Social Trends – Page 131 – Digital Finance Analytics (DFA) Blog

Six lessons on how to make affordable housing funding work across Australia

A suitable construction funding model is the critical missing ingredient needed to deliver more affordable housing in Australia. Aside from short-lived programs under the Rudd government, we have seen decades of inconsistent and fragmented policies loosely directed at increasing affordable housing. These have failed to generate anything like enough new supply to meet outstanding needs.

Our latest research looked at recently built, larger-scale affordable housing projects in contrasting markets across Australia. We examined each scheme’s cost, funding sources and outcomes. We then developed a housing needs-driven model for understanding the financial and funding requirements to develop affordable housing in the diverse local conditions across the country.

Up to now, the key stumbling block has been the “funding gap” between revenue from rents paid by low-income tenants and the cost of developing and maintaining good-quality housing. The Commonwealth Treasury acknowledged this problem last year. And the problem is greatest in the urban areas where affordable housing is most needed.

What does the new model tell us?

The Affordable Housing Assessment Tool (AHAT) enables the user to calculate cost-effective ways to fund affordable housing to meet specified needs in different markets. It’s a flexible interactive spreadsheet model with an innovative feature: it enables users to embed housing needs as the driver of project and policy, rather than project financial feasibility driving who can be housed.

Affordable housing developments have recently been relatively sparse. However, our research highlighted the varied and bespoke funding arrangements being used.

Despite this variety, too often project outcomes are driven purely by funding opportunities and constraints, rather than by defined housing needs. One notable constraint is the fragmented nature of affordable housing subsidy frameworks both within and across jurisdictions.

Our case study projects generated a diversity of housing outcomes. This can be seen as an unintended positive of the bespoke nature of affordable housing provision as a result of the need to “stitch together” gap funding from multiple sources on a project-by-project basis.

Equally though, the lack of policy coherence and fit-for-purpose funding added cost and complexity to the development process. By implication, this leads to a less-than-optimal outcome for public investment. Despite providers’ best efforts, current approaches are not the most efficient way to deliver much-needed affordable housing.

What are the lessons from this research?

We applied the model to typical housing development scenarios in inner and outer metropolitan areas and regions. By doing so, we identified six key lessons for funding and financing affordable housing delivery.

1) Government help with access to land is central to affordable housing development and enhances long-term project viability.

Especially in high-pressure urban markets, not-for-profit housing developers cannot compete with the private sector for development sites. High land costs, particularly in inner cities where affordable housing demand is most extreme, can render financial viability near impossible. Having access to sites and lower-cost land were two of the most important components of feasible projects.

2) Government equity investment offers considerable potential for delivering feasible projects and net benefit to government.

How governments treat the valuation of public land with potential for affordable housing development must be reviewed. Conventionally, even where affordable housing is the intended use, governments typically insist on a land sale price based on “highest and best use”.

It would be preferable in such cases to treat the below-market value assigned to public land as a transparent subsidy input. This would mean the sale price reflects the housing needs that the development seeks to meet. That is, the land value should be priced as an affordable housing development for a specific needs cohort.

By retaining an equity stake, government could account for its input as an investment that will increase in value over time as land values appreciate.

3) Reducing up-front debt load and lowering finance costs are critical to long-term project viability.

Debt funding imposes a large cost burden over a project’s lifetime. This is ultimately paid down through tenant rents. Reducing both the cost and scale of private financing can have a significant impact on project viability.

The analysis reinforces the rationale for the Australian government’s “bond aggregator” facility for reducing financing costs for affordable housing projects. But this must come in tandem with other measures to reduce up-front debt.

4) Delivery across the range of housing needs helps to meet overall social and tenure mix objectives. This also can help improve project viability through cross-subsidy.

Mixing tenure and tenant profiles can enable affordable housing providers to produce more diverse housing that meets the full range of needs.

Cross-subsidy opportunities arising from mixed-tenure and mixed-use developments can also enhance project feasibility. By improving a provider’s financial position, this helps advance their long-term goal of adding to the stock of affordable housing. And, by providing welcome flexibility, this enables organisations to better manage development risk across different markets and cycles.

5) The financial benefit of planning bonuses is limited

Inclusionary zoning mechanisms impose affordable housing obligations on developers through the planning system. This approach potentially offers a means of securing affordable housing development sites in larger urban renewal or master-planned areas.

However, our research demonstrated that planning bonuses allowing increased dwelling numbers in return for more affordable housing have little beneficial impact on project viability. This is because the additional dwellings allowed generate additional land and/or construction costs but no matching capacity to service a larger debt.

However, planning bonuses can be useful as part of a cross-subsidy approach. In this case, they may support project viability, without necessarily resulting in any additional affordable dwellings.

6) Increasing the scale of not-for-profit provision offers financial benefits that help ensure the long-term delivery of affordable housing.

Our analysis supports the case for targeting public subsidy to not-for-profit developers (government or non-government) to maximise long-term social benefit. Investing in permanently affordable housing ensures the social dividend of affordable housing can be continued into the future.

Comparable subsidies are not preserved when allocated to private owners. They will seek to trade out at some stage, capitalising the subsidy into privatised gain.

The results of our case study analyses and modelling highlight the need to develop comprehensive funding and subsidy arrangements that account for different costs in different locations. These arrangements also must be integrated nationally to support affordable housing delivery at scale.

This study reiterates the common finding of research over the last decade: both Commonwealth and state/territory governments need to develop a coherent and long-term policy framework to provide housing across the full spectrum of need.

Authors: Laurence Troy, Research Fellow, City Futures Research Centre, UNSW; Bill Randolph, Director, City Futures – Faculty Leadership, City Futures Research Centre, Urban Analytics and City Data, Infrastructure in the Built Environment, UNSW; Ryan van den Nouwelant, Senior Research Officer – City Futures Research Centre, UNSW; Vivienne Milligan, Visiting Senior Fellow – City Futures Research Centre, Housing Policy and Practice, UNSW

How Resilient Will Consumption Growth Be If Income Growth Stays Weak?

RBA Assistant Governor (Economic) Luci Ellis spoke at the ABE Conference “Three Questions About the Outlook“.

The section on the impact of weak income growth is significant, because it examines why households are under financial pressure, and the impact of this. She says “continued weak income growth presents a particular risk to the consumption outlook in the context of high household indebtedness”.

One aspect of recent developments where Australia’s experience differs, though, relates to household income and consumption. As we discussed in the Statement, consumption growth in the major advanced economies has been quite robust, supported by strong growth in employment. In Australia, we’ve also had especially strong employment growth over the past year – more than double the rate of growth in the working-age population. But that hasn’t translated into strong consumption growth. Household income growth has been weak for a number of years, and that has weighed on consumption growth (Graph 4). Consumption growth hasn’t slowed as much as income growth. This is what you’d expect, given that households generally try to smooth their consumption through episodes of income volatility. But there’s a real question of how long that could continue if income growth stays weak. This clearly has implications for how we think about the risks to our consumption forecasts.

Graph 4: Household Consumption and Income — *Graph 4*

The weakness in incomes goes beyond the downward pressure on wage growth that I’ve already spoken about. Yes, growth in the wage price index (WPI) has stepped down. But the WPI captures a fixed pool of jobs. It abstracts from compositional change. Average earnings as measured in the national accounts have been even weaker than the WPI (Graph 5). This has not occurred because workers shifted between industries; it is also seen within industries. It might be partly driven by the end of the mining investment boom, as workers moved out of mining-related work, including in the construction and business services industries. But it seems to have been broader than that. Our central forecast is that this weakness will end as the drag from the end of the boom dissipates and spare capacity is absorbed, such that average earnings growth recovers. There is no guarantee of this, though, and therein lies the risk.

Graph 5: WPI and AENA by Sector — *Graph 5*

The living cost pressures that many households feel have therefore been an income story, not a price inflation story. Although utilities prices did increase significantly in some states in recent quarters, much of households’ regular spending has seen relatively little in the way of price increases for a number of years.

Weak income growth can run below consumption growth for a time, but not forever. If households start to see this weakness in income growth as permanent, they are likely to change their spending patterns in response. We might be seeing this in the details of the consumption figures: growth in spending on discretionary items, like travel and eating out, has slowed while growth in spending on essentials has held up (Graph 6).

Graph 6: Household Consumption — *Graph 6*

Continued weak income growth presents a particular risk to the consumption outlook in the context of high household indebtedness. Households do not just wake up one day and collectively decide to pay down their debt. But if incomes turn out weaker than they expect, or some other adverse news should arise, the households carrying the most debt might feel they have to rein in their spending quite a bit.

Banks and financial providers one step ahead of consumers who struggle with personal bias

From The Conversation.

There’s more than 30 years of research showing financial consumers have behavioural biases that can lead to poor decisions. Financial providers and banks have known this too, and have designed some products to take advantage of consumer habits rather than benefit them.

Legislation soon to be introduced to parliament is intended to curb these practices, but credit products are being left out to consumer detriment.

Regulators have relied on two strategies to help consumers with this problem. Disclosure of the nature and prospects of the products providers offer. Also, encouraging consumers to seek financial advice.

Neither of these has worked well. The Financial System Inquiry in 2014 recognised that disclosure hasn’t closed the gap in consumer capability. Worse, the providers of these products may have incentives through remuneration which may not serve the customer’s interest and only about 25% of financial consumers seek advice.

The Productivity Commission’s report on competition in financial services, illustrates many of these points in arguing for regulation of mortgage brokers. Brokers are supposed to be the customer’s agent to scout for and advise on the best mortgage terms and cost. Instead they are remunerated by mortgage providers (like the banks), take commissions and, according to the Productivity Commission, generally cost more than loans directly from a bank.

Bias in financial decision-making

Consumers are prone to a range of biases which may also impair their financial decisions. For example overconfidence may cause them to ignore new information or hold unrealistic views about how high returns will be.

As we age or as our circumstances change, our tolerance for risk also changes. As we get older our tolerance for risk decreases, while having a higher income increases it. Men are also more risk tolerant than women.

Consumers may also give too much weight to recent events and things they know already and can be unduly influenced by the opinions of friends and family.

This sort of consumer decision-making is no match for providers’ knowledge of financial conditions and product features. Banks and other financial service providers have learned from experience, but most of all their own command of consumer behaviour research.

The latter leaves providers able to design and sell products that benefit from consumers not overcoming mistakes, or at times, exacerbating mistakes.

Helping customers make better choices

In a bill soon to be before the Australian parliament, those selling financial products will have to make a “target market determination”. This records and describes the market for a product (those who would buy it). It must also set out any conditions under which the product must be distributed, for example that it can only be sold with advice.

It’s designed so that financial products meet the needs and financial situation of the people acquiring them.

There are criminal and civil penalty sanctions for failing to make and ensure products are sold in accordance with a determination. Also, for failure to revise and reissue it, if circumstances change.

Twinned with this requirement are new intervention powers for the Australian Securities and Investments Commission (ASIC). ASIC will be able to make interim rules, effectively prohibiting sales or imposing conditions, if continued sale would result in “significant detriment” to financial consumers.

The purpose of product regulation is clearly to allow ASIC to be more active and reduce over-reliance on ineffective disclosure, conflicted advice and drawn out dispute resolution.

Product regulation is no panacea. This version has a large gap, as credit products (for example credit cards or mortgages) do not require a target market determination. It’s not difficult to read the politics of regulation in this omission. There is also a risk that target market determinations will become pro-forma and add to compliance and not to consumer benefit. Although a description of the target market must be in the advertising, it’s not clear it must be in formal disclosure, so consumers may never read it.

Product intervention powers apply across investment, insurance and credit products but it will never be easy for ASIC to prove the risk of “significant consumer detriment”. Intervention orders also expire in 18 months unless made permanent by parliament.

The regulation of product design and distribution in the spirit of consumer safety has been commonplace (if imperfectly realised) in car, pharmaceuticals and other consumer markets, for decades. There are modest grounds for optimism that in Australia financial product safety might catch on too, but the government needs to include credit products as well.

Authors: Dimity Kingsford Smith, Professor of Law, UNSW

A Viable Alternative To Pay Day Loans

National not-for-profit, Good Shepherd Microfinance, has made a bold move into online lending with the support of NAB to launch Speckle – a fast online cash-loan which offers a better alternative for people seeking small cash loans under $2,000.

They also cite our updated research on the Pay Day Loan market in Australia.

We think this is a significant move, and could tilt the lending landscape towards consumers, who according to our research are more likely to reach for short term credit, thanks to wages and costs of living pressures, and the greater availability on online finance. Speckle is a cheaper accessible alternative.

With an increasingly casual workforce, the rising cost of living and low wage growth, recent research has found that one in five households in Australia have used payday loans[1] in the past three years. To address this need, Good Shepherd Microfinance, backed by NAB, developed a product that is better for customers by keeping the fees and costs as low as possible.

Adam Mooney, CEO at Good Shepherd Microfinance, said for the first time people will be able to access a low cost alternative that is different to anything else in the market.

“In most cases, Speckle loans are up to 50 per cent cheaper than other small cash loans. Most lenders charge the maximum fees allowed by law. As a not-for-profit program, Speckle is significantly cheaper for customers.”

“Every day we see the negative impact of high cost loans on individuals and families. In addition, the latest research shows that the number of women using short term cash loans continues to increase and women tend to use these loans at an earlier age than men[2].

“It was clear that we needed a better solution for anyone who needs to use small cash loans. Speckle will enable people to access lower cost credit when they need it most,” said Mr Mooney.

Building on their long-term partnership, NAB and Good Shepherd Microfinance have joined forces to develop Speckle using leading edge technology and with the help of skilled volunteers from across the bank.

Andrew Thorburn, NAB CEO said the bank shares Good Shepherd Microfinance’s mission to create fair and affordable financial products that address the gaps in the market.

“We know there are many people who, because of their financial situation don’t typically qualify for mainstream finance, are having to turn to payday loans. We’ve worked with our long-term partner Good Shepherd Microfinance to develop Speckle as a better alternative.

“At NAB, we want to support people to improve their financial resilience so if times get tough they can bounce back better. It’s important that everyone can access appropriate credit.

Good Shepherd Microfinance also offers no interest or low interest loans and referrals to financial counselling and other services to ensure that people are able to get the financial support they need.

To be eligible for a Speckle loan, applicants must be over 18, earn more than $30,000 a year (not inclusive of government benefits), and can’t have had two or more small amount credit contracts in the past 90 days. Where applicants are deemed unsuitable they are referred to other financial support.

Background:

About Speckle:

Speckle is a fast online cash loan for amounts of $200 – $2,000, that is around half the cost of other similar loans.
Speckle’s fees include a 10 per cent establishment fee and two per cent monthly fee compared to the market norm of 20 per cent and four per cent.
Repayment options range from three months to one year, and are flexible so customers can pay as early or as often as they wish with no extra fees. Speckle loans are offered by anot for profit organisation which puts customers at the heart of products and services that are fair and affordable.

About Good Shepherd Microfinance and NAB’s partnership:

NAB has backed Good Shepherd Microfinance to create Speckle NAB and Good Shepherd Microfinance have been working together for over 15 years to provide people in Australia with access to fair and affordable finance through the No Interest Loan Scheme (NILS) and StepUP low interest loans.
The partnership has seen more than $212 million in no and low interest loans provided to over half a million people in Australia doing it tough.
Last year more than 27,000 loans valued at almost $30 million were provided to people on low incomes through a national network of more than 180 community organisations in 694 locations across Australia.
Good Shepherd Microfinance are leaders in the development and delivery of microfinance programs for people who experience limited access to financial products and services.
NAB has committed $130 million for lending to people on low incomes and together with Good Shepherd Microfinance aims to reach 100,000 people each year.

About payday lending in Australia:

The use of short term cash loans by households in Australia has more than doubled in the past 12 years (from 356,000 in 2005 to 786,500 in 2017).
Use of short term cash loans by women (25.4%) is growing faster than the market growth (22.3%).
Women are using cash loans at a younger age than men. In the 20-30 year range, women represent 34% and men 15%.[3]
4 million adults in Australia were facing some level of financial stress in 2016 and around 25 per cent of the population lack access to any form of credit such as a credit card or personal loan.[4]

[1]2018, Digital Finance Analytics, ‘Women and Pay Day Lending – An Update 2018, page 2

[2]2018, Digital Finance Analytics, ‘Women and Pay Day Lending – An Update 2018, page 2 & 4

[3] 2018, Digital Finance Analytics, ‘Women and Pay Day Lending – An Update 2018,

[4] Financial Resilience in Australia 2016, Centre for Social Impact and NAB

Household Financial Confidence Slips Again In January

Digital Finance Analytics has released the January 2018 update of our Household Financial Confidence Index, using data from our rolling 52,000 household surveys.

The news is not good, with a further fall in the composite index to 95.1, compared with 95.7 last month. This is below the neutral setting, and is the eighth consecutive monthly fall below 100.

This result highlights the ongoing disconnect between business confidence, and consumers who are still reeling from rising costs of living, flat incomes and high debt.

Across the age bands, there was a small rise in those older than 50 years, but younger households, from 20 -50 all tracked lower.

There was a significant drop in confidence in Victoria, which has now been overtaken again by New South Wales as the most confident state. Confidence fell in South Australia and Queensland, whilst there was little change in Western Australia, which recovered somewhat earlier in the year.

Household’s property footprint impacts confidence levels significantly, with those who are not property active and so living in rented accommodation sitting significantly below those who own property. Owner occupied property holders saw a small uplift this month, reflecting the lower refinancing rates available, and more first time buyers. However, property investors, traditionally the more bullish, continues to languish, dragging the whole index lower.

The segmental scorecard shows that whilst job security rose a little, pressure from large levels of debt rose further, with 44% of households less comfortable than a year ago, and only 3% more comfortable. Pressure on savings continues, with lower returns on deposits, and more dipping into savings to pay the bills. 46% of households were less comfortable with their savings, compared with a year ago, and 4% only were more comfortable.

Costs of living pressures are very real, with 73% of households recording a rise, up 1.5% from last month, and only 3% a fall in their living costs. A litany of costs, from school fees, child care, fuel, electricity and rates all hit home.

On the other hand, only 1% of households records a real rise in incomes compared with a year ago, while 50% said their real incomes had been eroded, and 45% stayed the same. More evidence that incomes are rising more slowly than costs. Those employed in the private sector are particularly hard hit, with many recording no pay rises for the past 2 years.

Finally, household net worth is under pressure for some, as property prices slide, and savings are being eroded (despite high stock market prices). Whilst 58% said wealth had improved, 15% recorded a fall, and 23% said there was no change. A further fall in property prices was the overwhelming concern of those holding real-estate, with more than half now expecting a fall in the months ahead. This expectation is already impacting their spending patterns, and have reduced their prospect of buying more property.

So, overall we see the ongoing slide in household financial confidence, and there is nothing on the horizon which is likely to change momentum. We expect wages growth to remain contained, and home prices to slide, while costs of living pressures continue to grow.

By way of background, these results are derived from our household surveys, averaged across Australia. We have 52,000 households in our sample at any one time. We include detailed questions covering various aspects of a household’s financial footprint. The index measures how households are feeling about their financial health. To calculate the index we ask questions which cover a number of different dimensions. We start by asking households how confident they are feeling about their job security, whether their real income has risen or fallen in the past year, their view on their costs of living over the same period, whether they have increased their loans and other outstanding debts including credit cards and whether they are saving more than last year. Finally we ask about their overall change in net worth over the past 12 months – by net worth we mean net assets less outstanding debts.

We will update the results again next month.

Rising Expenses Stopping Aussies from Getting Ahead – ME Bank

Despite improved job conditions and households reporting healthier financial buffers, the overall financial comfort of Australians is not advancing, according to ME’s latest Household Financial Comfort Report.

In its latest survey, ME’s Household Financial Comfort Index remained stuck at 5.49 out of 10, with improvements in some measures of financial comfort linked to better employment conditions – e.g. a greater ability to maintain a lifestyle if income was lost for three months – offset by a fall in comfort with living expenses.

“Households’ comfort with paying their monthly living expenses fell 3% to 6.40 out of 10 during the six months to December 2017, the lowest it’s been since mid-2014,” said Jeff Oughton, ME consulting economist and co-author of the report.

“In fact, ME’s latest report shows many households’ financial situation is getting worse and again the culprit is living expenses, with 40% reporting this as a key reason their situation is worsening.

“Around 46% of households surveyed also cited the cost of necessities such as fuel, utilities and groceries as one of their biggest worries.

“It’s unsurprising households are still feeling the pinch, given subdued income growth and the rising costs of energy, childcare, education and health.

“If it wasn’t for a decline in comfort with monthly living expenses, the report’s overall Household Financial Comfort Index would’ve likely increased,” said Oughton.

“The rising cost of necessities is currently holding Australians back when it comes to their finances.”

Oughton said that over the past year, 16% of households were not always able to pay their utility bills on time, while 19% sought financial help from family or friends and 13% pawned or sold something to buy necessities – a clear illustration of bill stress, particularly for those on lower incomes.

In other findings from the ABS, childcare costs have doubled in the past six years, while the cost of primary and secondary education has increased by 50%.

But Oughton said one household group of Australians is bucking the trend.

“Households under 35 years old without children – commonly dubbed the ‘avocado generation’ − many of whom have benefited from improved employment conditions without the burden of childcare costs or potentially a mortgage, are not as worried. Their financial comfort rose by 8%, and their comfort with living expenses increased 2% during 2017.”

Oughton said the report’s most encouraging result was households’ improved ability to maintain a lifestyle, if income was lost for three months, which rose 3% to 4.82 out of 10 in the past six months to December 2017 – its highest outcome since 2015. This finding reflects stronger labour market conditions, although mainly among full-time workers.

Victorians’ comfort plummets, while NSW’s rises

Household financial comfort in Victoria dropped significantly below New South Wales’ financial comfort for the first time since the survey began in 2011.

New South Wales improved by 3% in the past six months to 5.83 out of 10 in December 2017, the highest in three years, while Victoria fell 7% to 5.30 out of 10, its lowest level in the past six years.

“New South Wales’ superior financial comfort can be linked to greater confidence in handling a financial emergency (loss of income for three months) – a reflection of healthier employment conditions in the state,” said Oughton.

“Meanwhile, Victoria’s decline can be attributed to falls across most key drivers of financial comfort, including lower confidence in handling a financial emergency (loss of income for three months) and less comfort with investments.

“The discrepancy between the two states is significant given both have traditionally felt similar levels of comfort in the past,” added Oughton.

High levels of mortgage payment stress – set to worsen
More than half of households (56%) renting or paying off a mortgage reported they are contributing over 30% of their disposable household income towards this cost – a common indicator of financial stress – with 72% of renters spending 30% or more of their disposable income on rent and 46% of those paying off a mortgage putting 30% or more of their disposable income towards this.

Furthermore, the proportion of households who ‘worried about their household’s level of debt over the last month’ increased by 1 point to 38%. This proportion increased to 51% among mortgage holders, compared to 27% with no mortgage and 23% who own their own home outright.

“Seven per cent of households reported they could not always pay their mortgage on time during the past year, and 7% could not pay their rent on time.”

“Mortgage defaults may escalate if interest rates increase, particularly among vulnerable low-income households already dealing with the rising cost of necessities,” said Oughton.
The gap between Australia’s rich and poor continues to widen

A disparity in financial comfort between some household groups remain, with 30% of households reporting their financial situation worsened in the past year, while 35% reported it remained the same and 35% reported it improved.
“Around 61% of households with ‘low levels of comfort’ reported a significant worsening in their overall financial situation during 2017, while almost 70% of households on ‘high levels of comfort’ reported that their financial comfort improved during 2017. In other words, the rich are getting richer and the poor are getting poorer,” said Oughton.

Hardest hit were households with incomes below $40,000, 45% of which said their financial situation had worsened, as well as single parents and baby boomers, 36% of which reported their situation had worsened.

For the third consecutive report, disparity was also evident in household income improvements, with more than 50% of those earning over $100,000 reporting income gains while only 29% of those earning between $40,001 and $75,000 reporting income gains.

“Despite continued improvement in the labour market and general economic conditions, the benefits are not trickling down to many households. For these households it will only get worse as the cost of necessities keeps going up,” added Oughton.

Other findings

SA still feeling the pinch: Household financial comfort in South Australia fell by 4% to 5.00 out of 10 during the past six months, to remain the lowest of the mainland states.

WA and QLD continue to trend higher: Comfort in both Western Australia and Queensland remained broadly unchanged at 5.49 and 5.39 out of 10 respectively. Both resource-dominated regions are recovering from the mining downturn to be more in line with the level of household financial comfort reported across Australia as a whole.

The Household Financial Comfort Report is based on a survey of 1,500 Australians conducted by DBM Consultants in December 2017. The Report is produced every six months, with the first survey conducted in October 2011.

The Home Price Crunch – The Property Imperative Weekly – 03 Feb 2018

The Home Price Crunch is happening now, but how low will prices go and which areas will get hit the worst? Welcome to the Property Imperative Weekly to 3^rd February 2018.

Welcome to our digest of the latest finance and property news. Watch the video or read the transcript.

There was lots of new data this week, after the summer break. NAB released their Q4 2017 Property Survey and it showed that property dynamics are shifting. They see property prices easing as foreign buyers lose interest, and a big rotation from the east coast. Tight credit will be a significant constraint. National housing market sentiment as measured by the NAB Residential Property Index, was unchanged in Q4, as big gains in SA and NT and WA (but still negative) offset easing sentiment in the key Eastern states (NSW and VIC). Confidence levels also turned down, led by NSW and VIC, but SA and NT were big improvers. First home buyers (especially those buying for owner occupation) continue raising their profile in new and established housing markets, with their share of demand reaching new survey highs. In contrast, the share of foreign buyers continued to fall in all states, except for new property in QLD and established housing in VIC, with property experts predicting further reductions over the next 12 months. House prices are forecast to rise by just 0.7% (previously 3.4%) and remain subdued in 2019 (0.8%). Apartments will under-perform, reflecting large stock additions and softer outlook for foreign demand.

Both CoreLogic and Domain released updated property price data this week. It is worth comparing the two sets of results as there are some significant variations, and this highlights the fact that these numbers are more rubbery than many would care to admit. Overall, though the trends are pretty clear. Sydney prices are sliding, along with Brisbane, and the rate of slide is increasing though it does vary between houses and apartments, with the latter slipping further. For example, Brisbane unit prices have continued their downward slide, down to $386,000; a fall of 2.2 per cent for the quarter and 4.4 per cent for the year. Here units are actually at a four-year low. Momentum in Melbourne is slowing though the median value was up 3.2 per cent to $904,000 in the December quarter, according to Domain. Perth and Darwin remains in negative territory. Domain said Darwin was the country’s worst performer with a 7.4 per cent drop in its median house price to $566,000 and a 14 per cent plunge in its unit price to $395,000, thanks to a slowing resources sector. It also hit Perth, with a house median fall of 2.5 per cent to $557,000, and its units 1.7 per cent to $369,000. On the other hand, prices in Hobart and Canberra are up over the past year and Hobart is the winner, but is it 17% or 12%, a large variation between the two data providers? And is Canberra 8% or 4%? It depends on which data you look at. Also, these are much smaller markets, so overall prices nationally are on their way down. My take out is that these numbers are dynamic, and should not be taken too seriously, though the trend is probably the best indicator. Perhaps their respective analysts can explain the variations between the two. I for one would love to understand the differences. The ABS will provide another view on price movements, but not for several months.

The latest ABS data on dwellings approvals to December 2017 shows that the number of dwellings approved fell 1.7 per cent in December 2017, in trend terms, and has fallen for three months. Approvals for private sector houses have remained stable, with just under 10,000 houses approved in December 2017, but the fall was in apartments, especially in NSW and QLD. More evidence of the impact of the rise in current supply of apartments, and why high rise apartment values are on the slide. Also, the ABC highlighted the fact that Real estate sales companies are using big commissions to tempt mortgage brokers, financial planners and accountants to sell overpriced properties to unsuspecting clients. This is a way to offload the surplus of high-rise apartments, and looks to be on the rise, another indicator of risks in the property sector.

In other economic news, the ABS released the latest Consumer Price Index (CPI) which rose 0.6 per cent in the December quarter 2017. Annual inflation in most East Coast cities rose above 2.0 per cent, due in part to the strength in prices related to Housing. This follows a rise of 0.6 per cent in the September quarter 2017. However, there were some changes in methodology which may have impacted the results. Softer economic conditions in Darwin and Perth have resulted in annual inflation remaining subdued at 1.0 and 0.8 per cent respectively. Many commentators used this data to push out their forecast of when then RBA may lift the cash rate – but my view is we should watch the international interest rate scene, as this is where the action will be.

Whilst the FED held their target rate this week, there is more evidence of further rate rises ahead. Most analysts suggest 2-3 hikes this year, but the latest employment data may suggest even more. The benchmark T10 bond yield continues to rise and is at its highest since 2014, and now close to that peak then of about 3%. Have no doubt interest rates are on their way up. This will put more pressure on funding costs around the world, and put pressure on mortgage rates here. In fact Alan Greenspan, the former Fed Chair, speaking about the US economy said “there are two bubbles: We have a stock market bubble, and we have a bond market bubble”. “Irrational exuberance” is back! He said we’re working, obviously, toward a major increase in long-term interest rates, and that has a very important impact, on the whole structure of the economy. Greenspan said. As a share of GDP, “debt has been rising very significantly” and “we’re just not paying enough attention to that.” US rate hikes will lift international capital market prices, putting more pressure on local bank margins.

We published our latest mortgage stress research, to January 2018, Across Australia, more than 924,000 households are estimated to be now in mortgage stress compared with 921,000 last month. This equates to 29.8% of borrowing households. In addition, more than 20,000 of these are in severe stress, down 4,000 from last month. We estimate that more than 51,500 households risk 30-day default in the next 12 months, down 500 from last month. We expect bank portfolio losses to be around 2.7 basis points, though with losses in WA are likely to rise to 4.9 basis points. Some households have benefited from refinancing to cheaper owner occupied loans, giving them a little more wriggle room in terms of cash flow. The typical transaction has saved up to 45 basis points or $187 each month on a $500,000 repayment mortgage. You can watch our separate video blog on the results, where we count down the top 10 most stressed postcodes.

But the post code with the highest count of stressed households, once again is NSW post code 2170, the area around Liverpool, Warwick Farm and Chipping Norton, which is around 27 kilometres west of Sydney. There are 7,375 households in mortgage stress here, up by more than 1,000 compared with last month. The average home price is $815,000 compared with $385,000 in 2010. There are around 27,000 families in the area, with an average age of 34. The average income is $5,950. 36% have a mortgage and the average repayment is about $2,000 each month, which is more than 33% of average incomes.

We continue to see mortgage stress still strongly associated with fast growing suburbs, where households have bought property relatively recently, often on the urban fringe. The ranges of incomes and property prices vary, but note that it is not necessarily those on the lowest incomes who are most stretched. Banks have been more willing to lend to these perceived lower risk households but the leverage effect of larger mortgages has a significant impact and the risks are underestimated.

The latest data from The Australian Financial Security Authority, for the December 2017 quarter shows a significant rise in personal insolvency – a bellwether for the financial stress within the Australian community. The total number of personal insolvencies in the December quarter 2017 was 7,578 and increased by 7.4% compared to the December quarter 2016. This year-on-year rise follows a rise of 8.0% in the September quarter 2017.

This is in stark contrast to the latest business conditions survey from NAB. They say that the business confidence index bounced 4pts to +11 index points, the highest level since July 2017, perhaps driven by a stronger global economic backdrop and closes the gap between confidence and business conditions. Business confidence is strongest in trend terms in Queensland and SA and to a lesser extent NSW. Confidence is also reasonable in WA, and is in line with business conditions in the state. Victoria and Tasmania meanwhile are reporting levels of confidence which are lower than their reported level business conditions. But the employment index suggests employment growth may ease back from current extraordinary heights.

The RBA credit aggregates data reported that lending for housing grew 6.3% for the 12 months to December 2017, the same as the previous year, and the monthly growth was 0.4%. Business lending was just 0.2% in December and 3.2% for the year, down on the 5.6% the previous year. Personal credit was flat in December, but down 1.1% over the past year, compared with a fall of 0.9% last year. This is in stark contrast to the Pay Day Loan sector, which is growing fast – at more than 10%, as we discussed on our Blog recently (and not included in the RBA data). Investor loans still make up around 36% of all loans, and a further $1.1 billion of loans were reclassified in the month between investment and owner occupied loans, and in total more than 10% of the investor mortgage book has been reclassified since 2015.

The latest data from APRA, the monthly banking stats for ADI’s shows a growth in total home loan balances to $1.6 trillion, up 0.5%. Within that, lending for owner occupation rose 0.59% from last month to $1.047 trillion while investment loans rose 0.32% to $553 billion. 34.56% of the portfolio are for investment purposes. The portfolio movements within institutions show that Westpac is taking the lion’s share of investment loans (we suggest this involves significant refinancing of existing loans), CBA investment balances fell, while most other players were chasing owner occupied loans. Note the AMP Bank, which looks like a reclassification exercise, and which will distort the numbers – $1.1 billion were reclassified, as we discussed a few moments ago.

Standing back, the momentum in lending is surprisingly strong, and reinforces the need to continue to tighten lending standards. This does not gel with recent home price falls, so something is going to give. Either we will see home prices start to lift, or mortgage momentum will sag. Either way, we are clearly in uncertain territory. Given the CoreLogic mortgage leading indicator stats were down, we suspect lending momentum will slide, following lower home prices. We will publish our Household Finance Confidence Index this coming week where we get an updated read on household intentions. But in the major eastern states at least, don’t bank on future home price growth.

If you found this useful, do like the post, leave a comment or subscribe for future updates. By the way, our special post on Bitcoin will be out in the next few days, we have had to update it based on recent market gyrations.

Population Ageing and the Macroeconomy

From The Bankunderground.

An unprecedented ageing process is unfolding in industrialised economies. The share of the population over 65 has gone from 8% in 1950 to almost 20% in 2015, and is projected to keep rising. What are the macroeconomic implications of this change? What should we expect in the coming years? In a recent staff working paper, we link population ageing to several key economic trends over the last half century: the decline in real interest rates, the rise in house prices and household debt, and the pattern of foreign asset holdings among advanced economies. The effects of demographic change are not expected to reverse so long as longevity, and in particular the average time spent in retirement, remains high.

An unprecedented demographic change…

Population ageing is typically summarised by the old age dependency ratio, the ratio of the population over 65 relative to the working population. In industrialised countries, this ratio has risen from under 15% in 1950 to over 30% in 2015, and is forecast to rise to 50% in the next 20 years (dark blue line in Chart 1). Looking at a few countries where population data is available from the 19^th century, shown in the dashed lines in Chart 1, this trend is unprecedented. While falling birth rates do play a part, the trend is driven predominantly by increasing longevity. The same ageing process is also happening, albeit more slowly, in middle and low income countries.

Chart 1: Old Age Dependency Ratio across industrialised countries (%)

Note: The ratio is defined as population over 65 divided by population aged 20-64. The thick navy line shows aggregate data from the UN Population Statistics for 17 industrialised countries (Australia, Austria, Belgium, Canada, Denmark, France, Germany, Ireland, Italy, Japan, Netherlands, New Zealand, Portugal, Spain, Switzerland, UK and USA), and dashed navy lines show the high- and low-fertility scenarios in their projections. Thin dashed lines show the historical data for Belgium, Denmark, France, Netherlands, Switzerland and UK from The Human Mortality Database.

From an individual perspective, this trend reflects an increasing fraction of life spent in old age. People that reach retirement age can now look forward to living a further 20 years, on average. Assuming no change in the retirement age, this number is projected to rise to almost 30 years for generations born 20 to 30 years from now. Consider that when Bismarck, Lloyd George and others pioneered state pensions over a century ago, workers were lucky merely to reach retirement age. While raising the retirement age can work to stabilise the time spent in retirement relative to time spent working, the increases proposed in most advanced economies are not yet enough to offset this rise in life expectancy.

… with a profound effect on desired wealth accumulation…

One of the primary ways that population ageing affects the economy is through savings and wealth accumulation. While many developed countries have some form of implicit transfers from workers to retirees through state pensions, private saving remains an important component of retirement income. This is evident in the life-cycle pattern of wealth holdings: in the United States, where the most data is available, wealth peaks close to retirement age and then falls gradually (Chart 2).

Chart 2: Net worth over the life-cycle, with and without housing (thousand US Dollars)

Note: The data is taken from Survey of Consumer Finances, averaged over 1989-2013. The dark solid line shows total net worth, and the light dashed line shows net worth excluding housing wealth.

The rise in life expectancy raises the economy’s desired level of wealth for two reasons. Firstly, people need to accumulate more wealth during their working life to fund their consumption over a longer expected retirement. In terms of the life-cycle profile of wealth, all else equal, this would mean that wealth rises more steeply and reaches a higher peak. Secondly, even without any change in behaviour over the life-cycle, the changing population age structure would imply rising aggregate wealth. Specifically, Chart 2 shows us that households accumulate much of their wealth by around age 50, and hold on to that wealth throughout retirement. Therefore, when adding up individuals’ wealth, the increasing share of people in these high-wealth stages of life will imply a higher aggregate level of wealth.

… With far-reaching macroeconomic implications…

What are the macroeconomic effects of this rise in wealth? In terms of a simple concrete example, household savings find their way to firms, who invest them in machines, structures and intangibles such as branding and research. To the extent that it is harder for firms to employ extra machines as profitably as existing ones, i.e. that the returns to these investments are diminishing at the margin, households get lower returns as their savings increase. In other words market interest rates are lower.

The effects of ageing do not stop there. As desired wealth rises, the demand for other assets, including for example housing, also rises, pushing up on prices. Borrowing also rises, in response to both the fall in the interest rate, which makes borrowing cheaper, and the rise in house prices, as younger and less wealthy households borrow to buy housing. Within open economies, countries that are ageing relatively faster will accumulate assets in countries that are ageing relatively more slowly. This would explain why rapidly ageing countries, like Japan or Germany, are lending money to relatively younger countries, such as Australia.

While the mechanism described above is, of course, simplified, there is evidence that the ratio of capital-to-GDP is indeed much higher now than in the past (Chart 3). This provides additional evidence in favour of our underlying mechanism.

Chart 3: Measures of Capital-to-GDP in industrialised countries (Index)

Note: The blue line shows an index of the ratio of the capital stock to value added in the US business sector from Fernald (2014), equal to 1 in 1947. The red line shows an index of the ratio of capital services to GDP for 19 OECD countries, which, for comparison, we normalise to equal the Fernald measure in 1985 when the series begins.

… which are quantitatively significant

In a recent staff working paper, we have embedded the mechanisms described above in a life-cycle model, in order to quantify these effects for industrialised countries. Households in our model follow the life-cycle patterns of work, home ownership and wealth that we see in the data. This means we take as given that retirees keep their high level of wealth, and assume that future retirees will do the same. We assume that households know their life expectancies accurately, take account of current and expected house prices and interest rates, and hence plan ahead for their future consumption. This implies that households are able to save more in anticipation of their longer retirements, rather than having to work longer or give up their consumption in old age.

In equilibrium, the real interest rate adjusts to balance the supply of capital from the household with the demand from firms. This sets to one side the fact that, in practice, there is a large spread between the risk-free interest rate in financial markets and the interest that firms earn on new investments. This spread is comprised, among other things, of various premia for liquidity and risk, and profits that firms earn in excess of their costs, which we abstract from. House prices also adjust to balance demand for housing with a supply that we assume is fixed per head.

We allow birth and death rates to fall in line with UN data and projections for industrialised countries, as defined in Chart 1. This will be the only external driver of the dynamics in our model. We set the model to match the level of interest rates, and some other aggregate variables in the 1970s, and then measure how the demographic trends have affected the economy since then.

We find that demographic change alone can explain 160bps of the 210bps decline in interest rates since the early 1980s measured by Holston et al. (2017). The model predicts an increase in house prices of over 45% since 1970, corresponding to around 75% of the change observed in the data (Chart 4a). It also explains the doubling of the private debt-to-GDP ratio between 1970 and the start of financial crisis, an increase of around 45pp (Chart 4b). These results confirm that ageing does have a sizeable economic impact. Implications for cross-country imbalances are also important: the pattern of foreign asset accumulation (net borrowing and lending) across industrialised economies predicted by the model explains almost 30% of the variation observed in 2010.

Chart 4: House prices and gross private debt-to-GDP in the model and in the data

Note: House prices are shown in percentage deviation from the 1970 value, and private debt-to-GDP is shown as a percentage. In both cases, the blue solid lines show the results of our model simulations and red dashed lines show the equivalent series in the data.

Finally, the model allows us to gauge the effects of demographics going forward, based on the projections in the UN data. Importantly, these effects are set to increase over the future. The retirement of baby boomers is sometimes cited as potentially driving a decrease in aggregate savings. This does not happen in our quantitative model, both because new generations are expecting to live ever longer into retirement, and are therefore saving more, and because we can expect that baby boomers will retain their high wealth levels throughout retirement. This means that population ageing will continue to keep long run interest rates lower than they would otherwise be, as long as life expectancy, in particular the expected duration of retirement, remains high.

Bank Underground is a blog for Bank of England staff to share views that challenge – or support – prevailing policy orthodoxies. The views expressed here are those of the authors, and are not necessarily those of the Bank of England, or its policy committees.

Pay Day Lending Still Running Hot

We monitor Pay Day lending – or Small Amount Credit Contracts (SACC) – as they should be called, via our surveys. We have just run our 2017 updates, and we find that SACC lending is still growing, and well above inflation and wage growth. A symptom of financial stress in the community .

Watch the video, or read the post.

But SACC lenders are targeting different borrowers now, and mainly via online channels.

This first chart shows the relative lending flows split by distressed households and stressed households. Stressed households, we define as those with cash flow problems (often thanks to poor budgeting or over commitment) but many will have other financial assets, and even may own property. Most will be in employment. Lenders are targeting this group (especially using TV, radio and online channels) and there has been substantial growth.

Distressed households are those under financial pressure, often with limited employment, and are very likely to be on Government assistance. Recent tightening of the lending rules has reduced the share of lending to these distressed groups – which is a good thing.

The overall net effect is the total lending from Pay Day providers, including the many online players – has risen to around $842m flow and $994m stock. Growth in 2015 -2016 was 10.7% and 2016-17 was 14.5%. We expect growth at least 10% in 2018, perhaps higher.

The share of loans originated online continues to rise, from 48% in 2015, to more than 75% now, and it will continue to rise further. These online services are easy to access, and borrowers, once they sign up can get “special” deals.

The online environment is of course hard to police, but the interest rates offered by many players are right at the top end of the allowable range.

The latest changes to the SACC legislation are still in the works. But we think there should be a further review looking at the online lending environment. This is clearly where the action (and risks) are. By plugging the lending to our most vulnerable households, the industry has regrouped around more affluent but needy connected households. There are more to target, and the prospect of substantial growth.

For an outline and critique of the proposed payday lending* reforms, see the following articles by Gill North (Professor of Law at Deakin University and Joint Principal of Digital Finance Analytics)

‘Small Amount Credit Contract Reforms in Australia: Household Survey Evidence & Analysis’ (2016) 27 Journal of Banking and Finance Law and Practice 203
‘Small Amount Credit Contract Reforms: Will the Affordability Cap Achieve Its Intended Objectives Without Unintended Adverse Consequences?’ (2017) 32 Australian Journal of Corporate Law 1
‘Small Amount Credit Contract Reforms: Have Transparency and Competition Concerns Been Forgotten?’ (2017) 25 Competition & Consumer Law Journal 101

Draft versions of these papers are available at https://ssrn.com/author=905894

Defined as “small amount credit contracts” in the National Consumer Credit Protection Act 2009 (Cth)