratio requirements and buffers for PRA-regulated banks, building societies and investment firms, including:

a minimum leverage ratio requirement to remove or reduce systemic risks attributable to unsustainable leverage in the financial system;
a supplementary leverage ratio buffer that will apply to G-SIBs and other major domestic UK banks and building societies, including ring-fenced banks to remove or reduce systemic risks attributable to the distribution of risk within the financial sector;
a countercyclical leverage ratio buffer to remove or reduce systemic risks attributable to credit booms — periods of unsustainable credit growth in the economy.

The Government intends to lay the final legislation before Parliament in early 2015, alongside publishing a consultation response document and impact assessment. As with the housing instruments, the FPC intends to issue a draft Policy Statement in early 2015 to inform the Parliamentary debate.

HM Treasury intends to consult separately on LTV/interest coverage ratio powers for the buy-to-let sector in 2015, with a view to building further evidence on how the UK buy-to-let housing market may pose risks to financial stability.

Results of UK Bank’s Stress Tests

The Bank of England announced the results of the first concurrent stress testing exercise of the UK banking system. Alongside the stress test publication, the Bank of England also published its Financial Stability Report, which sets out the Financial Policy Committee’s (FPC) assessment of the outlook for the stability and resilience of the financial sector, and the Systemic Risk Survey, which quantifies and tracks market participants’ perceptions of systemic risks.

Following on from the EU-wide stress test, the 2014 UK stress test of the eight major UK banks and building societies was designed specifically to assess their resilience to a very severe housing market shock and to a sharp rise or snap back in interest rates. This was not a forecast or expectation by the Bank of England regarding the likelihood of a set of events materialising, but a coherent, severe ‘tail risk’ scenario.

The eight banks and building societies tested as part of this exercise were Barclays Bank, Co-operative Bank, HSBC Bank, Lloyds Banking Group, Nationwide Building Society, Royal Bank of Scotland, Santander UK and Standard Chartered.

There was substantial variation across the banks and building societies in terms of the impact of the stress scenario. From an individual-institution perspective, the Prudential Regulation Authority (PRA) Board judged that this stress test did not reveal capital inadequacies for five out of the eight participating banks, given their balance sheets at end-2013 (Barclays, HSBC, Nationwide, Santander UK and Standard Chartered). The PRA Board did not require these banks to submit revised capital plans.

Following the stress testing exercise, the PRA Board judged that, as at end-2013, three of the eight participating banks (Co-operative Bank, Lloyds Banking Group and Royal Bank of Scotland) needed to strengthen their capital position further. But, given continuing improvements to banks’ resilience over the course of 2014 and concrete plans to build capital further going forward, only one of these banks (Co-operative Bank) was required to submit a revised capital plan.

The FPC considered the information provided by the stress-test results from the perspective of the resilience of the UK banking system as a whole. The FPC noted that only one bank fell below the 4.5% threshold at the trough of the stress scenario, that the capitalisation of the system had improved further over the course of 2014 and that the PRA Board had agreed plans with banks to build capital further. Overall, the FPC judged that the resilience of the system had improved significantly since the capital shortfall exercise in 2013. Moreover, the stress-test results and banks’ capital plans, taken together, indicated that the banking system would have the capacity to maintain its core functions in a stress scenario. Therefore, the FPC judged that no system-wide, macroprudential actions were needed in response to the stress test.

Projected CET1 capital ratios in the stress scenario

	Actual (end 2013)	Minimum Stressed ratio (before the impact of ‘strategic’ management actions)	Minimum Stressed ratio (after the impact of ‘strategic’ management actions)	Actual (latest, Q2 or Q3 2014)
Barclays	9.1%	7.0%	7.5%	10.0%
Co-operative Bank Plc	7.2%	-2.6%	-2.6%	11.5%
HSBC Bank Plc	10.8%	8.7%	8.7%	11.2%
Lloyds Banking Group	10.1%	5.0%	5.3%	12.0%
Nationwide Building Society	14.3%	6.1%	6.7%	17.6%
Royal Bank of Scotland	8.6%	4.6%	5.2%	10.8%
Santander UK	11.6%	7.6%	7.9%	11.8%
Standard Chartered Plc	10.5%	7.1%	8.1%	10.5%

Rates Unlikely to Change Anytime Soon

The minutes from the December RBA Board meeting were released today. Looks like rates will stay at current levels for some time yet.

In assessing the stance of monetary policy in Australia, members noted that the outlook for the global economy was little changed over the past month, with growth of Australia’s major trading partners forecast to be a little above average in 2014 and 2015. Commodity prices, particularly those for iron ore and oil, had declined over the year to date. Demand-side factors, such as the weakness in Chinese property markets, had played a role over recent months, though expansions in global supply appeared to have played a larger role earlier in the year. Global financial market conditions had remained very accommodative.

Domestically, the data that had become available over the month suggested that the forces underpinning the outlook for domestic activity were much as they had been for some time. GDP growth was still expected to be below trend over 2014/15 before gradually picking up to an above-trend pace towards the end of 2016. Mining investment was expected to decline sharply and resource exports were expected to grow strongly as the transition from the investment to the production phase of the mining boom continued. Very low interest rates had supported activity in the housing market, which in turn was expected to support consumption. However, members noted that subdued labour market conditions were likely to weigh on consumption growth and consumer confidence more generally. With spare capacity in labour and product markets likely to weigh on domestic inflationary pressures for some time, the inflation outlook remained consistent with the target of 2 to 3 per cent, notwithstanding some temporary upward pressure from the recent depreciation of the exchange rate.

Members noted that the current accommodative setting of monetary policy was expected to support demand and help growth strengthen at the same time as delivering inflation outcomes consistent with the target over the next two years. Despite the depreciation of the exchange rate, the Australian dollar remained above most estimates of its fundamental value, particularly given the significant declines in key commodity prices over recent months. Members agreed that further exchange rate depreciation was likely to be needed to achieve balanced growth in the economy. They noted that market expectations implied some chance of an easing of policy during 2015 and discussed the factors that might be producing such an expectation.

On the information available, the Board judged that the current stance of monetary policy continued to be appropriate for fostering sustainable growth in demand and inflation outcomes consistent with the target. Members considered that the most prudent course was likely to be a period of stability in interest rates.

MYEFO – Underlying Cash Deficit of $40.4 Billion is Now Expected in 2014-15

The Government published their mid-term review today. Since May, two key factors have primarily driven the $43.7 billion deterioration in the budget over the forward estimates: the impact of the economy on tax receipts and payments; and the impact of the Senate’s decisions. Primarily as a result of the collapse in iron ore prices by over 30 per cent and weaker than expected wage growth, tax receipts have been revised down by $31.6 billion. Government payments have also been affected. Delays in passing legislation and negotiations with the Senate have cost the budget more than $10.6 billion over the forward estimates, keeping debt and interest payments higher for longer. An underlying cash deficit of $40.4 billion is now expected in 2014-15 (2.5 per cent of GDP), narrowing to a deficit of $11.5 billion (0.6 per cent of GDP) by 2017-18.

Overall, the outlook for real GDP growth is unchanged since Budget. Real GDP is forecast to grow at 2½ per cent in 2014-15, before increasing to near-trend growth of 3 per cent in 2015-16. This reflects the expectation of solid growth of real activity in the economy continuing.
However, the changes to the economic outlook since the Budget are driven by the sharper than expected fall in the terms of trade, including significant falls in prices of iron ore and coal, and weaker wage growth. While the forecasts for solid real GDP growth are unchanged, the prices we receive for our production have declined significantly. Accordingly, nominal GDP growth in 2014-15 is expected to be weaker than forecast at Budget, at 1½ per cent. This would be the weakest nominal GDP growth in a financial year in over 50 years.

Iron ore prices have unexpectedly fallen by over 30 per cent since the Budget. MYEFO assumes a free-on-board iron ore price of US$60 per tonne over the next two years, which compares with a spot price of US$95 at Budget. The fall in iron ore prices has led to company tax receipts being revised down by $2.3 billion in 2014-15 and $14.4 billion over the forward estimates. At the same time weaker wage and employment growth are expected to lower individuals’ income tax receipts by $2.3 billion in 2014-15 and $8.6 billion over the forward estimates. Weaker wage and employment growth will also increase payments for existing government programmes. Excluding policy changes, total taxation receipts have been revised down by $6.2 billion in 2014-15 and $31.6 billion over the forward estimates. This brings the total writedown in tax receipts since the Government was elected to over $70 billion. To avoid detracting from economic growth, the Government has let the impact on the budget from sharply lower iron ore prices and slower wage growth flow through to the bottom line, rather than taking decisions to cut expenditure dramatically or increase tax.

The 2013-14 MYEFO showed that, without action, the budget would not return to surplus for a decade, and debt would reach $667 billion by 2023-24 and still be rising. Despite the deterioration in the fiscal outlook over the forward estimates, the medium-term outlook for the budget is considerably better than a year ago. Debt is now projected to be nearly $170 billion lower than it would have been by 2023-24 and to be falling. The underlying cash balance is projected to reach surplus in 2019-20, with the surplus reaching 0.8 per cent of GDP by the end of the medium term, including future tax relief being incorporated from 2020-21. This remains a considerable improvement from the 2013-14 MYEFO projections.

Vehicle Sales Down, Slightly – ABS

The ABS released the New Motor Sales statistics to November 2014 today. The trend estimate (92 324) has decreased by 0.2% when compared with October 2014. The trend estimate for year to date has new vehicle sales reaching the one million mark. The November 2014 seasonally adjusted estimate (91 869) has decreased by 0.6% when compared with October 2014.

When comparing national trend estimates for November 2014 with October 2014, sales of Passenger and Other vehicles decreased by 0.5% and 0.7% respectively. Over the same period, Sports utility vehicles increased by 0.4%. When comparing seasonally adjusted estimates for November 2014 with October 2014, sales of Passenger and Other vehicles decreased by 1.1% and 2.3% respectively. Over the same period, Sports utility vehicles increased by 1.3%.

Five of the eight states and territories experienced a decrease in new motor vehicle sales when comparing November 2014 with October 2014. Western Australia recorded the largest percentage decrease (1.3%), followed by both Queensland and the Australian Capital Territory (0.6%). Over the same period, the Northern Territory recorded the largest increase in sales of 0.7%. Five of the states and territories experienced a decrease in new motor vehicle sales when comparing November 2014 with October 2014. Western Australia recorded the largest percentage decrease (2.2%) followed by New South Wales (2.0%) and the Northern Territory (1.2%). Victoria and the Australian Capital Territory both recorded an increase of 1.7%.

Investment Loans 50.8% Of Mortgages

The ABS released their finance data to October 2014. The total value of owner occupied housing commitments excluding alterations and additions rose 0.2% in trend terms, and the seasonally adjusted series rose 1.0%.

The trend series for the value of total personal finance commitments rose 0.7%. Fixed lending commitments rose 1.1% and revolving credit commitments rose 0.1%. The seasonally adjusted series for the value of total personal finance commitments rose 6.5%. Revolving credit commitments rose 11.2% and fixed lending commitments rose 3.0%.

The trend series for the value of total commercial finance commitments fell 2.6%. Revolving credit commitments fell 7.9% and fixed lending commitments fell 0.6%. The seasonally adjusted series for the value of total commercial finance commitments fell 2.2%. Revolving credit commitments fell 11.5%, while fixed lending commitments rose 0.9%.

The trend series for the value of total lease finance commitments rose 0.8% in October 2014 and the seasonally adjusted series fell 4.7%, following a fall of 0.9% in September 2014.

The housing lending data shows another record was achieved last month with 50.8% of mortgages for investment purposes. Another record.

This is starkly show by plotting the flows of owner occupied versus investment loans over the past few years.

Housing Finance Regulation – Tweaked, Not Reformed

Fresh on the heels of the FSI report, the core thesis of which is that the Australian Banks are too big to fail, so capital buffers must be increased to protect Australia from potential risks in a down turn (a “mild” crash could lead to the loss of 900,000 jobs and a $1-2 trillion or more cost to the economy), it was interesting to see the publication yesterday by APRA of the guidelines for mortgage lending, and ASIC’s targetting interest only loans. This action is coordinated via the Council of Financial Regulators (CFR). This body is the conductor of the regulatory orchestra, and has only had an independant website since 2013. It is the coordinating body for Australia’s main financial regulatory agencies. It is a non-statutory body whose role is to contribute to the efficiency and effectiveness of financial regulation and to promote stability of the Australian financial system. The Reserve Bank of Australia (RBA) chairs the Council and members include the Australian Prudential Regulation Authority (APRA), the Australian Securities and Investments Commission (ASIC), and The Treasury. The CFR meets in person quarterly or more often if circumstances require it. The meetings are chaired by the RBA Governor, with secretariat support provided by the RBA. In the CFR, members share information, discuss regulatory issues and, if the need arises, coordinate responses to potential threats to financial stability. The CFR also advises Government on the adequacy of Australia’s financial regulatory arrangements.

Whilst FSI recommended beefing up ASIC, and introducing a formal regulatory review body, it did not fundamentally disrupt the current arrangements. Interestingly, CFR is a direct interface between the “independent” RBA and Government.

So, lets consider the announcements yesterday. None of the measures are pure macroprudential, but APRA is reinforcing lending standards by introducing potential supervisory triggers (which if breached may lead to more capital requirements, or other steps) using an affordability floor of 7% or more (meaning if product interest rates fell further, banks could not assume a fall in serviceability requirements) and at least an assumed rise in rates of 2% from current loan product rates. In addition, any lender growing their investment lending book by more than 10% p.a. will be subject to additional focus (though APRA makes the point this is not a hard limit). These guidelines relate to new business, and does not directly impact loans already on book (though refinancing is an interesting question, will existing borrowers who refinance be subject to new lending assessment criteria?) ASIC is focussing on interest-only loans, which are growing fast, and are often related to investment lending.

The banks currently have different policies with regards to serviceability buffers. Analysts are looking at Westpac in the light of these announcements, because it grew its investment housing lending book fast, uses 180 basis points serviceability buffer and an interest rate floor of 6.8%. Investment property loans make up ~45% of WBC’s housing loan portfolio (compared with the majors average of ~36%), and has grown at ~12% year on year this financial year (compared with the average across the majors of ~10%). WBC made some interesting comments in their recent investor presentation relating to investment loans, highlighting that investors tended to have higher incomes than owner occupied loans.

Other banks have different underwriting formulations with buffers of between 1.5% and 2.25% buffers. ASIC has of course also stressed that lenders must consider borrowers ability to repay and take account other expenditure. There is evidence of the “quiet word from the regulator” working as recently we have noted some slowing investment lending at WBC (currently they would be below the 10% threshold) and amongst some other lenders too. However, some of the smaller lenders may be impacted by APRA guidance, given stronger recent growth.

What does this all mean. First, we see now what APRA meant in their earlier remarks “collecting additional information, counselling the more aggressive lenders, and seeking assurances from Boards of our lenders that they are actively monitoring lending standards. We’re about to finalise guidance on what we see as sound mortgage lending practice”. Second, we do not think this will materially slow down housing investment lending, and this is probably what the RBA wants, given its belief consumer spending should replace mining investment as a source of growth. The regulators are trying to manage potential risks in the system, by targetting higher risk lending whilst letting housing lending continue to run. Third, it leaves open the door to macroprudential later if needed. Lastly, existing borrowers may be loathe to churn if they are now required to meet additional buffers. This may slow refinancing, and increase longevity of loans in portfolio (and loans held longer are more profitable for the banks).