Category: Property Market

Walking The Tightrope – The Property Imperative Weekly 18 Nov 2017

A really mixed bag of news this week, with stronger business and employment data, lower mortgage defaults and yet weak wage growth, and more evidence of the pressure on households. We pick over the coals and try to make sense of what’s going on.

 Welcome to the Property Imperative Weekly to 18 November 2017. Watch the video or read the transcript.

We start with some good news.

The latest National Australia Business (NAB) survey — a composite indicator that measures trading activity, profitability and employment — surged by a massive 7 points to +21, leaving it at the highest level since the survey began in 1997. On this measure, Australian businesses have not had it so good in at least two decades. There were enormous increases recorded in trading and profitability, suggesting that demand was rampant during October. However, beware, this included a massive unexplained jump in manufacturing and the survey’s lead indicators softened over the month, which, along with an unchanged reading on business confidence, raises questions as to whether the bounce in the conditions index can be sustained.

Deputy Governor Guy Debelle spoke at the UBS Australasia Conference on “Business Investment in Australia“. He argued that investment has been strong over the last decade, thanks to the mining sector. This is now easing back, and the question is will the non-mining sector start firing or not? Even if it does, they have huge boots to fill!

Luci Ellis RBA Assistant Governor (Economic) delivered the Stan Kelly Lecture on “Where is the Growth Going to Come From?“. An excellent question given the fading mining boom, and geared up households! But we really got few answers. Australia’s population is growing faster than in almost any other OECD economy. That has remained true over the past couple of years. The rate of natural increase is higher than many other countries, but most of the difference is the large contribution from immigration. Of course, just adding more people and growing the economy to keep pace wouldn’t boost our living standards. Next, employment participation has been rising recently. The increase has been concentrated amongst women and older workers and is linked with the increase in health and education employment. Finally, productivity can improve, especially if innovation can be leveraged, although she noted the rate of technology adoption has slowed down since the turn of the century. We wonder if this has something to do with the sluggish and underpowered NBN rollout currently underway.

The monthly trend unemployment rate remained at 5.5 per cent in October 2017, according to figures released by the Australian Bureau of Statistics. While the trend is down, it was not as strong as some analysts were expecting.  The seasonally adjusted unemployment rate decreased by 0.1 percentage points to 5.4 per cent and the labour force participation rate decreased to 65.1 per cent.

The ABS released their analysis of individual state accounts to Jun 2017. This includes an estimate of average gross household disposable income per capita. The variations across states are significant and interesting. Of note is the astronomical value, and trajectory of individuals in the ACT, at more than $90,000. We saw a decline in gross incomes in WA (one reason why mortgage defaults are rising there) at around $50,000. NSW was also around $50,000 while VIC was around $45,000 and TAS was $40,000.

Wages rose 0.5 per cent in the September quarter 2017 and 2.0 per cent over the year, according to the ABS. This was below consensus expectation, and continues the slow grind in household income, for many falling below the costs of living.  Those in the public sector continue to do better than those in the private sector. In original terms, wage growth to the September quarter 2017 ranged from 1.2 per cent for the Mining industry to 2.7 per cent for Health Care and Arts and recreation services. Western Australia recorded the lowest growth through the year of 1.3 per cent and Victoria, Queensland and Tasmania the highest of 2.2 per cent.

The legislation to tighten some aspects of investment property, and levy a charge on vacant foreign owned property has been passed in the Senate. The legislation prevents property investors from claiming travel expenses when travelling between properties, as well as tightening depreciation on plant and equipment tax deductions. Foreign owners will be charged a fee if they leave their properties vacant for at least six months in a 12-month period, in an attempt to release more property to ease supply. The latest Census showed that there are 200,000 more vacant homes across Australia than there were ten years ago.

Turning to the mortgage industry, Fitch Ratings says Australia’s RBMS mortgage arrears fell to 1.02% in 3Q17, a 15bp decrease from the previous quarter; consistent with the nine-year long seasonal trend where 30+ days arrears have eased in the third quarter. They say the curing of third-quarter arrears was helped by borrowers using tax return receipts to make repayments. The 30+ days arrears were 4bp lower than in 3Q16, reflecting Australia’s improved economic environment and lower standard variable interest rates for owner-occupied lending. They said the gap between investor lending and owner-occupied rates has widened, as banks respond to regulatory investment and interest-only limits on new loan origination. Historically, investors paid a 25bp-30bp premium over owner-occupied loans, but this widened to 60bp in September 2017.

S&P Global Ratings said RMBS Mortgage arrears fell to 1.08% in September across Australian down from 1.10% in August 2017. They say mortgage arrears rose in both the Northern Territory and the ACT during September but fell elsewhere. The ACT mortgage arrears it is only at a low 0.64%, compared with Western Australia who has the highest arrears of 2.21%. However, while outstanding loan repayments on 30-to-60-day arrears also declined in most states between January and September, 90-day+ arrears rose in Western Australia and Queensland. This is the same as we saw recently in the bank reporting season. S&P expects arrears to rise over the coming months, as they “traditionally start to increase in November and continue through to March.”

There was more evidence of poor mortgage lending practice this week, following the recent UBS “Liar Loans” research study. A liar loan is a loan that is approved on the basis of unverified and possibly false information about income, assets or capacity to repay. This is important because mortgage delinquency and default may rise due to excessive risk taking in mortgage lending combined with deteriorating economic conditions; or due to falling income and rising unemployment during a housing downturn.

Connective remained brokers of their obligations, and pointed to findings from the 2016 Veda Cybercrime and Fraud Report, which recorded a 27 per cent year-on-year increase in falsifying personal information. “Falsified documentation — particularly documents that verify a customer’s income — is the most common type of fraud that a mortgage broker is likely to encounter,” the aggregator said. Back in June, Equifax informed brokers at a Pepper Money roadshow that 13 per cent of frauds reported were targeting home loans and there has been a 25 per cent year-on-year increase in frauds originating from the broker channel.

In the same vein, NAB has said it has commenced a remediation program for some of its customers, after a review identified their home loan may not have been established in accordance with NAB’s policies. NAB identified around 2,300 home loans since 2013 that may have been submitted without accurate customer information and/or documentation, or correct information in relation to NAB’s Introducer Program. As a result of NAB’s review, 20 bankers in New South Wales and Victoria had their employments terminated, or are no longer employed by NAB, and an additional 32 bankers had consequences applied including the reduction of remuneration. NAB has commenced writing to these customers – many of whom live overseas – asking them to participate in a detailed review of their loan, which may include verification of documents submitted at the time of their home loan application. Affected customers may be offered compensation as appropriate.

More evidence of the risks in the system came when The Reserve Bank in New Zealand said that Westpac New Zealand has had its minimum regulatory capital requirements increased after it failed to comply with regulatory obligations relating to its status as an internal models bank. Internal models banks are accredited by the Reserve Bank to use approved risk models to calculate how much regulatory capital they need to hold. Westpac used a number of models that had not been approved by the Reserve Bank, and materially failed to meet requirements around model governance, processes and documentation.

Still talking of risks, there was an interesting paper from the Federal Reserve Bank of Cleveland “Three Myths about Peer-to-Peer Loans” which suggested these platforms, which have experienced phenomenal growth in the past decade, resemble predatory loans in terms of the segment of the consumer market they serve and their impact on consumers’ finances and have a negative effect on individual borrowers’ financial stability. This is of course what triggered the 2007 financial crisis. There is no specific regulation in the US on the borrower side.  Given that P2P lenders are not regulated or supervised for antipredatory laws, lawmakers and regulators may need to revisit their position on online lending marketplaces.

We published two research reports this week. First our Quiet Revolution Banking Channel and Innovation Report, which is available for free download. And second the impact of rising interest rates on households.

It seems that eventually mortgage rates will rise in Australia, as global forces exert external pressure on the RBA, and as the RBA tries to normalise rates (at say 2% higher than today). Timing is, of course, not certain. But it is worth considering the potential impact. While our mortgage stress analysis takes a cash flow view of household finances, our modelling can look at the problem another way. One algorithm we have developed is a rate sensitivity calculation, which takes a household’s mortgage outstanding, at current rates, and increments the interest rate to the point where household affordability “breaks”.  We use data from our household survey to drive the analysis.

So we start with the average across the country. We find that around 10% of households would run into affordability issues with less a 0.5% hike in mortgage rates, and around another 8% would be hit if rates rose 0.5%, and a larger number would be added to the “in pain” pile, giving us a total of around 25% of households across the country in difficulty if rates went 1% higher. [Note that the calculation does not phase the rate increases in]. Around 40% of households would be fine even if rates when more than 7% higher. At a state level we found that around 40% of households in NSW would have a problem, compared with 27% in VIC and 24% in WA. We can also take the analysis further, to a regional view across the states. This reveals that the worst impacted areas would be, in order, Greater Sydney, Central Coast, Curtain and Greater Melbourne. These are all areas where home prices relative to income are significantly extended, thus households are highly leveraged.

CoreLogic said Mortgage clearance rates have continued to track below 70 per cent since June the year; this is a considerably softer trend than what was seen over the same period last year when clearance rates were tracking around the mid 70 per cent range for most of the second half 2016.  Results across each of the individual markets were varied this week, with Canberra recording the highest preliminary auction clearance rate of 72.9 per cent, while in Brisbane only 45.7 per cent of auctions cleared.

So to, two important reports.

According to the eighth edition of the Credit Suisse Research Institute’s Global Wealth Report, in the year to mid-2017, total global wealth rose at a rate of 6.4%, the fastest pace since 2012 and reached USD 280 trillion. But wealth distribution has become more uneven. This reflected widespread gains in equity markets matched by similar rises in non-financial assets (home prices), which moved above the pre-crisis year 2007’s level. Household wealth in Australia grew at an average annual growth rate of  12%, with about half the rise due to exchange-rate appreciation against the US dollar. Australia’s wealth per adult in 2017 is USD 402,600, the second highest in the world after Switzerland.

However, the composition of household wealth in Australia is heavily skewed towards non-financial assets, which average USD 303,200, and form 60% of gross assets. The high level of real assets partly reflects a large endowment of land and natural resources relative to population, but also results from high property prices in the largest cities.

Finally, Industry Super Australia, published an excellent discussion paper on “Assisting Housing Affordability” which endeavours to identify the underlying causes of affordability issues, and  considers some useful policy responses in the current and historical context. They rightly consider both supply and demand related issues.

They call out specifically the impact of incoming migration, especially around university suburbs in the major centres as one major factor.

More broadly, they articulate the problem facing many, in that access to affordable housing – a basic need – is now more difficult than ever and the issue is affecting household spending decisions:

  • Key workers like police officers, teachers and nurses can’t afford to live near the communities they serve.
  • Children are staying at home for longer, marrying later and taking longer to save for a home deposit.
  • Many older Australians are locked into big houses that no longer suit their needs while a greater number of near retirees are renting or paying off a mortgage.
  • Commuters spend too much time on congested roads and trains which are now the norm in certain Australian cities.
  • More Australians are renting.

The report is worth reading because it knits together the complex web of issues, and confirms the complexity which is housing affordability, and that there are no simple single point solutions.

And that’s the point. Sure, employment looks strong, but the nature of that employment is favouring lower wage occupations. Business confidence is strong, because business profits are up, but this is not translating into higher wages. As a result, wealth distribution is becoming more skewed, as home prices and stock prices rise. But the risks remain. Property is overvalued, and we lack joined up thinking to address the fundamental structural issues which exist. So meantime we muddle on, hoping that wage growth will start to rise before home prices fall too far and mortgage rates rise. Don’t look down, we are walking a tightrope!

So that’s the Property Imperative weekly to 18th November 2017. If you found this useful, do leave a comment below, subscribe to receive future updates, and check back next time.  Thanks for watching.

Housing Affordability, A Complex Equation

Industry Super Australia, a research and advocacy body for Industry super funds, has published an excellent discussion paper on “Assisting Housing Affordability” which endeavors to identify the underlying causes of affordability issues, and to consider some useful policy responses in the current and historical context. They rightly consider both supply and demand related issues.

They call out specifically the impact of incoming migration, especially around university suburbs in the major centres as one major factor.

More broadly, they articulate the problem facing many, in that access to affordable housing – a basic need – is now more difficult than ever and the issue is affecting household spending decisions:

  • Key workers like police officers, teachers and nurses can’t afford to live near the communities they serve.
  • Children are staying at home for longer, marrying later and taking longer to save for a home deposit.
  • Many older Australians are locked into big houses that no longer suit their needs while a greater number of near retirees are renting or paying off a mortgage.
  • Commuters spend too much time on congested roads and trains which are now the norm in certain Australian cities.
  • More Australians are renting.

This has been a long standing issue, but they say from 2013 the problem of housing affordability became more serious.

Many property developers (small and large) entered the market, chasing short-term speculative capital gains. This coincided with a ramping up of student arrivals who drew on their parents’ savings (a safe haven strategy) to acquire bricks and mortar, usually near centres of education. Alarm bells did not ring for Australian governments, even though most new arrivals were settling in a limited number of localities. These factors and market dynamics combined to drive record house prices in key centres. The key drivers of low housing affordability are due to imbalances in demand and supply in certain key markets.

  • On the demand side, key factors include the extent of unanticipated or uncoordinated immigration flows to growth centres; the relationship between international student intake and the dynamics of foreign investment in established dwellings; the interaction between record low interest rates and investors chasing future capital gains via gearing-oriented tax concessions; and lax lending practices.
  • On the supply side, key factors include poorly coordinated land release and infills approvals and the outright restriction of supply by state governments; private land developers stockpiling tracks of land around the urban fringe, and restrictive town planning and zoning rules by local governments that have produced very long lead-times for the construction of new, denser housing stock in areas where affordability is worsening.

There are significant risks attached to ignoring affordability issues.

The lack of coordination in housing policy across all levels of Australian government has generated hotspots in property markets that have undermined macroeconomic stability. Destabilising wealth effects and the continuing expansion of household debt are feeding an unsustainable cycle of property price inflation. Net foreign indebtedness has risen to concerning levels for a small open economy that lacks a diversified economic structure and runs persistent current account deficits. Australia is far too dependent on property and pits (extraction of iron ore, coal and now liquefied natural gas) as the launch pad of its economic advance. This is very risky and may end in tears.

Booming house prices are good news for existing owners and bad news for those entering the market for the first time. Prospective buyers paying 2017 prices must have faith, at a time when even investment professionals believe a purchase now is, over the short to medium term, ill-advised. They must also have faith in their capacity to maintain an adequate income to service their debt, or hope that prices will just keep rising. In Sydney, where prices have risen 87 per cent over five years, whilst incomes have risen around 15 per cent on average, that is a tough call. Yet so many people (mostly Australians below age 35) have been prepared to take out home loans valued at over six times their income, facilitated by the relatively lax lending standards of banks.

The paper confirms the complexity which is housing affordability, and that there are no simple single point solutions.

The key findings of the paper are:

  • Australia’s housing affordability problem has developed over several decades and will require a long-term commitment by all levels of government to resolve.
  • Destabilising wealth effects and the continuing expansion of household debt are feeding a cycle of property price inflation which looks unsustainable.
  • Policy responses that increase the buying power of households (for example, through grants, or reduced taxes) will only increase demand, and therefore prices.
  • Ignoring the emerging crisis in assisted housing (affordable, public and community) now risks major future social and productivity costs.
  • Simply increasing overall housing stock will not ensure that more assisted housing becomes available. Instead, increasing the supply of assisted housing specifically is required.
  • Waitlists for social housing remain intractable and this system no longer serves as a safety net.
  • Achieving the necessary growth in assisted supply is beyond the capacity of Australian governments, and private investment is required.

To resolve the issues in assisted housing, Federal, state and local governments need to coordinate their activity without duplication or political interference. The core elements of any strategy will require:

  • A central body to provide rigorous housing supply forecasting, which will assist with planning.
  • Developing appropriate incentives (for example, tax policy) to encourage institutional investment in a new assisted housing asset class.
  • Expanding the capacity and professionalism of the community housing sector to deal with larger scale developments and tenant administration.

Additionally, some general policy suggestions to address broader housing affordability issues are as follows:

  • Explicitly linking state and local government planning and housing approvals to estimates of regional housing supply gaps.
  • Encouraging more work and student visa holders to reside outside of property market hot-spots.
  • Directing all foreign investment in residential property to new buildings.
  • Streamlining town planning procedures by mandating the removal of unreasonable height restrictions within urban infill development zones (including ‘inner’ and ‘middle-ring’ suburbs).
  • Discouraging land hoarding by identifying underutilised assets for redevelopment (including assisted housing), and providing recycling bonuses to incentivise the release of public and private sites.
  • Reorienting some current tax concessions for existing property towards investment in new housing and institutional investment in new assisted housing.
  • Reforming land taxes in Australia via the abolition of stamp duties and replacing them with a mix of land and betterment taxes.
  • Promoting stability around property – the largest asset class held by ordinary Australians.

Assessing China’s Residential Real Estate Market

The IMF just published a working paper examining real estate in China.

After a temporary slowdown in 2014-2015 China’s real estate market rebounded sharply in 2016. As signs of overheating emerged, the government turned to tighten real estate markets through a range of macroprudential and administrative measures. Many empirical studies point out that the house price surge is driven by fundamentals, while others consider the pickup of real estate activity is unsustainable. This paper uses city-level real estate data to estimate the range of overvaluation of real estate markets across city-tiers, and assesses the main risks of a real estate slowdown and its impact on economic growth and financial stability.

Real estate has been a key engine of China’s rapid growth in the past decades. Real estate investment grew rapidly from about 4 percent of GDP in 1997 to the peak of 15 percent of GDP in 2014, with residential investment accounting for over two thirds of the total real estate investment.

Bank lending to the sector makes up 25 percent of total bank loans, about half of all new loans in 2016, and banks’ increasing exposures to real estate, including through property developers and household mortgages, may pose financial stability concerns. Real estate also has strong linkages to upstream and downstream industries (about a quarter of GDP is real-estate related).2 In addition, land sales are a key source of local public finance, accounting for about 30 percent of local government revenue in 2016, while general government net spending financed by land sales is about 9 percent of the headline revenue in 2016. There has been a rapid expansion of government subsidies on social housing, consisting of nearly 6 million apartment units in 2015-2017.

Real estate markets vary significantly in China because of its large economic size, economic and social diversity, and fragmented local government policies. The real estate cycles tend to be more pronounced in top-tier cities in terms of price volatility, but they account for a small fraction of real estate inventory and investment.  Smaller cities constitute over half of residential real estate investment, but the price increase on average was much lower during 2013-16.

Distortions render China’s property market susceptible to both price misalignment and overbuilding. On the supply side, the market is distorted by local governments’ control over land supply and their reliance on land sales to finance spending. On the demand side, the market is prone to overvaluation—housing is attractive as an investment instrument given a history of robust capital gains, high savings, low real deposit interest rates, a lack of alternative financial assets, as well as capital account restrictions.

The government has closely monitored real estate activity given its importance in the economy. Policies are highly decentralized, with local governments (often with local branches of the financial regulators) deciding land sale and infrastructure development, granting construction and sales permits to developers, and setting purchases restrictions. The central government and financial regulators can also affect the housing market through financing conditions and macro-prudential tools for mortgage lending.

If house prices rise further beyond “fundamental” levels and the bubble expands to smaller cities, it would increase the likelihood and costs of a sharp correction, which would weaken growth, undermine financial stability, reduce local government spending room, and spur capital outflows. Empirical analysis suggests that the increasing intensity of macroprudential policies tailored to local conditions is appropriate. The government should expand its toolkit to include additional macroprudential measures and push forward reforms to address the fundamental imbalances in the residential housing market.

Note: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Senate Approves Foreign Vacant Property Fine

The legislation to tighten some aspects of investment property, and levy a charge on vacant foreign owned property has been passed in the Senate.

The legislation prevents property investors from claiming travel expenses when travelling between properties, as well as tightening  depreciation on  plant and equipment tax deductions.

Foreign owners will be charged a fee if they leave their properties vacant for at least six months in a 12-month period, in an attempt to release more property to ease supply. The latest Census showed that there are 200,000 more vacant homes across Australia than there were ten years ago.

 

Introduced with the Foreign Acquisitions and Takeovers Fees Imposition Amendment (Vacancy Fees) Bill 2017, the bill amends the: Income Tax Assessment Act 1997 to: provide that travel expenditure incurred in gaining or producing assessable income from residential premises is not deductible, and not recognised in the cost base of the property for capital gains tax purposes; and limit deductions for plant and equipment assets used for producing assessable income from residential premises to when the asset was first used for a taxable purpose; Foreign Acquisitions and Takeovers Act 1975 to implement an annual vacancy fee on foreign owners of residential real estate where residential property is not occupied or genuinely available on the rental market for at least six months in a 12-month period; and Taxation Administration Act 1953 to make consequential amendments.

Auction Clearance Rates Continue To Track Below 70%

From CoreLogic.

This week, there were 2,894 auctions held across the combined capital cities returning a preliminary auction clearance rate of 66.5 per cent, increasing on last week when the final auction clearance rate fell to its lowest reading since early 2016, when 61.5 per cent of the 2,045 auctions cleared. Clearance rates have continued to track below 70 per cent since June the year; this is a considerably softer trend than what was seen over the same period last year when clearance rates were tracking around the mid 70 per cent range for most of the second half 2016.  Results across each of the individual markets were varied this week, with Canberra recording the highest preliminary auction clearance rate of 72.9 per cent, while in Brisbane only 45.7 per cent of auctions cleared.

2017-11-13--auctionresultscapitalcities

Another Weak Set of Auction Results – 11 Nov 2017

The Domain preliminary auction clearance results are in, and they appear to reveal another weak result, especially in the Sydney market.  The overall rates are lower than this time last year.

The clearance rate in Brisbane was 32% on 143 listed,  Adelaide achieved 76% on 81 scheduled and Canberra 71% on 102 auctions.

Another Nice Mess – The Property Imperative Weekly – 11 Nov 2017

In our latest weekly update, we explore how that RBA is caught between stronger global economic indicators, and weaker local conditions, and what this means for local households, the property market and banks.

Welcome to the Property Imperative weekly to 11th November 2017. Read the transcript or watch the video.

We start this weeks’ digest with the latest results from the banking sector.

CBA’s 1Q18 Trading Update reported a rise in profit, and volumes, as well as a lift in capital. Expenses were higher, reflecting some provisions relating to AUSTRAC, but loan impairments were lower. WA appears to be the most problematic state. Their unaudited statutory net profit was around $2.80bn in the quarter and their cash earnings was $2.65bn in the quarter, up 6%. Both operating income and expense was up 4%.

Westpac’s FY17 results were a bit lower than expected, impacted by lower fees and commissions, pressure on margins, the bank levy and a one-off drop to compensate certain customers.  Despite a strong migration to digital, driving 59 fewer branches and a net reduction of ~500 staff, expenses were higher than expected. There has been a 23% reduction in branch transactions over the past two years in the consumer bank, once again highlighting the “Quiet Revolution” underway and the resulting problem of stranded costs. Treasury had a weak second half. But the key point, to me, is that around 70% of the bank’s loan book was in one way or another linked to the property sector, so future performance will be determined by how the property market performs. Provisions were lower this cycle, and at lower levels than recent ANZ and NAB results. WA mortgage loans have the highest mortgage arrears but were down a bit.

Looking at mortgage defaults across the reporting season, there were some significant differences. Some, like Westpac, indicated that WA defaults in particular are easing off now, while others, like ANZ and Genworth, are still showing ongoing rises. This may reflect different reporting periods, or it may highlight differences in underwriting standards. Our modelling suggests that the rate of growth in stress in WA is indeed slowing, but it is rising in NSW (see the Nine TV News Segment on this which featured our research) and VIC; and there is an 18 to 24-month lag between mortgage stress and mortgage default. So, in the light of expected flat income growth, continued growth in mortgage lending currently at 3x income, rising costs of living and the risk of international funding rates rising too, we think it is too soon to declare defaults have peaked. One final point, many households have sufficient capital buffers to repay the bank, thanks to ongoing home price rises. Should prices start to fall, this would change the picture significantly.

Banks have enjoyed strong balance sheet growth in recent years as they lend ever more for mortgages, at the expense of productive business lending. A number of factors have driven the housing boom including population and income growth for the past 25 years, a huge fall in interest rates and increases in the tax advantages to property investment through negative gearing and the halving of the capital gains tax level.

Fitch Ratings says the banks’ had solid results for the 2017 financial year, supported by robust net interest margins and strong asset quality. However, Australia’s four major banks will face earnings pressure from higher impairment charges and lower revenue growth in their 2018 financial year, and cost control to remain an important focus. They benefitted from the APRA inspired repricing of mortgages, and from lower impairment charges. Fitch said that mortgage arrears have increased modestly from low bases in most markets – Western Australia has had more noticeable deterioration – and they expect this trend to continue in FY18 due in part to continued low wage growth and an increase in interest rates for some types of mortgages.

The latest household finance data from the ABS confirms what we already knew, lending momentum is on the slide, and first time buyers, after last month’s peak appear to have cooled. With investors already twitchy, and foreign investors on the slide, the level of buyer support looks anaemic. Expect lots of “special” refinance rates from lenders as they attempt to sustain the last gasp of life in the market.

The number of new loans to first time buyers was down 6.3%, or 630 on last month. We also see a fall in fixed loans, down 14%.  The DFA sourced investor first time buyers also fell again, down 4%. More broadly, the flow of new loans was down $19 million or 0.06% to $33.1 billion. Within that, investment lending flows, in trend terms, fell 0.52% or $62.8 million to $12.1 billion, while owner occupied loans rose 0.32% or $47.7 million to $15.0 billion.  So investment flows were still at 44.6% of all flows, excluding refinances. Refinances comprise 17.9% of all flows, down 0.07% or $3.9 million, to $5.9 billion.

Auction volumes were also lower this past week, partly because of the Melbourne Cup festivities, and CoreLogic’s latest data suggests a slowing trend, more homes listed, and further home price falls in Greater Sydney. As a result, we expect home lending to trend lower ahead.

The MFAA says there has been a boom in mortgage brokers, but this may be unsustainable, given lower mortgage growth.  The snapshot, up to March 2017, shows that the number of brokers was estimated to be 16,009, representing 1 broker for every 1,500 in the population and they originated around 53% of new loans.  Overall the number of brokers rose 3.3% but net lending grew only 0.1%. As a result, the average broker saw a fall in their gross annual income. Also, on these numbers, brokers cost the industry more than $2 billion each year!

We published data on the dynamic loan-to-income data (LTI) from our household surveys. Currently we estimate that more than 20% of owner occupied mortgage loans on book have a dynamic LTI of more than 4 times income. Some LTI’s are above 10 times income, and though it’s a relatively small number, they are at significantly higher risk. Looking at the data by state, we see that by far the highest count of high LTI loans resides in NSW (mainly in Greater Sydney), then VIC and WA. Younger households have a relatively larger distribution of higher LTI loans. Reading across our core segmentation, we see that Young Affluent, Exclusive Professional and Multi-Cultural Establishment are the three groups more likely to have a high dynamic LTI. We also see a number of Young Growing Families in the upper bands too. As many lenders also hold the transaction account for their mortgage borrowers, it is perfectly feasible to build an algorithm which calculates estimated income dynamically from their transaction history, and use this to estimate a dynamic LTI. This would give greater insight into the real portfolio risks, compared with the blunt instrument of LVR. It is less misleading that LTI or LVR at origination.

The latest edition of our Household Financial Security Confidence Index to end October shows households are feeling less secure about their finances than in September. The overall index fell from 97.5 to 96.9, and remains below the 100 neutral setting. We use data from our household surveys to calculate the index.  While households holding property for owner occupation remain, on average, above the neutral setting, property investors continue to slip further into negative territory, as higher mortgage rates bite, rental returns slide and capital growth in some of the major markets stalls.  Property inactive households remain the most insecure however, so owning property in still a net positive in terms of financial security. There are significant variations across the states. VIC households continue to lead the way in terms of financial confidence, and WA households are moving up from a low base score. However, households in NSW see their confidence eroded as prices slide in some post codes (the average small fall as reported does not represent the true variation on the ground – some western Sydney suburbs have fallen 5-10% in the past few months). Households in QLD and SA on average have held their position this month. Confidence continues to vary by age bands, although the average scores have drifted lower again. Younger households are consistently less confident, compared with older households, who tend to have smaller mortgages relative to income, and more equity in property and greater access to savings.

As expected the RBA held the cash rate again this week, for the 15th month in a row.  The RBA’s statement on Monetary Policy highlighted the tension between stronger global growth, reflected in expected rising interest rate benchmarks in several countries, including the USA; and weaker inflation and growth in Australia. As a result, pressure to lift the cash rate here appears lower than before. Underlying inflation is expected to remain steady at around 1¾ per cent until early 2019, before increasing to 2 per cent. The revised CPI weightings now announced by the ABS, will tend to reduce the inflation numbers in the next release. The RBA suggests growth will be lower for longer though is still holding to a 3% growth rate over their forecast period, They also highlighted the impact of stagnant wage growth and high household debt once again.

If rates do stay lower for longer here, it may benefit households already suffering under mountains of mainly housing related debt, but put pressure on the dollar and terms of trade, as rates overseas climb, sucking investment dollars away from Australia and lifting funding costs. Some are suggesting that the gap between income and credit growth, 2% compared with 6% over the past year, will require the RBA to lift the cash rate sooner, and ANZ for example is still forecasting rate hikes in 2018.

International conditions are on the improve, and many assume the rises in benchmark cash rates will be slow and steady. However, A GUEST post on the unofficial Bank of England’s “Bank Underground” blog makes the point, by looking at data over the past 700 years, that most reversals after periods of interest rate declines are rapid. When rate cycles turn, real rates can relatively swiftly accelerate. The current cycle of rate decline is one of the longest in history, but if the analysis is right, the rate of correction to more normal levels may be quicker than people are expecting – and a slow rate of increases designed to allow the economy to acclimatize may not be possible.  Not pretty if you are a sovereign or household sitting on a pile of currently cheap debt!

So, we see on one side global conditions improving, with interest rates set to rise, while locally economic indicators are weakening suggesting the RBA may hold the cash rate lower for longer. This is creating significant tension, and highlights the dilemma the regulators face. But as we said before, this is a problem of their own making, as they dropped rates too far, and did not recognise the growing risks in the housing sector soon enough. So, already on the back foot, we expect to see some further targeted regulatory intervention, and we expect the cash rate to stay lower for longer, until the international upward pressure swamps the local situation. We think this may be much sooner than many, who are now talking of no rate change for a couple of years.  Meantime households with large loans, little income growth and facing rising costs will continue to spend less, tap into savings, and muddle though. Not a good recipe for future growth, and economic success. As Laurel and Hardy used to say ” Well, here’s another nice mess you’ve gotten me into!”

And that’s the Property Imperative Weekly to 11th November 2017. If you found that useful, do leave a comment, subscribe to receive future updates, and check back next week.

How the property boom has pulled the banks into housing market risk

From The New Daily.

Experts warn the increasing dependence of Australian banks on the property boom is putting both the banking system and the wider economy at risk.

Just how important playing the property game has become for the banks was highlighted when Westpac recently released its annual results. The bank’s chief Brian Hartzer, who earned $6.7 million for the year, said lending for mortgages accounted for 62.4 per cent of the bank’s outstanding loan book of $684.9 billion.

Martin North, analyst and principal of Digital Financial Analytics, said that figure would “be closer to 70 per cent” if you add in the lending to property developers and other businesses related to the industry.

Around 20 years ago the banks typically lent almost as much to business as they did to housing, he said.

Source: APRA

The above table details the move to housing lending. However it differs slightly from the figures Westpac quoted as it is gleaned from figures the banks report to APRA rather than the way they report in their shareholders.

Nonetheless, all figures on the chart are calculated in the same way so it tells a story about the shift to mortgage lending over the past 15 years.

What it demonstrates is that the four major banks are lending a greater proportion of their loan assets to the residential property market than they were in 2002 when both owner-occupied and investment lending are added together.

Two of the big four, Westpac and NAB, have reduced their proportional exposure to home loans slightly, but when all residential property lending is added together, all have increased their relative exposures.

The ANZ has seen its home loan exposure jump from 38.7 per cent to 43.4 per cent of its exposures.

As a result, the ANZ, traditionally a business-focused bank, has seen its proportion of corporate lending decline from 33 per cent of the loan book to 26.8 per cent.

This is potentially dangerous.

Mr Hartzer warned on Monday the residential construction cycle had “peaked” with no sign that business investment was growing fast enough to take up the slack.

“It’s hard to see what will take its place,” he said.

Independent economist Saul Eslake told The New Daily the move to property lending has been in train for some time.

“Business has been pretty conservative about borrowing for investment since the last recession in the 1990s,” Mr Eslake said.

“We had a big mining investment boom but most of it was funded by equity because of the degree of risk in those mining projects. And because 80 per cent of the mining industry is foreign-owned most of the money it did borrow came from foreign banks through existing relationships.

“The projects were so big the Australian banks mostly couldn’t have funded them.”

The banks would be more exposed than in the past to the effects of a major house price fall, Mr Eslake said, although he doubted such a disastrous outcome would eventuate.

“I don’t expect that to happen although some people have been talking about it.”

A number of factors have driven the housing boom including population and income growth for the past 25 years, a huge fall in interest rates and increases in the tax advantages to property investment through negative gearing and the halving of the capital gains tax level, he said.

Auction Volumes Fall Across the Combined Capitals

From CoreLogic.

There were significantly fewer homes taken to auction across the combined capital cities this week, after last week saw volumes reach a year-to-date high (3,713). There were a total of 2,019 auctions held returning a preliminary auction clearance rate of 66.8 per cent, increasing on last week’s final clearance rate of 64.5 per cent. Over the corresponding week last year, 73.6 per cent of the 2,517 auction held were successful.

Melbourne saw the most notable decrease in volumes; the lower volumes a likely result of the upcoming Melbourne cup festivities and coming off the back of the busiest week for auctions ever recorded for the city last week, with only 309 held this week and 77.3 per cent clearing. Sydney’s preliminary auction clearance rate rose this week to 67.4 per cent, after last week’s final auction clearance rate fell to its lowest recorded since January 2016 (58.3 per cent), while volumes remained steady week-on-week. Performance across this remaining capital cities was varied this week, with Perth returning the lowest clearance rate of 30 per cent.

2017-11-06--auctionresults_capitalcities

Westpac FY17 Up 3%; Margin Down – Banking on Property

Westpac has released their FY17 results. They are literally banking on property. They do not expect home prices to fall significantly and they expect mortgage lending to continue to grow.

Statuary net profit was $7,990 million, up 7% on 2016, and cash earnings up 3% to $8,062.

This is a bit lower than expected, impacted by lower fees and commission, pressure on margins, the bank levy and a one-off drop to compensate certain customers.  Despite strong migration to digital, driving 59 fewer branches and a net reduction of ~500 staff, expenses were higher than expected. There has been a 23% reduction in branch transactions over the past two years in the consumer bank. Treasury had a weak second half.

Around 70% of the bank’s loan book is one way or another linked to the property sector, so future performance will be determined by how the property market performs.

Provisions were lower this cycle, and at lower levels than recent ANZ and NAB results. WA mortgage loans have higher mortgage arrears.

The balance sheet is strong on all the critical ratios. They are “essentially done” they say.

Cash earnings per share is up 2% to 239.7 cents and the cash return on equity is 13.8%. There was no change to the dividend.

Net interest margin was 2.09%, 4 basis points lower, compared with FY16, reflecting higher wholesale funding costs, bank levy and some asset repricing. The bank levy cost $95m pretax, or 2 basis points, or 2 cents per share.

Margin improved in the second half, thanks to loan repricing and improved wholesale funding. Mortgage repricing contributed 7 basis points in 2H17.

The cost of refunding customers who were entitled to certain product discounts, but may not have been aware that they needed to specifically request them was $118 million this year, equivalent to 1.5% of earnings. This is a one-off hit.

Non-interest income was down 9%, with $209m fall in trading income and $97 million in fees and commissions.

Growth in the consumer bank (mainly mortgages) was the strongest.

Costs were up 2% to $4,604 million, and the expense ratio 42%, including productivity savings of $262 million. They still want to get below 40%, eventually. Compliance costs rose.

Total provisions fell from $3.6 billion in 2016 to $3.1 billion in FY17.

Impaired assets to gross loans were down 10 basis points to 0.22%. Their impairment charge was was down 24% over the year to $853 million, which equates to 13 basis points, down 4 basis points on last year.

Westpac is a significant property aligned bank with 62% of the loan book related to Australian mortgage lending, which showed strong growth, with net flows of $13 billion in 2H17. There were more fixed rate loans, and less interest only loans. The value of the book was up 3% in the 2H17, to $427.2 billion.  Mortgage offset balances are $38.1 billion.  Commercial property lending is 6.48% of total lending, or $49.6 billion. So overall property exposure is close to 70% of the bank! $6.9 billion are in the residential apartment sector. Inner city consumer mortgages for apartments is $14.1 billion.

They reported $18.6bn of switching from IO to P&I mortgages in 2H17.

Investor loans lending is growing and is 46.8% of flow, and 39.8% of the portfolio. Around 54% of mortgage flows are via proprietary channels, while the portfolio sits at 57%. So broker flows have lifted to 46%.

WA delinquencies remain higher than other states, but are falling slightly. Westpac says they think delinquencies in WA have peaked.

There are more properties in possession in QLD than WA, mostly in regional mining areas.

This data on vacancy rates highlights the issue with investment property in WA!

The CET1 ratio is 10.6%, above the APRA target.

In FY18, they expect lower lending growth (but they think mortgages will still grow), margin will be impacted by more mortgage switching from interest only to principal & interest and there will be a $50m headwind from ATM and transaction fees. They will target cost savings of 2-3% and await the final APRA guidance on capital weights and mortgages.