Social Trends – Page 172 – Digital Finance Analytics (DFA) Blog

If The Worm Turns, What Happens To Household Mortgage Stress?

The wind appears to be changing. First the new head of APRA warned at a CEDA event they were watching the mortgage lending of the banks closely, “The Australian banking system clearly has a concentration of risk in housing. If anything was to go wrong in the housing market it would have very severe impact on the viability and health of the banking system, so it’s naturally something we watch very carefully.” Meantime in London, Treasury Secretary Martin Parkinson spoke to Chatham House where he mused on the low interest rate strategies being adopted by many countries, the limits of monetary policy and the potential for macroprudential measures. Locally, whilst fixed rate mortgages are being offered at record lows below 5%, the consensus appears to be shifting towards a lift in rates in Australia, partly as a result of rising inflation, although timing is not certain. So, what is the potential impact of a rate rise on Australian mortgage holders, bearing in mind that the average loan to income is stretched? How far would rates rise? Where would the pain be felt most?

To answer these questions, we have examined interest rate trends, and incorporated a rising rate scenario into our mortgage stress models. First, let’s look at rate trends. This is a plot of the RBA target rate since 1990. If we take a linear average, we see that currently we are well below the “neutral” range. An RBA rate of 4-4.5% would on this basis be a neutral rate. This is the first assumption I have made in my stress modelling.

Then we have to estimate the spread above the target rate the variable rate mortgage will be coming in at. We still have most households on a floating rate, although 15% are locking in fixed at the moment. This plot shows the target cash rate, against the spread between a CMT deposit account and a standard variable mortgage. Lets assume an average uplift of 300 basis points. That would put the mortgage rate at about 7%.

Now, we will assume rates will be lifted to this level in the next 12-15 months. We will also assume that income rises at the level it has in the past 2 years, and that unemployment stays at 6% (to isolate the effect of the rate movement). We then calculate for the 26,000 households in our survey the impact on their income/expenditure if their mortgages do rise. The impact is of course immediate, unless households are on a fixed loan. This is incorporated in the modelling. Now, we calculate the proportion of households which will be in mortgage stress in 18 months time (see the definitions we use here). Lets take Sydney as an example. This geo-mapping shows where the main movements are in terms of increases in mortgage stress. The blue postcodes are worst hit. Many of these households are in the western suburbs, and are typically younger, and on lower incomes. Many are first time buyers.

Mortgage stress does not mean an immediate crisis, but households hunker down short term, and it is a warning of trouble ahead because many households who get into difficulty are ultimately forced to sell. My read on this modelling is that if rates rise, the impact on the property market could be quite profound. This in turn does indeed lay potential bear traps for the banks, because of their high leverage into property. There is a strong case to lift the currently relatively low capital rules for the big four, to provide a buttress against rising rates, and to avoid financial stability issues. The recent FSI interim report touched on this. If rates do indeed start to rise, we will need to be alert to the issues. Actually, the regulators should have been acting sooner, as the genie is now out of the bottle. We will publish data on this scenario for other states another day.

Savers Quest For Yield

The CPI data which came out from the RBA yesterday registered 3%. This was very bad news for households with savings in deposit accounts at the banks, because ever more are finding that returns after tax are well below CPI. This is part of a worrying trend for many, and is prompting them to seek out alternative and possibly higher risk saving vehicles. Today we examine this issue in the light of latest data from our household surveys.

First, here are some benchmark savings rates mapped to the CPI and RBA benchmark rate. Many savings rates are now below the CPI, even before we consider the tax implications, as of course income from deposits is taxable. More and more households will see their savings eroded in real terms. It may not be as bad as in the UK, where thanks to even lower base rates, central bank intervention and other factors, deposit rates are around 1% and inflation above 3%, but its getting all too familiar.

The RBA has observed in its monthly updates that investors are seeking higher risk, higher return alternatives to bank deposits. Our surveys illustrate this nicely. We have been asking savings households about their intentions each month. Now, up to 80% of households with savings of more than $250k are actively seeking alternatives. It is lower for smaller balances, because typically these need to be readily available in case of emergencies. But even here, 35% are reconsidering their options.

We also split the analysis between those saving within SMSF and those outside, as SMSF have advantaged tax treatment we expected these savers to be less concerned, but not so. We found that more of those saving via a SMSF were more actively seeking alternatives than those saving in their own names. This is a clue to why SMSF’s are investing direct in property.

For households looking beyond bank deposits, it is worth highlighting they are moving away from secure savings options, because of course the government guarantee on deposits remains at $250,000 per customer per institution without charge. So if households start looking for other options, they might consider shares (though the market is close to its highs), property (will prices rise further?) or other wealth management products, where fees are not well disclosed, advisors may not give best advice, and returns are uncertain. There are certainly no simple alternatives. That in turn allows the banks to let their deposit rates slip, source funding cheaper from overseas wholesale markets, and by maintaining loan deposit rates, bolster their profits. We are mandated to save, yet the fact is, its hard to find solutions which provide returns above inflation at reasonable risk. Caveat Emptor!

Government To Review Retirement Income Rules

The Treasury today announced a review seeking feedback on the types of products which would be appropriate for people approaching or in retirement with a focus on ensuring they do not out live their savings.

The Government’s superannuation election commitments include reviewing:

the regulatory barriers restricting the availability of relevant and appropriate income stream products in the Australian market; and

the minimum payment amounts for account-based pensions, to assess their appropriateness in light of current financial market conditions.

Given their interactions, this discussion paper Review of retirement income stream regulation forms the basis for consultation on both reviews.

In addition, on 14 December 2013, the Government announced it would not proceed with the previous government’s unlegislated measure to facilitate the provision of deferred lifetime annuities and that it would instead consider the proposal as part of the review of the regulatory arrangements for retirement income streams. This paper also provides a basis for consultation on extending concessional tax treatment to deferred lifetime annuities.

The Government welcomes views on this discussion paper, and written submissions will be accepted until 5 September 2014.

We believe there is opportunity to create new products and services, provided they are fairly priced and transparent. In our review of the demand for annuity products in Australia, we found that many were concerned about these issues, and of course the UK just moved from a mandatory annuity structure to allowing retirees complete freedom to save and spend as they please. They had a major mess previously. DFA believes that households should not be forced to take a particular solution, but products correctly structured and priced would be of significant help. We know from our household surveys that many are not saving sufficient to support their expected life in retirement. Indeed many had no clear expectation of how long they might live, and what they might need to have invested.

The Payments Revolution Around The Corner

The FSI Interim report, released earlier in the week, includes a section on how technology may disrupt payments, a critical domain in financial services.

The report says ” Advances in technology have reduced traditional barriers to market entry in payments, such as the need to construct a dedicated network. New entrants can leverage high levels of internet connectivity, penetration of smart devices and pre-existing networks to connect users to payments services more easily and cheaply than incumbents. The payment hub, being developed by eftpos Payments Australia Limited, and the New Payments Platform (NPP), an industry project being developed as a result of the Reserve Bank of Australia’s (RBA’s) strategic innovation review, may further reduce barriers to entry and drive competition. Incumbents in the Australian payments industry are facing competitive challenges from new market entrants, such as PayPal, POLi, PayMate and Stripe. Closed-loop pre-paid systems operated by companies outside the financial sector, such as Apple, Skype and Starbucks, are holding growing amounts of customers’ funds. Apple has also recently signalled its interest in mobile payments more broadly and recently developed fingerprint biometric authentication for its phones. Advances in cryptography and computer processing power have facilitated the development of virtual or crypto-currencies.

Today we look at the potential convergence of new payment mechanism, overlaid on smart devices, and in the context of customer centric thinking. Consider this, the ubiquitous smart mobile device is essentially a mobile wallet plus a payment instrument, a centre of interaction and potentially can provide secure identification.

You walk down a high street and receive a personalised messages from a retailer, based on your profile, as you pass. The offer is triggered by your proximity to the store. It is a deep discount on that item you were goggling last night, available for just 10 minutes. You decide to accept the offer, pay direct from your phone using your secure wallet, and the deal is done. Rather than collect it, you choose to have it delivered to your home, later in the day. No human interaction, simply a combination of technologies to fundamentally change the customer experience.

Consider the disruptive impact of this, on the retail trade, the payments system, and human behaviour.

Is this far fetched? Not at all. For example, Apple has been working on iBeacon, which is “a new technology that extends Location Services in iOS. Your iOS device can alert apps when you approach or leave a location with an iBeacon. In addition to monitoring location, an app can estimate your proximity to an iBeacon (for example, a display or checkout counter in a retail store). Instead of using latitude and longitude to define the location, iBeacon uses a Bluetooth low energy signal, which iOS devices detect”. It is still early, but Apple has been testing it since December last year in its US retail stores. In the UK, Virgin Atlantic is also conducting trial of iBeacon at Heathrow airport, so that passengers heading towards the security checkpoint will find their phone automatically pulling up their mobile boarding pass ready for inspection. Paypay is experimenting with its own version of beacon – “hands Free shopping – the future in here”, they say.

In May, St. George revealed that is trialling iBeacon at three Sydney branches. When a customer walks into the bank, the iBeacon senses the person’s entrance and sends a welcome message and personalised information directly to the iPhone or iPad, according to Computerworld. George Frazis, CEO of St. George Banking Group, said in a statement the launch of the new technology forms part of an increased focus on delivering an innovative and customer-centric in-branch experience. “The future of business will be in the ability to anticipate customer’s needs, understand what matters to them and act on that knowledge to surprise and delight them,” he said. “Our investment in iBeacon will help us to achieve that — and it has the potential to dramatically change the service experience in Australian banking.”

The question is, what is the right regulatory settings to, on one hand allow innovations like this to flourish, whilst on the other hand, ensure that adequate protections are in place. That is the question posed, but not yet answered in the FSI interim report.

“Some submissions argue that firms performing similar functions should be regulated in the same way. This position is often made by large incumbent players concerned about the capacity of new players to operate around the edge of the regulatory perimeter. Failure to apply equivalent regulation may result in an uneven playing field and regulatory arbitrage. It may also incentivise those within the current regulatory perimeter to lower their own standards of compliance to compete. However, applying the full weight of prudential or conduct regulation to small players and new start-ups, regardless of the materiality of the risk they represent, may stifle valuable innovation unnecessarily.”

What is clear to me, based on our survey of households and their use of mobile devices, there is potentially a revolution round the corner, which will disrupt traditional payment mechanisms, retail behaviour and customer expectations. Actually many people are ahead of many of the incumbents, and are expecting to do ever more with their ubiquitous mobile devices. The real power is wedding the multiple technologies contained in the device, to create a seamless consumer experience, with smart analytics and segment data. The marketeers dream of one to one targetting is here. Unless people to select to opt out – if they can find the right tab. That may not be easy.