Warnings On The Profitability Of Global Banks, Excessive Risk-taking and Leverage

The Committee on the Global Financial System  at The Bank for International Settlements (BIS) has published an important report “Structural changes in banking after the crisis“.

The report highlights a “new normal” world of lower bank profitability, and warns that banks may be tempted to take more risks, and leverage harder in an attempt to bolster profitability. This however, should be resisted. They also underscore the issues of banking concentration and the asset growth, two issues which are highly relevant to Australia.

The report highlights that in some countries the 2007 banking crisis brought about the end of a period of fast and excessive growth in domestic banking sectors.  Worth noting the substantial growth in Australia, relative to some other markets and of particular note has been the dramatic expansion of the Chinese banking system, which grew from about 230% to 310% of GDP over 2010–16 to become the largest in the world, accounting for 27% of aggregate bank assets.

They also call out the concentration banking to a smaller number of larger players since the crisis.  The number of banks has fallen in most countries
over the past decade. Post-crisis reductions in bank numbers have been mainly among smaller institutions, aside from a handful of distressed large banks in the euro area and the retreat of some international banks from specific foreign markets. Concentration has also risen in some countries that were less affected by the crisis and where bank numbers have
continued to expand or remained steady (Australia, Brazil, Singapore).

The decade since the onset of the global financial crisis has brought about significant structural changes in the banking sector. The crisis revealed substantial weaknesses in the banking system and the prudential framework, leading to excessive lending and risk-taking unsupported by adequate capital and liquidity buffers. The effects of the crisis have weighed heavily on economic growth, financial stability and bank performance in many jurisdictions, although the headwinds have begun to subside. Technological change, increased non-bank competition and shifts in globalisation are still broader environmental challenges facing the banking system.

Regulators have responded to the crisis by reforming the global prudential framework and enhancing supervision. The key goals of these reforms have been to increase banks’ resilience through stronger capital and liquidity buffers, and reduce implicit public subsidies and the impact of bank failures on the economy and taxpayers through enhanced recovery and resolution regimes. At the same time, the dynamic adaptation of the system and the emergence of new risks warrant ongoing attention.

In adapting to their new operating landscape, banks have been re-assessing and adjusting their business strategies and models, including their balance sheet structure, cost base, scope of activities and geographic presence. Some changes have been substantial and are ongoing, while a number of advanced economy banking systems are also confronted with low profitability and legacy problems.

This report by the CGFS Working Group examines trends in bank business models, performance and market structure, and assesses their implications for the stability and efficiency of banking markets.

The main findings on the evolution of banking sectors are as follows:

  1. Changes in banking market capacity and structure. The crisis ended a period of strong growth in banking sector assets in many advanced economies. Several capacity metrics point to a shrinking of banking sectors relative to economic activity in several countries directly impacted by the crisis. This adjustment has occurred mainly through a reduction in business volumes rather than the exit of firms from the market. Banking sectors have expanded in countries that were less affected by the crisis, particularly the large emerging market economies (EMEs). Concentration in banking systems has tended to increase, with some exceptions.
  2. Shifts in bank business models. Advanced economy banks have tended to reorient their business away from trading and more complex activities, towards less capital-intensive activities, including commercial banking. This pattern is evident in the changes in banks’ asset portfolios, revenue mix and increased reliance on customer deposit funding. Large European and US banks have also become more selective and focused in their international banking activities, while banks from the large EMEs and countries less affected by the crisis have expanded internationally.
  3. Trends in bank performance. Bank profitability (return on equity) has declined across countries and business model types from the historically high rates seen before the crisis. At least in part, this reflects lower leverage induced by the regulatory reforms. In addition, many advanced economy banks, in particular banks in some European countries, are facing sluggish revenues and an overall cost base that has been resistant to cuts, including, in some cases, legacy costs associated with past investment decisions and misconduct.

The main findings regarding the impact of post-crisis structural change for the stability of the banking sector are related to three areas:

  1. Bank resilience and risk-taking. Banks globally have enhanced their resilience to future risks by substantially building up capital and liquidity buffers. The increased use of stress testing by banks and supervisors since the crisis also provides for greater resilience on a forward-looking basis, which should help support credit flows in good and bad times. In addition, advanced economy banks have shifted to more stable funding sources and invested in safer and less complex assets. Some of these adjustments may be driven partly by cyclical factors, such as accommodative monetary policy, and hence may diminish as conditions change. Qualitative evidence
    indicates that banks have considerably strengthened their risk management and internal control practices. Although these changes are hard to assess, supervisors point to significant scope for further improvements, in particular because of the inherent uncertainties about the future evolution of risks.
  2. Market sentiment and future bank profitability. Despite a recovery in marketbased indicators of investor sentiment towards larger institutions in recent years, equity investors remain sceptical towards some banks with low profitability. Simulation analysis carried out by the Working Group suggests that some institutions need to implement further cost-cutting and structural adjustments.
  3. System-wide effects. Assessing the impact of structural change on system-wide stability is harder than in the case of individual banks because of complex interactions within the system. Nonetheless, a number of changes are consistent with the objectives of public authorities and the reform process. First, banks appear to have become more focused geographically in their international strategy and tend to intermediate more of their international claims locally. Second, direct connections between banks through lending and derivatives exposures have declined. Third, some
    European banking systems with relatively high capacity have made progress with consolidation. Fourth, while the effect of less business model diversity arising from the repositioning of many banks towards commercial banking cannot be assessed yet, this trend has been accompanied by a shift towards more stable funding sources (such as deposits). A range of other reforms has also enhanced systemic stability (eg money market mutual fund reforms) and further progress has been made on resolution and recovery frameworks.

 

Changes in banking sector resilience have to be measured against the impact on the services provided by the sector. The main findings regarding the impact of changes on the efficiency of financial intermediation services are:

  1. Provision of bank lending to the real economy. Trends in bank-intermediated credit have been uneven over time and across countries, reflecting differences in their crisis experience and related overhang of credit. Credit declined significantly relative to economic activity in advanced economies that bore the brunt of the crisis, and in most countries started to recover only from 2015. But the adjustment is still ongoing
    in others, reflecting in part a legacy of problem bank assets that continues to hamper the growth of fresh loans. By comparison, advanced economy banking systems not significantly affected by the crisis continued to report solid loan growth, notwithstanding tighter regulations.Recognising the difficulty of disentangling demand and supply drivers, the
    evidence gathered by the group does not suggest a systematic change in the
    willingness of banks to lend. But, in line with the objectives of regulatory reform, lenders have become more risk-sensitive and more discriminating across borrowers. In contrast to many advanced economies, bank lending has expanded strongly in EMEs, raising sustainability concerns and prompting the use of macroprudential measures and the tightening of certain lending standards more recently.
  2. Capital market activities. Crisis-era losses combined with regulatory changes have motivated a significant reduction in risk and scale in the non-equity trading and market-making businesses of a number of global banks.
  3. International banking was one of the areas most affected by the crisis. Aggregate foreign bank claims have seen a significant decline since the crisis, driven particularly by banks from the advanced economies most affected by the crisis, especially from some European countries. By contrast, banks from other non-crisis countries have expanded their foreign activities, in some cases quite substantially, resulting in a significant change in the country composition of global banking assets.

The report highlights four key messages for markets and policymakers:

  1. Post-crisis, a stronger banking sector has resumed the supply of
    intermediation services to the real economy, albeit with some changes in
    the balance of activities.
    – Bank credit growth remains below its excessive pre-crisis pace in advanced economies but without indications of a systematic reduction in the supply of local credit. Lending to some sectors and borrowers has seen reductions, however, as banks have adjusted their risk profile, and policymakers should remain attentive to potential unintended gaps in the flow of credit.
    – Experience from crisis countries underscores the benefits of acting early in addressing problems associated with non-performing loans (NPLs).
    – The withdrawal of some banks from capital markets-related business has
    coincided with signs of fragile liquidity in some markets, although causality
    remains an open question.
  2. Longer-term profitability challenges require the attention of banks and
    supervisors, as they may signal risk-taking incentives and overcapacity. Low profitability partly reflects cyclical factors but also higher capitalisation and more resilient bank balance sheets. As such, banks and their investors need to adapt to a “new normal”. Market concerns about low profitability may deprive banks of an important source of fresh capital, or encourage risk-taking and leverage by banks, thus placing a premium on robust risk management, regulation and supervision. In some cases, low profitability might also signal the existence of excess capacity and structural impediments to exit for individual banks, requiring decisive policy action to apply relevant rules.
  3. Consolidation and preservation of gains in bank resilience requires ongoing
    surveillance, risk management and a systemic perspective. Key indicators
    show areas of improvement since the crisis, but also areas which are still a work in progress. Authorities and market participants should not become complacent. The system is adapting to a variety of changes, the interaction of which is difficult to predict. Authorities should monitor the ongoing adaptation and evolution in the nature and locus of risk-taking within the banking sector and the financial system more broadly. In this regard, the group sees scope for the international supervisory community to undertake a post-crisis study of bank risk management practices. In addition, ample buffers remain critical to coping with unexpected losses from new risks.
  4. Better use and sharing of data are critical to enhanced surveillance of
    systemic risk. Surveillance is crucial, given that the financial sector evolves
    dynamically and because future risks will likely differ from past ones. Although data availability has improved, there is a need to make better use of existing data to assess banking sector structural adjustment and related risks. This effort will likely require additional conceptual work, building on the data sets of national authorities and the international financial institutions. Areas that warrant further analysis include the potential for increased similarities in the exposure profile of banks to correlated shocks, the growing role and implications of fintech, and the migration of activity and risk to the non-bank sector.

 

Who Are The Winners Under The Revised Trans-Pacific Partnership Trade Deal?

From The Conversation.

The revived trade agreement, now known as the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), has finally made it across the line. It’s a considerable win for Australian farmers and service providers, in a trading area worth about A$90 billion.

The 11 remaining countries from the initial Trans-Pacific Partnership agreement finally agreed to go ahead with the deal without the US, at the annual meeting of the World Economic Forum in Davos, Switzerland.

The deal reduces the scope for controversial investor-state dispute settlements, where foreign investors can bypass national courts and sue governments for compensation for harming their investments. It introduces stronger safeguards to protect the governments’ right to regulate in the public interest and prevent unwarranted claims.

Despite earlier union fears of the impact for Australian workers, the CPTPP does not regulate the movement of workers. It only has minor changes to domestic labour rights and practices.

The new agreement is more of an umbrella framework for separate yet coordinated bilateral deals. In fact, Australia’s Trade Minister Steven Ciobo said:

The agreement will deliver 18 new free trade agreements between the CPTPP parties. For Australia that means new trade agreements with Canada and Mexico and greater market access to Japan, Chile, Singapore, Malaysia, Vietnam and Brunei.

It means a speedier process for reducing import barriers on key Australian products, such as beef, lamb, seafood, cheese, wine and cotton wool.

It also promises less competition for Australian services exports, encouraging other governments to look to use Australian services and reducing the regulations of state-owned enterprises.

Australia now also has new bilateral trade deals with Canada and Mexico as part and parcel of the new agreement. This could be worth a lot to the Australian economy if it were to fill commercial gaps created by potential trade battles within North America and between the US and China.

What’s in and out of the new agreement

The new CPTPP rose from the ashes of the old agreement because of the inclusion of a list of 20 suspended provisions on matters that were of interest for the US. These would be revived in the event of a US comeback.

These suspended provisions involved substantial changes in areas like investment, public procurement, intellectual property rights and transparency. With the freezing of further copyright restrictions and the provisions on investor-state dispute settlements, these suspensions appear to re-balance the agreement in favour of Australian governments and consumers.

In fact, the scope of investor-state dispute settlements are narrower in the CPTPP, because foreign private companies who enter into an investment contract with the Australian government will not be able to use it if there is a dispute about that contract. The broader safeguards in the agreement make sure that the Australian government cannot be sued for measures related to public education, health and other social services.

The one part of the agreement relating to the temporary entry for business people is rather limited in scope and does not have the potential to impact on low-skilled or struggling categories of Australian workers. In fact, it only commits Australia to providing temporary entry (from three months, up to two years) of only five generic categories of CPTPP workers. These include occupations like installers and servicers, intra-corporate transferees, independent executives, and contractual service suppliers.

The above categories squarely match the shortages in the Australian labour market, according to the Lists of Eligible Skilled Occupation of the Home Affairs Department.

Bits of the original agreement are still included in the CPTPP such as tariffs schedules that slash custom duties on 95% of trade in goods. But this was the easy part of the deal.

Before the deal is signed

The new agreement will be formally signed in Chile on March 8 2018, and will enter into force as soon as at least six members ratify it. This will probably happen later in the year or in early 2019.

The geopolitical symbolism of this timing is poignant. The CPTPP is coming out just as Donald Trump raises the temperature in the China trade battle by introducing new tariffs. It also runs alongside China’s attempts to finalise a much bigger regional trade agreement, the 16-nation Regional Comprehensive Economic Partnership.

Even though substantially the CPTPP is only a TPP-lite at best, it still puts considerable pressure on the US to come out of Trump’s protectionist corner.

It spells out the geopolitical consequences of the US trade policy switch, namely that the Asia Pacific countries are willing to either form a more independent bloc or align more closely with Chinese interests.

Will this be enough to convince the Trump administration to reverse its course on global trade? At present, this seems highly unlikely. To bet on the second marriage of the US with transpacific multilateral trade would be a triumph of hope over experience.

Author: Giovanni Di Lieto, Lecturer, Bachelor of International Business, Monash Business School, Monash University

Financial Advice Conflicts Still Exists In Vertically Integrated Firms

An Australian Securities and Investments Commission (ASIC) review of financial advice provided by the five biggest vertically integrated financial institutions has identified areas where improvements are needed to the management of conflicts of interest. 68% of clients’ funds were invested in in-house products.

This highlights the problems in vertically integrated firms, something which the Productivity Commission is also looking at.

The review looked at the products that ANZ, CBA, NAB, Westpac and AMP financial advice licensees were recommending and at the quality of the advice provided on in-house products.

The review was part of a broader set of regulatory reviews of the wealth management and financial advice businesses of the largest banking and financial services institutions as part of ASIC’s Wealth Management Project.

The review found that, overall, 79% of the financial products on the firms’ approved products lists (APL) were external products and 21% were internal or ‘in-house’ products. However, 68% of clients’ funds were invested in in-house products.

The split between internal and external product sales varied across different licensees and across different types of financial products. For example, it was more pronounced for platforms compared to direct investments. However, in most cases there was a clear weighting in the products recommended by advisers towards in-house products.

ASIC noted that vertical integration can provide economies of scale and other benefits to both the customer and the financial institution. Consumers might choose advice from large vertically integrated firms because they seek that firm’s products due to factors such as convenience and access, and recommendations of ‘in-house’ products may be appropriate. Nonetheless, conflicts of interest are inherent in vertically integrated firms, and these firms still need to properly manage conflicts of interest in their advisory arms and ensure good quality advice.

ASIC will consult with the financial advice industry (and other relevant groups) on a proposal to introduce more transparent public reporting on approved product lists, including where client funds are invested, for advice licensees that are part of a vertically integrated business. ASIC noted that any such requirement is likely to cover vertically integrated firms beyond those included in this review. The introduction of reporting requirements would improve transparency around management of the conflicts of interests that are inherent in these businesses.

ASIC also examined a sample of files to test whether advice to switch to in-house products satisfied the ‘best interests’ requirements. ASIC found that in 75% of the advice files reviewed the advisers did not demonstrate compliance with the duty to act in the best interests of their clients. Further, 10% of the advice reviewed was likely to leave the customer in a significantly worse financial position. ASIC will ensure that appropriate customer remediation takes place.

Acting ASIC Chair Peter Kell said that ASIC is already working with the major financial institutions to address the issues that have been identified in the report on quality of advice and management of conflicts of interest.

‘There is ongoing work focusing on remediation where advice-related failures have led to poor customer outcomes, and the results of this review will feed into that work,’ said Mr Kell.

ASIC is already working with the institutions to improve compliance and advice quality through action such as:

  • improvements to monitoring and supervision processes for financial advisers; and
  • improvements to adviser recruitment processes and checks.

ASIC will continue to ban advisers with serious compliance failings.

ASIC highlighted that the findings from this review should be carefully examined by other vertically integrated firms. ‘While this review focused on five major financial services firms, the lessons should be considered by all vertically integrated firms in the financial services sector.’

Download the report

What Australia can learn from overseas about the future of rental housing

From The Conversation.

When we talk about rental housing in Australia, we often make comparisons with renting overseas. Faced with insecure tenancies and unaffordable home ownership, we sometimes try to envisage European-style tenancies being imported here.

And, over the past year, there has been a surge of enthusiasm for developing a sector of large-scale institutional landlords, modelled on the UK’s build-to-rent sector or “multi-family” housing in the US.

Our review of the private rental sectors of ten countries in Australasia, Europe and North America identified innovations in rental housing policies and markets Australia might try to emulate – and avoid. International comparisons also give a different perspective on aspects of Australia’s own rental housing institutions that might otherwise be taken for granted.

Not everyone in Europe rents

In nine of the ten countries we reviewed, private rental is the second-largest tenure after owner-occupation. Only in Germany do more households rent privately than own their housing. Most of the European countries we reviewed have higher rates of home ownership than Australia.

In most of the European and North American countries in our study, single people and lower-income households and apartments are heavily represented in the private rental sector. Higher-income households, families with kids, and detached houses are represented much more in owner-occupation. It’s less uneven in Australia: more houses, kids and higher-income households are in private rental.

Two key potential implications follow from this.

First, it suggests a high degree of integration between the Australian private rental and owner-occupier sectors, and that policy settings and market conditions applying to one will be transmitted readily to the other.

So, policies that give preferential treatment to owner-occupied housing will also induce purchase of housing for rental, and rental housing investor activity will directly affect prices and accessibility in the owner-occupied sector.

It also heightens the prospect of investment in both sectors falling simultaneously, with little established institutional capacity for countercyclical investment that makes necessary increases in ongoing supply.

A second implication relates to equality. Australian households of similar composition and similar incomes differ in their housing tenure – and, considering the traditional value placed on owner-occupation, this may not be by choice.

This suggests housing tenure may figure strongly in the subjective experience of inequality. It raises the question of whether housing is a primary driver of inequality, and not the outcome of difference or inequality in other aspects of life.

The rise of large corporate landlords

In almost all of the countries we reviewed, the ownership of private rental housing is dominated by individuals with relatively small holdings. Only in Sweden are housing companies the dominant type of landlord.

However, most countries also have a sector of large corporate landlords. In some countries, these landlords are very large. For example, America’s five largest corporate landlords own about 420,000 properties in total. Germany’s largest landlord, Vonovia, has more than 330,000 properties alone.

These landlords’ origins vary. Germany’s arose from massive sell-offs of municipal housing and industry-related housing in the early 2000s.

In the US, multi-family (apartment) landlords have been around for decades. And in the aftermath of the global financial crisis, they have been joined by a new sector of single-family (detached house) landlords that have rapidly acquired large portfolios from bulk purchases of foreclosed, formerly owner-occupied homes.

In these countries and elsewhere, the rise of largest corporate landlords has been controversial. Germany’s have a poor record of relations with tenants – to the extent of being the subject of popular protests in the 2000s – and their practice of characterising repairs as improvements to justify rent increases.

American housing advocates have voiced concern about “the rise of the corporate landlord” – especially in the single-family sector, where there’s some evidence that they more readily terminate tenancies.

These landlords also don’t build much housing. They are most active in renovating (for higher rents), merging with one another, and – especially in the US – developing innovative financial instruments such as “rental-backed securities”.

“Institutional landlords” are now a standing item on the Australian housing policy agenda. Considering the activities of large corporate landlords internationally, we should get specific about the sort of institutional landlords we really want, how we will get them, and how we will ensure they deliver desired housing outcomes.

Policymakers and housing advocates have, for years, looked to the community housing sector as the prime candidate for this role. They envisage its transformation into an affordable housing industry that works across the sector toward a wide range of policy outcomes in housing supply, affordability, security, social housing renewal and community development.

With interest in the prospect of build-to-rent and multifamily housing rising in the property development and finance sectors, there is a risk that affordable housing policy may be colonised by for-profit interests.

The development of a for-profit large corporate landlord sector may be desirable for greater professionalisation and efficiencies in the management of tenancies and properties. However, this should not come at the expense of a mission-oriented affordable housing industry that makes a distinctive contribution to housing outcomes.

Bringing it home

Looking at the policy settings in the ten countries, we found some surprising results and strange bedfellows.

For example, Germany – which has had a remarkably long period of stable house prices – has negative gearing provisions and tax exemptions for capital gains, much like Australia. But, in Australia, these policies are blamed for driving speculation and booming prices.

And while the UK taxes landlords more heavily than most other countries, it has the fastest-growing private rental sector of the countries we reviewed.

However, these challenging findings should not be taken to diminish the explanatory power or effectiveness of these settings in each country’s housing policy. Rather, they show the necessity of considering taxation and other policy settings in interaction with each other and in wider systemic contexts.

So, for example, Germany’s conservative housing finance practices, and regulation of rents, may mean the speculative potential of negative gearing and tax-free capital gains isn’t activated there.

Strategy in Australia for its private rental sector should join consideration of finance, taxation, supply and demand-side subsidies and regulation with the objective of making private rental housing outcomes competitive with other sectors.

Author: Chris Martin, Research Fellow, City Housing, UNSW

Irresponsible Mortgage Lending A Significant Risk For Seniors

From NestEgg.com.au

Surging property prices in Australia’s capital cities can be attributed to irresponsible lending, but it’s not just young buyers suffering the consequences, a consumer organisation has said.

In its submission to the royal commission into Misconduct in the Banking, Superannuation and Finance sector, the not-for-profit consumer organisation, the Consumer Action Law Centre (CALC) said the number of Aussie households facing mortgage stress has “soared” nearly 20 per cent in the last six months, and argued that lenders are to blame.

Referencing Digital Finance Analytics’ prediction that homes facing mortgage stress will top 1 million by 2019, CALC said older Australians are at particular risk.

The organisation explained: “Irresponsible mortgage lending can have severe consequences, including the loss of the security of a home.

“Consumer Action’s experience is that older people are at significant risk, particularly where they agree to mortgage or refinance their home for the benefit of third parties. This can be family members or someone who holds their trust.”

Continuing, CALC said a “common situation” features adult children persuading an older relative to enter into a loan contract as the borrower, assuring them that they will execute all the repayments.

“[However] the lack of appropriate inquiries into the suitability of a loan only comes to light when the adult child defaults on loan repayments and the bank commences proceedings for possession of the loan in order to discharge the debt,” CALC said.

The centre referred to a Financial Ombudsman Service (FOS) case study in which retiree and pensioner, Anne, entered into a loan contract with her son Brian. The repayments were to be made out of Brian’s salary and Anne’s pension. The loan was requested in order to extend her home so that Brian could live with her.

Following loan approval, the lender provided more advances under the loan contract. The advances were used to pay off Brian’s credit debt and buy a car.

When Brian left his job to travel, Anne could no longer afford the repayments and the lender said it would repossess her home.

“Anne lodged a dispute with FOS. After considering the dispute, FOS concluded that Anne was appropriately a co-debtor in the original loan contract, as she had received a direct benefit from the loan (the extension to her home and therefore an increase in its value),” CALC said.

“However, FOS considered that she was not liable for the further advances as she did not directly benefit from the application of the funds. Even though the repayment of Brian’s credit card debts may have provided more towards the household income, FOS concluded that this was not a direct benefit to Anne.

“Neither was the purchase of a car for Brian, as there was no information to show that Anne used the car or relied on Brian to transport her.”

CALC also expressed concern that the Household Expenditure Measure (HEM) is not a robust enough living expense test.

Noting that the Australian Prudential Regulation Authority shares their concern, the centre said the reliance on the HEM test raises concerns about the robustness of the actual measure.

“APRA states that it has concerns about whether these benchmarks provide realistic assessments of a borrower’s living expenses.

“In the same vein, ASIC has issued proceedings against Westpac in the Federal Court for failing to properly assess whether borrowers could meet repayment obligations, due to the use of benchmarks rather than the actual expenses declared by borrowers.”

CALC warned that over-indebtedness has ramifications for the economy but also for individuals and families.

Highlighting the link between high levels of debt and lower standards of living, CALC said it can have significant long-term effects as well, with the capacity to damage housing, health, education and retirement prospects

The Housing Affordability Crisis In Australia

Our latest Video Blog discusses the Demographia Housing Affordability Report with specific reference to Australia.

The latest 14th edition of the Annual Demographia International Housing Affordability Survey: 2018, using 3Q 2017 data continues to demonstrate the fact that we have major issues here. There are no affordable or moderately affordable markets in Australia. NONE!

Rising Interest Payments Are Real

From NorthmanTrader.

Is anyone paying attention? I don’t know, but the cost of carrying debt has been rising and it’s already showing measurable impacts despite the Fed Funds rate still being very low.

My concern of course is that the global debt construct will bring global growth to a screeching halt (see also The Debt Beneath).

As the 10 year is already piercing above the 2.6% area now I want to pay attention to the data coming in as the Fed is dot plotting more rate hikes to come:

After all the Fed has hiked 5 times off the bottom floor in the past 2 years:

Can we see any measurable impact? You bet we can. Here are personal interest payments for consumers:

Mind you we are still near the lows of the previous cycle and already total interest payments are near record highs.

The driver of course is record consumer debt and credit card debt (see also macro charts). But despite rates still being historically low this rise in interest rates has an impact on the consumer.

Already we see this:

“The big four US retail banks sustained a near 20 per cent jump in losses from credit cards in 2017, raising doubts about the ability of consumers to fuel economic expansion. “People are using their cards to get from pay cheque to pay cheque,” said Charles Peabody, managing director at the Washington-based investment group Compass Point. “There’s an underlying deterioration in the ability of the consumer to keep up with their debt service burden.” Recently disclosed results showed Citigroup, JPMorgan Chase, Bank of America and Wells Fargo took a combined $12.5bn hit from soured card loans last year, about $2bn more than a year ago.”

I repeat: “There’s an underlying deterioration in the ability of the consumer to keep up with their debt service burden.”

That’s a problem given the Fed’s dot plot. Before you know it consumers will be handing over a good portion of their tax cuts to credit card companies. Winning.

Is the government carrying record debt immune to this? Nope. Here’s the latest monthly Treasury statement:

Interest on debt alone was $32B for 1 month. During the same month the year prior it was $25B:

That’s a 28% increase year over year. Perhaps the data is lumpy month to month, we’ll see confirmation in the next few months. But much of this US government debt has to be refinanced in the next few years, meaning it will be subject to much higher rates and the US needs to continue to add to its debt to keep itself financed..

Indeed the recent tax cuts only exacerbate an already existing debt sale schedule:

“Economists with Deutsche Bank expect the extra debt the Treasury must issue to fund President Donald Trump’s tax package and the amount of debt the Federal Reserve plans to redeem at maturity this year will bloat issuance to about $1tn in 2018. That’s up more than 50 per cent from a year earlier and, when coupled with a 30 per cent rise in the amount of corporate debt that’s due to mature, leaves questions of who the eventual buyer will be.“

A good question indeed. That’s a lot of debt issuance:

Somebody has to buy it or the pain is real:

“If demand for US fixed income doesn’t double over the coming years then US long rates will move higher, credit spreads will widen, the dollar will fall, and stocks will probably go down as foreigners move out of depreciating US assets,” Torsten Sløk, an economist with the bank, said.”

No, we can all pretend rising rates don’t have an impact, we can also pretend deficits don’t matter, and we can also pretend money grows on trees.

But we can’t pretend interest payments aren’t rising. Because they are. Right now.

ASIC Updates Commonwealth Bank Financial Planning Licence Conditions

ASIC says under additional licence conditions imposed on Commonwealth Financial Planning Ltd and Financial Wisdom Ltd by the Australian Securities and Investments Commission, CBA will review all advice given to customers of five former representatives. CBA will pay compensation where customers have suffered loss.

As at 10 January 2018, CBA has reported to ASIC that approximately $1.9 million of compensation is due to customers of the five advisers. Compensation is likely to increase as CBA reviews further customer files. CBA recently wrote to over 3,500 customers of the five advisers informing them their advice was being reviewed. Following completed reviews CBA has issued assessment outcome letters to over 1,000 customers. CBA will continue to issue assessment outcome letters and compensation offers to affected customers between now and 31 March 2018.

ASIC appointed KordaMentha Forensic (KordaMentha) to complete a compliance review under the additional licence conditions. KordaMentha determined that CBA should review advice given by 16 potentially high-risk advisers, and has now reviewed and is satisfied with the processes that CBA used to:

  • select samples of advice given by the 16 advisers for review
  • review the appropriateness of advice given by the 16 advisers
  • calculate whether any inappropriate advice given by the 16 advisers resulted in customers losing money of suffering loss, and
  • conclude that all of the customers of five of the advisers should be reviewed in the compensation program and that no further review is required for 11 advisers.

The current round of compensation is in addition to $4.97 million including interest already offered to customers of different advisers under the additional licence conditions compensation scheme, as reported on in KordaMentha’s December 2016 compliance report.

For more information see the KordaMentha Compliance Report Part 3.

Background

In August 2014, ASIC imposed additional conditions on the Australian Financial Services licences of Commonwealth Financial Planning Ltd and Financial Wisdom Ltd, with the licensees’ consent. Under the additional licence conditions, ASIC appointed KordaMentha Forensic to assess the adequacy of CBA’s 2012 review of potentially high-risk advisers.

KordaMentha’s Identification Report (December 2015, available from the ASIC website) reported that the two licensees had taken reasonable steps to identify potentially high-risk advisers in 2012, but after identifying them, did not adequately review 17 of them to determine whether their clients should be included in a review and compensation program.

KordaMentha later determined that one of the 17 advisers did not need to be reviewed because the adviser had not, as CBA had previously informed KordaMentha, advise a high number of clients to invest 25% or more of their portfolios in property investments.

To address CBA’s failure to adequately review the remaining 16 advisers, KordaMentha’s Identification Report and subsequent work set out the ‘Additional Processes’ that the Licensees were required to take for the advisers:

  1. A review of a sample of six client files for each of the advisers to determine any instances of inappropriate advice that led to loss. For advisers where CBA identified no inappropriate advice with loss, KordaMentha did not require any further review. For advisers where CBA identified inappropriate advice with loss, step (ii) was required.
  2. A review of a further 25 files of the adviser. If no further instances of inappropriate advice with loss were identified, KordaMentha did not require the Licensees to take any further action or review for that adviser. If, after step (i) and (ii) (31 files reviewed), CBA identified that an adviser had provided between two and five instances of instances of inappropriate advice that led to loss, KordaMentha’s default position was that step (iii) was required – that CBA should review a further 25 files of that adviser. If six or more instances on inappropriate advice with loss were identified, CBA was required to implement the full compensation program for all of the adviser’s clients.
  3. A review of a further 25 files.
  4. If, after step (i) or (ii) or (iii) (between six and 56 files reviewed per adviser), CBA identified a total of six or more instances of inappropriate advice with loss, CBA was required to implement the full compensation program for the all of the adviser’s clients.

As a result of these steps:

  • KordaMentha does not require CBA to conduct any further review of 11 of the 16 advisers. KordaMentha concluded that those 11 advisers have been adequately reviewed by CBA and should have no further review under the additional licence conditions.
  • KordaMentha requires CBA to apply the full review and compensation program to all customers of the remaining five advisers, which includes reviewing their advice, issuing review outcome letters including compensation offers if applicable, and offering customers up to $5000 for an independent assessment of their advice.
  • Any customers who CBA identifiedin steps (i), (ii) or (iii) as having lost money through inappropriate advice, from any of the 16 advisers, will be compensated.

Previous KordaMentha reports on the additional licence conditions

The report released today is KordaMentha’s fourth report under the additional licence conditions. Previous reports are published on ASIC’s website at the following links:

  • Comparison Report (April 2015): REP 431
  • Identification Report (December 2015): REP 462
  • Compliance Report Part 1 & 2 (December 2016): REP 504

Next steps

ASIC will continue to report publicly on compensation under the additional licence conditions. ASIC will publish Compliance Report Part 4 when KordaMentha completes its assessment of CBA’s compliance with the additional licence conditions.

Global House Prices Will Rise, but Ideal Conditions to End – Fitch

Globally, national house prices are forecast to rise this year in 19 of 22 markets highlighted by Fitch Ratings in a new report, but growth is expected to slow in most markets and risks are growing as the prospect of gradually rising mortgage rates comes into view this year. Their data on Australia makes interesting reading.

Home Prices: Growth Decelerates

Combined capital city home prices showed yoy growth of 6.6% in the year to November 2017, down from 10.9% over the year to December 2016. The increase was driven by Hobart (+12.7%), Melbourne (+11.0%) and Sydney (+7.7%). Melbourne and Sydney experienced slower growth while Hobart experienced faster growth than a year earlier. Continued record low interest rates have supported price growth while gross rental yields slipped to a record low of 3.6% as of October 2017. Tighter lending standards and foreign ownership restrictions have dampened price growth however.

Fitch expects Sydney and Melbourne HPI to stabilise in 2018, due to low interest rates, falling rental yields, increasing supply, limited investment alternatives and growing dwelling completions, partially offset by high population growth.

Affordability: First-Home Buyers Back in the Market FTBs increased to 17.4% of owner-occupied lending in September 2017 from 13.1% in September 2016, after FTB grants were introduced in New South Wales and Victoria in July 2017. The state governments of Australia’s two most populous states have introduced new FTB support, such as abolished stamp duty for properties up to AUD650,000, reduced stamp duty for properties up to AUD800,000, and grants of up to AUD20,000 for the building of new homes.

Although FTB activity has increased since the announcement of the FTB changes, affordability is still a key issue for FTB. This is particularly true in major cities, as wage growth falls behind HPI.

Fitch expects the increase in FTB to be temporary; low income growth, tighter underwriting and rising living costs will maintain pressure on affordability for FTB. As mortgage rates are currently low, any material rate rise will weigh further on mortgage affordability and serviceability.

Mortgage Performance: Low Arrears to Continue

Mortgage arrears remained broadly stable in 1H17. This is despite lenders increasing mortgage rates, particularly for investment and interest-only loans, while the RBA has made no change to the cash rate. As at 3Q17, 30+ days arrears for prime RMBS were 1.02% according to our Dinkum RMBS index, compared with 1.09% at end-2016. The level of under-employment in Australia stabilised at 9.1% of employed persons in 3Q17 (9.2% in 3Q16), and this may be affecting the disposable income and servicing capacity for some borrowers.

Fitch expects mortgage performance to remain stable in 2018, as interest rates stay low. Fitch believes the adoption of APRA-prescribed serviceability practices by lenders in 2016 has improved borrower ability to service mortgage loans originated since then. However, the rising cost of living and sluggish wage growth are likely to increase pressure on recent borrowers who have little disposable income.

Mortgage Lending: Slower Growth. New mortgage lending growth has slowed in 2017 compared to end-2016, against a background of modest economic growth and reduced investment lending. Home sale transactions decreased in the year to October 2017 by 4.7% nationally (as per CoreLogic); combined capital city sales were 6.0% lower and combined regional market sales were down 2.2%. Lower investor demand, increasing transaction costs, higher capital requirements for banks, further prudential measures restricting lending to investors and stricter serviceability parameters, have restricted access to mortgages for some borrowers.

Fitch expects mortgage lending growth to slow to around 4% in 2018, based on continued record low interest rates and stable unemployment. This will once again be offset by continued underemployment, reduced investor demand and tougher lending practices.

Regulatory Environment: New Measures Introduced

In March 2017, the Australian Prudential Regulation Authority (APRA) announced additional supervisory measures to moderate investment lending in Australia. The APRA expects authorised deposit-taking institutions (ADI) to limit new interest-only lending to 30% of originations; limit growth in investment lending to 10% per year; ensure that serviceability metrics are set at “appropriate levels for current conditions”; and to continue to restrain lending growth in high-risk segments such as high loan-to-income loans, high LVR loans, and long tenure loans. The recently introduced measures relating to interest only lending have already been adopted by lenders and, along with the other restrictions brought in over the past two years, are reflected in the increased pricing of interest only and investment loans.

In July 2017, ownership restrictions were applied in New South Wales and Victoria; a 50% cap on foreign, non-resident ownership in new developments; a levy on foreign, non-resident investors whose properties are vacant for at least six months in a calendar year; increasing the capital gains tax (CGT) withholding rate to 12.5% from 10.0% and increasing the threshold for CGT to AUD2 million from AUD750,000. On 17 July 2017, the Treasury released draft legislation proposing that APRA extend its remit to regulate lending activities of non-ADIs.

Fitch expects the additional regulatory supervision measures to reduce the supply of lending to investors and moderate the house price growth in Sydney and Melbourne in 2018.

 

They say tighter mortgage regulation, record low rental yields, and increasing supply will slow Australian price growth. FTBs in Sydney and Melbourne received government support in 2017, but the impact is expected to be temporary, considering affordability pressure. Australia and New Zealand will post small rises in arrears as home prices in big cities stabilise.

Australia and the US have had nominal home price growth rates since 2010 of 41% and 32%, respectively, that have been substantially higher than rental growth rates. This has occurred despite a high rental growth of 19% in both countries over this period. Australia’s rental growth rate has flattened since 2016, while the rental growth for the US has been accelerating since then.

Australian housing completions have again been the highest of the countries covered. This has put downward pressure on prices in several cities and regions outside of Sydney and Melbourne, although immigration has kept the ratio per 1000 citizens more stable. In Sydney and Melbourne, much of the excess supply had been taken by non-residents, which will be dampened by limitations put in place in 2017.

Australia’s household debt as a proportion of GDP is now the highest across all tracked countries. It overtook the Danish household debt ratio, which has been deleveraging gradually since the peak of the housing market in 2009, helped last year by stable debt and an increase in GDP. Fitch’s mortgage market and macro outlooks are stable for Australia in 2018, but the high ratio increases reliance on a strong economy.

Here is their global summary.

“Arrears are at very low levels in most markets. They will only move in one direction as mortgage rates rise slowly due to higher policy rates and more expensive bank funding from the gradual unwinding of quantitative easing. Floating-rate loans and borrowers refinancing to new rates will be first affected,” said Suzanne Albers, Senior Director, Structured Finance, Fitch Ratings.

Long-term fixed-rate loans are less exposed to increasing rates, but fewer re-financings mean lower lending volumes, so lenders may face pressure to relax their origination standards, subject to regulatory limits.

Norway, Greece and the UK are the only countries not expected to see price rises this year, but Fitch notes that national trends can mask large performance variations within countries with some regions continuing to see unsustainable price rises while others stagnate or even fall.

“We expect home prices to stabilise in Sydney and Melbourne and show modest declines in Oslo, Toronto and London. However, if corrections are only limited after several years of very high growth, the risk of large price declines in future downturns remains,” added Ms. Albers.

Despite these challenges, six of the 22 housing markets covered by the report have seen upward revisions to their outlooks over the past 12 months compared with three being revised down, leaving just three, the UK, Canada and Norway, in Stable/Negative territory.

Fitch has a positive or stable/positive market outlook for seven of the nine eurozone countries in this report due to expectations for strong economic growth and continued quantitative easing (QE) in 2018. As the unwinding of QE and normalisation of interest rates is only expected in the medium-term, so the highlighted challenges are likely to materialise later than in other regions.

Fitch believes that in 2018 a combination of factors will be needed to constrain house price rises that have gone beyond market fundamentals and are primarily due to buyers’ expectations for further growth. Overheated markets slowed in 2017 when a combination of factors pressured prices, including lending limitations along with more local factors such as heightened supply and falling immigration in Oslo, multi-layered regulatory controls on home purchases and mortgage lending in China and for London, Brexit uncertainty plus the impact of buy-to-let (BTL) changes including lower tax deductibility of rental income.

Non-bank lenders (NBL) in the US, which tend to have more flexible credit standards, are six of the top 10 lenders by volume. In the UK, NBL have focussed on BTL lending where they have not yet been bound by stricter Prudential Regulation Authority guidelines that apply to deposit-taking institutions. NBL (especially government agencies) could also increase competition in Mexico as they move from index-linked lending to peso loans, the traditional market for banks.