Digital Finance Analytics (DFA) Blog – Page 1045

RBA’s Outlook for Australia’s Economy

In a speech today, Christopher Kent, Assistant Governor (Economic) outlined the current state of global and local economies, and commented on the outlook. Significantly he stressed that the RBA was looking for household expenditure to trickle through to stimulate business investment and thus lead to a lift in the labour market. However, noting the fall in average real income, and waning consumer confidence, we think this will take a long time, even at current very low interest rates. In addition, we have very high loan to income ratios, and this is absorbing household wealth significantly. Raises an interesting point, are the underlying economic assumptions valid this time around?

Our expectation is that growth will continue to be a bit below trend for a time, picking up gradually to be a bit above trend pace by 2016. And the unemployment rate is likely to remain elevated for some time.

The near-term weakness reflects a combination of three forces: a sharper decline in mining investment over the coming quarters than seen to date; the effects of the still high level of the exchange rate; and ongoing fiscal consolidation at state and federal levels. In contrast, resource exports are likely to make a further strong contribution to growth, with LNG exports expected to begin ramping up over coming quarters. At the same time, very low interest rates are working to support growth of household expenditure. In time, growth of household demand and the impetus to domestic demand provided by the exchange rate depreciation we have seen since early 2013 are expected to spur non-mining business investment.

Given this outlook, I want to touch on two relevant aspects of the business cycle that are important sources of uncertainty for our forecasts. One is related to household consumption, the other to business investment.

Household consumption

At this phase in the business cycle, it’s natural to worry about the possibility that consumption will be weighed down by slow growth in household incomes, driven in turn by the subdued state of the labour market. It is true that stronger growth of employment and wages would provide more support for consumption. However, that dynamic usually kicks in later in the cycle. In the meantime, it’s reasonable to expect that very low rates of interest will enable and encourage households to shift some expenditure from the future to now, including via higher asset prices. This would see a decline in the share of disposable income that households save (i.e. a lower saving ratio). There are limits to this, and it would be unwise to build a recovery on a foundation of a sharp decline in the saving ratio.

Our latest forecasts, however, suggest that there will be a gradual decline in the saving ratio over the next couple of years, of the same order of magnitude as we’ve already seen over the past couple of years.

A decline in the household saving ratio would be consistent with the tendency for labour market developments to lag developments in economic activity, including consumption, by a few quarters. Consumption and GDP growth tend to pick up ahead of an improvement in employment growth, which would in turn be expected to occur before we see wage growth start to return to more normal levels. This was the case during the recessionary episodes of the early 1990s and following the global financial crisis.

Non-mining business investment

I’ve spoken at length recently about the factors that might have led to subdued non-mining business investment over recent years.

In short, I concluded that this outcome had been consistent with a period of greater uncertainty and below-average confidence. Both of these have changed for the better more recently, yet firms still seem reluctant to take on risks associated with substantial new investment projects. If the appetite of businesses (and shareholders) for risk were to improve, investment could pick up. It’s hard to know when such a turning point in spirits might take place. But it is more likely when the fundamental determinants of investment are in place as they seem to be now. The ready availability of internal and external finance, at very low cost, is one such element of that. Also, there is the stronger growth of demand across the non-mining parts of the economy over the past year or so and measures of capacity utilisation have increased to around long-run average levels. So there is a reasonable prospect of business investment picking up, in time.

Even so, let me note some reasons why the anticipated recovery in non-mining business investment might not be quite as strong as in earlier episodes. But I will stress at the outset that if that comes to pass, it does not mean that growth of activity or of our prosperity need suffer.

One reason why investment in the non-mining sector might be lower than in the past is that service industries account for an increasing share of our economy – rising by about 12 percentage points in terms of the employment share over the past three decades. This is relevant to investment because service industries, on average, have much lower levels of capital relative to labour. So, in an economy in which services account for a higher share of economic activity, other things equal, the optimal (non-mining) capital stock should be lower than it otherwise would be (as a share of that economy). However, that doesn’t imply that GDP growth will be lower, nor does it suggest that the economy will be a less prosperous one. What matters for these things is whether we are taking advantage of profitable opportunities and using labour and capital in the most productive ways that we can. Also, it is worth emphasising that many services require high levels of human capital – in the form of education and training – which does not get picked up in investment as measured by the national accounts.

Investment today might also be lower (as a share of nominal GDP) than in the past for another reason. Over time there has been a sizeable decline in the price of many types of machinery and equipment (particularly those related to information and communications). So, businesses are able to spend less to obtain a given level of capital services. For example, they can purchase a lot more computing power for a given level of nominal spending. Once again, if this leads to lower investment (as a share of nominal GDP) than in the past it does not imply less output growth or lower prosperity. Indeed, given that Australia imports much of our machinery and equipment, a lower price of that capital is to our benefit.

Conclusions

The major advanced economies are in different stages of the business cycle. The recovery from recession is well established in the United States, but has a long way to go in the euro area. Japan has made some progress in reducing the extent of spare productive capacity, but inflation is still some way from the Bank of Japan’s target. Nevertheless, growth of Australia’s major trading partners has actually been around average for some time now and, as best we can tell, it is likely to remain at that rate in the year ahead.

Australian GDP growth has been a bit below trend pace over the past couple of years, consistent with a gradual rise in the unemployment rate. Much of the growth this past year owed to rising resource exports, although growth outside the mining sector also picked up. However, with mining investment set to fall more sharply over coming quarters, GDP growth is expected to be below trend for a time before gradually picking up to an above-trend pace by 2016.

The very low level of interest rates is supporting, and will continue to support, growth of household expenditure. In time, this is expected to support a recovery in non-mining business investment, and the economy more broadly, including an improvement in conditions in the labour market. If history is any guide, the recovery is likely to proceed in that order, from household expenditure to business investment to labour market conditions. History also suggests that a pick-up in business investment (outside of the resources sector) will come, in time. The fundamental forces are in place to support that recovery. And while I have suggested some reasons why business investment might not be quite as strong as past episodes of recovery might suggest, these don’t imply that the economy overall will be less strong than otherwise, but rather just one element of expenditure that we measure via the national accounts.

FCA fines five banks £1.1 billion for FX failings

The Financial Conduct Authority (FCA) has imposed fines totalling $1.7 billion on five banks for failing to control business practices in their G10 spot foreign exchange (FX) trading operations.

Between 1 January 2008 and 15 October 2013, ineffective controls at the Banks allowed G10 spot FX traders to put their Banks’ interests ahead of those of their clients, other market participants and the wider UK financial system. The Banks failed to manage obvious risks around confidentiality, conflicts of interest and trading conduct.

These failings allowed traders at those Banks to behave unacceptably. They shared information about clients’ activities which they had been trusted to keep confidential and attempted to manipulate G10 spot FX currency rates, including in collusion with traders at other firms, in a way that could disadvantage those clients and the market.

Today’s fines are the largest ever imposed by the FCA, or its predecessor the Financial Services Authority (FSA), and this is the first time the FCA has pursued a settlement with a group of banks in this way. We have worked closely with other regulators in the UK, Europe and the US: today the Swiss regulator, FINMA, has disgorged CHF 134 million ($138 million) from UBS AG; and, in the US, the Commodity Futures Trading Commission (‘the CFTC’) has imposed a total financial penalty of over $1.4 billion on the Banks and the Office of the Comptroller of the Currency (‘the OCC’) has imposed a total financial penalty of $700 million on Citibank N.A. and JPMorgan Chase Bank N.A.

Since Libor general improvements have been made across the financial services industry, and some remedial action was taken by the Banks fined today. However, despite our well-publicised action in relation to Libor and the systemic importance of the G10 spot FX market, the Banks failed to take adequate action to address the underlying root causes of the failings in that business.

Property Finance Continues To Lift In September

The ABS released their lending finance data today for September 2014. When compared with August,

Housing Finance For Owner Occupation

The total value of owner occupied housing commitments excluding alterations and additions rose 0.1% in trend terms and the seasonally adjusted series rose 1.4%.

Personal Finance

The trend series for the value of total personal finance commitments rose 0.4%. Fixed lending commitments rose 0.9%, while revolving credit commitments fell 0.3%.
The seasonally adjusted series for the value of total personal finance commitments fell 5.5%. Revolving credit commitments fell 7.7% and fixed lending commitments fell 3.7%.

Commercial Finance

The trend series for the value of total commercial finance commitments fell 1.6%. Revolving credit commitments fell 4.3% and fixed lending commitments fell 0.5%.
The seasonally adjusted series for the value of total commercial finance commitments rose 2.4%. Fixed lending commitments rose 4.9%, while revolving credit commitments fell 4.1%.

Lease Finance

The trend series for the value of total lease finance commitments rose 1.2% in September 2014 and the seasonally adjusted series fell 1.0%, after a rise of 9.3% in August 2014.

Housing finance made a significant contribution, mainly thanks to significant investment sector demand. Overall it rose 2.3% from last month. Refer our earlier discussion on investment lending for more details.

Were it not for the hot house prices, and unconstrained investment sector demand, the next movement in official interest rates would most likely be down thanks for contained business lending. The real question is how to redirect lending support away from unproductive investment in established dwellings, to new construction, and the commercial sector. Changes to negative gearing and capital buffers across lending categories should be on the table. However, economic sense is being blunted by the fear of political backlash. Nevertheless, we think think the time has come for a dose of reality as the blunt interest rate lever will just not cut the mustard.

GSIBs Will Likely Need More Capital

The Financial Stability Board released a draft discussion paper on the proposed revisions to the capital to be held by Globally Significant Banks GSIBs. The FSB proposes that a single specific minimum Pillar 1 TLAC requirement be set within the range of 16–20% of RWAs and at least twice the Basel 3 Tier 1 leverage ratio requirement. The final calibration of the common Pillar 1 Minimum TLAC requirement will take account of the results of this consultation and the Quantitative Impact Study and market survey which will be carried out in early 2015.

This is higher than current levels (by quite some way), and whilst we should stress that no Australian Banks are GSIBs, and that local capital calculations are worked slightly differently from some other countries, we should expect capital buffers to be increased in a trickle down effect, in due course. Individual banks would be impacted differently, but when we overlay recent APRA and RBA comments, our view that capital buffers will be raised eventually seem to be reinforced.

Australian Securitisation Under The Microscope

Today, in a speech by Chris Aylmer, Head of Domestic Markets Department, RBA, we got an interesting summary of recent developments in the market. This is important, because as at June, the Bank held about $25 billion of these assets under repo as part of their liquidity management operations. In addition, at the same forum, Charles Litterell, EGM APRA discussed the planned reforms to prudential framework for securitisation, highlighting that APRA want to facilitate a much larger, but very simple and safe, funding-only market and also facilitate a capital-relief securitisation market. In both cases, they want to impose a simpler and safer prudential framework than has evolved internationally. The RBA comments are worth reading:

While conditions in global financial markets have improved since the depths of the global financial crisis, the market for asset-backed securities has notably lagged this improvement. Issuance of private-label asset-backed securities in the US is currently equivalent to around 1½ per cent of GDP, compared with an average of around 8 per cent in the first half of the 2000s (Graph 1). Issuance of private-label residential mortgage-backed securities (RMBS) has been virtually non-existent since 2008. In contrast, issuance of auto loan-backed securities is nearing its pre-crisis level. Issuance of securities backed by student-loans and credit card receivables is also growing, though it remains well below its pre-crisis peak.

Activity in the European securitisation market remains very subdued, with annual issuance placed with investors relative to the size of the economy declining for the fourth year in a row. While the challenging economic conditions on the continent have contributed to this, European authorities have identified a number of other impediments and are developing proposals to address them.[²] In September the European Central Bank (ECB) announced that it will implement an asset-backed securities purchase program aimed at expanding the ECB’s balance sheet. While this program is not explicitly targeted at reviving the European ABS market, the ECB expects the programme to stimulate ABS issuance.

In comparison with its overseas counterparts, the Australian securitisation market, which remains predominantly an RMBS market, has experienced a strong recovery over the past couple of years, albeit not to pre global financial crisis levels. Issuance started to pick up in late 2012, reached a post-crisis high in 2013, and has remained high since then.

This mainly reflects the strong performance of Australian residential mortgages and the high quality of the collateral pools which are primarily fully documented prime mortgages. While delinquency rates on Australian prime residential mortgages increased after 2007, this increase was a lot less severe than in most other developed economies (Graph 2). Indeed, serious delinquencies in Australia, those of 90 days or longer, remained below 1 per cent and have declined since 2011 to around 0.5 per cent currently. Mortgage prepayment rates, which affect the timing of the payments to the RMBS notes, have also been relatively stable in Australia, resulting in subdued prepayment and extension risk for RMBS investors.

Issuance margins on RMBS continued to tighten throughout this year across all categories of issuers (Graph 3). Banks have been able to place their latest AAA-rated tranches in the market at weighted average spreads of 80 basis points – the lowest level since late 2007. Spreads on the AAA-rated tranches of non-bank issued RMBS have also declined, to around 100 basis points. Investor demand has extended across the range of tranches, with a significant pick-up reported in demand for mezzanine notes. As a result, a number of issuers have priced their mezzanine notes at some of the tightest spreads since 2007.

Similar to last year, RMBS issuance this year has mainly originated from the major banks (Graph 4). Indeed, issuance by the major banks is on par with their issuance prior to the global financial crisis. Issuance by other banks has also been robust this year, although it is still well below pre-crisis levels when these issuers accounted for around 40 per cent of the market.

Mortgage originators have been active this year, although their issuance has predominantly been of prime RMBS. Mortgage originators have issued only $1.6 billion of non-conforming RMBS in 5 transactions so far this year. The number of mortgage originators active in the market in the past two years has increased relative to the period from 2009 to 2012.

They are an important presence in the market. In the period preceding the global financial crisis, mortgage originators took advantage of innovations in the packaging and pricing of risk. In doing so, they were able to undercut bank mortgage rates. The banks responded and spreads on mortgages declined markedly. While a number of large mortgage originators have exited the market, the presence of mortgage originators promotes competition in the mortgage market.

Issuance of asset-backed securities other than RMBS has generally been in line this year with previous years. Issuance of commercial mortgage-backed securities (CMBS) and other ABS this year has been around $5 billion, compared with an average of about $6 billion over the three preceding years.

The investor base in Australian ABS has continued to evolve (Graph 5). The stock of RMBS held by non-residents has been relatively steady since late 2010 suggesting that non-residents have been net buyers of Australian ABS. The strong performance of Australian RMBS and lack of issuance elsewhere may have been an important driver behind the participation of foreign investors. There has been a pick-up in RMBS holdings by Authorised deposit-taking institutions (ADIs) – they now hold just under 40 per cent of marketed ABS outstanding – with the major banks accounting for much of the increase.

Holdings of ABS by real money domestic investors have gradually declined, to the point where these investors, in aggregate, now hold less than a quarter of what they held four years ago. The longer-term sustainability of the Australian securitisation market may well depend on increasing participation in the market by domestic real money investors.

One of the key structuring developments since mid 2007 has been the increase in credit subordination provided to the senior AAA-rated notes. This primarily reflects decreased reliance by the major banks on lenders mortgage insurance (LMI) support in their RMBS. This trend has been driven by investor preference for detaching the AAA-rating on the senior notes from the ratings of the LMI provider.

The increased subordination in the major banks’ RMBS has been to a level in excess of that required to achieve a AAA-rating without LMI support. This mitigates the downgrade risk owing to changes in ratings criteria. In contrast, other categories of RMBS issuers have continued to use LMI to support their structures, allowing them to achieve AAA-ratings on a larger share of their deals.

The RBA highlighted that “the risk management and valuation of ABS collateral is obviously an analytically intensive process, requiring considerable information about the security and the underlying assets. Over time we will further develop pricing and margins that reflect the specifics of the asset-backed security and its collateral pool. This could, for example, take the form of credit risk models of the collateral pool which take into account characteristics such as geographic concentrations, delinquencies and loan-to-value ratios. These collateral credit models will be combined with structural security models to calibrate margins specific to the security that reflect its projected behaviour under stress scenarios”.

Ratesetter P2P Launches In Australia

Ratesetter, a Peer To Peer Lender, has just launched in Australia.

“Redefining savings and loans in Australia. RateSetter connects lenders with creditworthy borrowers who want a simple, competitive personal loan. We are excited to be the first and only company in Australia to provide peer-to-peer lending to retail savers and investors. RateSetter is not a bank. RateSetter is part of a new generation of modern businesses, using technology to replace traditional middlemen and reduce the costs of providing financial services. We provide a transparent marketplace where lenders and borrowers, empowered by technology, can transact directly and share the benefits.

A peer-to-peer pioneer The RateSetter group in the United Kingdom was the first peer-to-peer lender globally to introduce the concept of a provision fund to help protect lenders from late borrower payments or default. This innovation represents a significant evolution in peer-to-peer lending. The money in the Provision Fund in Australia comes from borrowers, and is held on trust by an external trustee. Whilst the Provision Fund is not a guarantee or an insurance product, RateSetter Australia may make a claim on the Provision Fund on behalf of a lender in the event of a late borrower payment or default.

Regulated by ASIC RateSetter holds an Australian financial service licence and an Australian credit licence.”

RateSetter was founded in the United Kingdom in 2010 by ex-Lazard investment banker Rhydian Lewis and former Ashurst lawyer and RBS banker Peter Behrens. RateSetter has since attracted over 500,000 customer registrations and facilitated over $700 million in loans. RateSetter in the United Kingdom has been backed since the start of the company by private investors who have invested £8m of equity capital into the business. RateSetter in Australia is backed by RateSetter in the United Kingdom and other private investors. The launch of the Sydney office was kick-started with a $3.1m investment from local and international investors. RateSetter does not fund borrower loans. Rather, it is lenders who fund loans.

According to their product disclosure document RateSetter Australia is not a bank and your investment is not a deposit and does not benefit from depositor protector laws as if would if it were an amount deposited with an Australian ADI. All loans made to borrowers are subject to the provisions of the National Consumer Credit Protection Act 2009 (NCCP) and its related regulation. Your investment may be impacted if a borrower to whom your funds are on loan exercises certain rights under the NCCP, including requesting a variation to loan payments due to hardship, the effect of which is that the term of your investment may be impacted. An investor can lend in four different lending markets, with indicative terms of 1 month, 1 year, 3 years and 5 years. If you lend in the 1 Month or 1 Year lending markets, your funds may need to remain on loan to a borrower beyond the indicative term, although in such circumstances you should continue to receive borrower payments. You choose how much you wish to invest, in which lending markets, and at what rates. Their peer-to-peer information technology systems automatically match your funds to the loans of borrowers that have met our loan underwriting requirements. Whilst they perform comprehensive borrower risk assessment and lend only to creditworthy Australia-resident borrowers, there may be differences in the creditworthiness of borrowers to whom your funds are matched to. They only approve loan applications from creditworthy Australia-resident individuals aged 24 or over. They do not lend to businesses.

Loans to borrowers are between $2,001 and $35,000, for terms from six months to five years. Borrowers have a legal obligation to repay their loan in broadly equal payments each month over the term of the loan, with payments comprising both interest and principal. All loans to borrowers are governed by a standard form loan contract. Loans are unsecured. If a borrower defaults on a loan, they or a nominated third party may undertake a number of actions to pursue payments, which may include appointing an external collections agency or taking recourse to available legal remedies, including where appropriate, court action.

When you make an order to lend money in a lending market, your order may be matched to a single loan or multiple loans. This will depend on the amount of your order, the time your order was made relative to other orders in that lending market and the number and amount of loans available to be funded in that lending market.

Each borrower’s loan is governed by a single loan contract. The parties to the loan are the borrower and the Custodian. You as lender (and also other lenders, to the extent the loan is funded by more than on lender) do not have a contract with the borrower. Rather, when your funds are on loan, your RateSetter Account is updated to reflect that you have an interest in the relevant loan, and your rights in respect of that loan are governed primarily by the Constitution and this PDS. Importantly, when your funds are matched to a loan, you have a direct economic interest in that loan, and your interest in that loan is not directly impacted by the performance of other loans. Ratesetter believe that this is an important feature of any peer-to-peer lending investment structure.

The Provision Fund is a pool of money funded by borrowers and held on trust by an external trustee. RateSetter Australia may make a claim on the Provision Fund in the event of a borrower late payment or default on a loan. Any amount paid from the Provision Fund is credited to the lenders who funded the loan, in proportion to the amount funded by each lender.

As we predicted P2P lending is emerging in Australia. How well it develops will be determined by performance and demand. Demand exists certainly, according to our recent surveys.

ASIC Seeks To Stop Property Promoter’s Unlicensed Financial Advice on SMSFs

ASIC has commenced proceedings in the Supreme Court of New South Wales seeking interim and final orders to prevent property investment promoter, Park Trent Properties Group Pty Ltd (Park Trent), from carrying on an unlicensed financial services business.

Park Trent’s business promotes the use of self-managed superannuation funds (SMSFs) to purchase investment property.

ASIC alleges and is seeking declarations that Park Trent is unlawfully carrying on a financial services business without an Australian financial services (AFS) licence.

ASIC understands that Park Trent has advised at least 500 members of the public to establish and switch funds into an SMSF which are then used to purchase investment properties that are owned or promoted by Park Trent companies.

ASIC is also seeking orders requiring Park Trent to notify current and former clients about the proceeding and to post a notice regarding ASIC’s proceeding on its website.

ASIC Commissioner Greg Tanzer said, ‘Collectively, Australians hold over $1.85 trillion worth of assets in superannuation funds, with $557 billion held in SMSFs. It is important when making decisions regarding superannuation to consider obtaining appropriate advice from an authorised financial adviser.

‘Dealing with an authorised adviser affords specific protections under the law, such as acting in the best interests of clients, a duty to avoid conflicts of interest and providing access to dispute resolution schemes.’

The first hearing of the matter is listed for 26 November 2014.

Over 50% Investment Loans In September

The latest ABS housing finance data to September 2014 has just been released. We broke more records, as more than half the loans written, excluding refinance, were for investment purposes.

First time buyers continue to languish, especially in the hot Sydney market. Further evidence of the market being out of kilter, per the RBA’s recent comments. In seasonally adjusted terms, the total value of dwelling finance commitments excluding alterations and additions rose 2.3%.

In original terms, the number of first home buyer commitments as a percentage of total owner occupied housing finance commitments rose to 12.0% in September 2014 from 11.8% in August 2014. Still near the lowest on record.

NSW first time buyers continues at the lowest levels, though with a slight uplift this month. WA data flatters the Australia-wide averages for first time buyer finance. It is not just a Sydney thing.

In trend terms, the number of commitments for owner occupied housing finance fell 0.2% in September 2014. In trend terms, the number of commitments for the purchase of established dwellings fell 0.3%, while the number of commitments for the purchase of new dwellings rose 1.2% and the number of commitments for the construction of dwellings rose 0.2%.