Getting Deep and Dirty On Mortgage Risk

We have been busy adding in new functionality to our Core Market Model, which is our proprietary tool, drawing data from our surveys and other public and private data sources to model and analyse household finances.

We measure mortgage stress on a cash flow basis – the October data will be out next week – and we also overlay economic data at a post code level to estimate the 30-day risk of default (PD30). But now we have added in 90-day default estimates (PD90) and the potential value which might be written off, measured in basis points against the mortgage portfolio. We also calibrated these measures against lender portfolios.

So today we walk though some of the findings, and once again demonstrate that granular analysis can provide a rich understanding of the real risks in the portfolio. Risks though are not where you may expect them!

First we look risks by by state. This chart plots the PD30 and PD90 and the average loss in basis points. WA leads the way with the highest measurement, then followed by VIC, SA and QLD. The ACT is the least risky area.

So, looking at WA as an example, we estimate the 30-day probability of  default in the next 12 months will be 2.5%, 90-day default will be 0.75% and the risk of loss is around 4 basis points. This is about twice the current national portfolio loss, which is sitting circa 2 basis points.

Turning to our master household segmentation, we find that our Multicultural Establishment segment has the highest basis point risk of loss, at around 3 basis points, followed by Young Affluent, Exclusive Professionals and Young Growing Families. This immediately shows that risk and affluence are not totally connected. In fact our lower income groups, are some of the least risky. The PD30 and PD90 follows this trend too.

The Loan to Value bands show some correlation to risk, although the slope of the curve is not that aggressive, indicating that LVR as a risk proxy is not that strong. This is because in a rising market, LVRs will rise automatically, irrespective of serviceability.

A more sensitive measure of risk is Loan To Income (which APRA mentioned yesterday for the first time!). Here we see a significant rise in risk as LTI rises. Above 6 times income the risk starts to rise, moving from around 3 basis points, to 6 basis points at an LTI of 10, and 12 basis points at an LTI of 15+. So rightly LTI should be regarded as the leading risk indicator, yet many lenders are yet to incorporate this in their models. It is better because in the current flat income environment, income ratios are key.

Age is a risk indicator too, with households below 40 showing a higher risk of loss (3 basis points) compared with those over 50 (2.25). Even those into retirement will still represent some level of risk.

Finally, and here it gets really interesting, we can drill down into post codes. We plotted the top 20 most risky post codes across the country from a basis points loss perspective. What we found is that in the top 20 there is a high representation of more affluent post codes, especially in WA, with Cottlesloe, Nedlands and City Beach all registering. We also find places like Double Bay and Dover Heights in Sydney, Hinchenbrook  in QLD and Caulfield in VIC appearing. These are, on a more traditional risk view, not areas which would be considered higher risk, but when we take the size of the loans and cash flows into account, they currently carry a higher risk profile from an absolute loss perspective.

So, we believe the time has come for more sophisticated, data driven analysis of mortgage risks. And risks are not where you might think they are!

New Sydney Land Costs Top $1,000 per SQM

According to the HIA-CoreLogic Residential Land Report, over the year to June 2017, residential land costs in key markets have soared to a new high with vacant land in Sydney now over $1,000 per square metre.

Price pressures in the market for residential land were most intense in Melbourne where the median price increased by 19.6 per cent over the previous 12 months. The pace of land price growth was also strong in Sydney (+9.8 per cent) and Adelaide (+8.0 per cent) over the same period. Land price gains were more modest in Perth (+5.0 per cent) and Brisbane (+0.1 per cent) over the same period. Hobart was the only capital city to experience a reduction in the median land price over the year to June 2017 (-15.8 per cent).

The report indicates that the median lot price nationally increased to $256,683, an increase of 8.5 per cent on a year earlier and across Australia, land turnover is down about 9 per cent on a year ago.

“Land supply policy has to be central to making real and sustainable progress on housing affordability. This requires improved outcomes with respect to financing of housing infrastructure, monitoring and timely reporting on land release and speeding up zoning and subdivision process,” said HIA’s Shane Garrett.

According to Eliza Owen, CoreLogic’s Commercial Research Analyst, “Record high lot prices over the past five quarters are likely to have contributed to worsening affordability and influenced the unprecedented level of high density residential development that is currently under construction.

“As the Australian economy shifts from residential to non-residential construction, demand for vacant residential land may shift in location and scope. New and prospective infrastructure developments such as the inland freight rail and Badgerys Creek Airport will open up new employment and development opportunities further from the metropolitan regions which may stimulate demand for housing in areas with a more affordable price tag,” concluded Eliza Owen.

PayPal launches solution for marketplaces, platforms and crowdfunding sites

PayPal has announced the rollout of a new product designed for customers operating larger online marketplaces, like ride-sharing platforms, crowdfunding portals, peer-to-peer e-commerce sites, room rentals platforms, and others, starting in the USA.

They say that PayPal for Marketplaces is a comprehensive payments solution for marketplaces, crowdfunding platforms, and other environments where people buy and sell goods and services or raise money. The solution is ideal if you run a multi-party commerce platform and want a flexible, end-to-end solution for processing payments.

PayPal for Marketplaces supports a variety of common business types, including:

The platform can be tailored to the business’s needs, based on how much risk they want to manage with regard to their transactions. So for example, a business can decide if they want to handle payment disputes and chargebacks themselves, or if they want to turn over that responsibility to PayPal to manage instead.

Over the past few years, we’ve seen impressive growth in marketplaces and other platforms with unique payment needs. Marketplaces have become the center of ecommerce activity. Today, more than half of consumers who shop online are making purchases on marketplaces, and global marketplaces are expected to own nearly 40 percent of the global online retail market by 2020.

PayPal has long served marketplaces — from its origins with eBay to Uber and Airbnb — but until now, we’ve supported these customers with a variety of different solutions. Today, we’re excited to share that we’ve launched PayPal for Marketplaces, an end-to-end global payment solution that can help businesses harness the capabilities of the world’s best known marketplaces. We’re beginning to roll this out globally and expect to be available to all markets in the coming months. Marketplaces like Grailed and Rocketr are already using PayPal for Marketplaces today.

PayPal for Marketplaces is a comprehensive and flexible payment solution for businesses accepting and disbursing funds — whether consumers pay using their PayPal wallet, credit cards or debit cards. Marketplace businesses—from ride sharing and room-rental platforms, to online crowdfunding portals and peer-to-peer e-commerce sites—have unique needs, like collecting commissions and fees, setting payouts and multi-party disbursements. And because of PayPal’s global reach, we can support buyers in more than 200 markets and sellers in more than 120 markets. We can also tailor our solution based on the marketplace’s need. For example, for marketplaces that don’t want to take on all of the risk, we offer solutions that allow PayPal to help manage the risk. But we also offer a solution for other marketplaces that want more control and risk ownership.

As always, PayPal offers value-added benefits like buyer and seller protection, risk- and fraud-detection capabilities and seamless checkout solutions that drive conversion for merchants. This includes  One Touch, which enables more than 70 million of consumers around the world to skip logging in to PayPal at eligible merchant sites.

MP grills CBA on brokers, offsets and big mortgages

From The Adviser.

NSW MP Kevin Hogan said that mortgage brokers have told him that it is in their best interest to get clients to borrow as much as they can.

Mr Hogan was on the parliamentary committee that questioned CBA chief executive Ian Narev in Canberra on Friday (20 October), where he was eager to find out from the CEO how brokers were behaving.

“You have one of the most extensive broker networks in the country,” Mr Hogan said, addressing Mr Narev.

“Brokers, as well as customers, tell me it’s obviously in the broker’s interest to get the customer to borrow the maximum amount of money they can get them to borrow — they get remunerated that way — even though they might not need that much money. And then they open an offset account and put the money they don’t need in that account, but they have drawn down the maximum amount of money they can borrow.”

The MP then asked Mr Narev if he has noticed “a big difference” in the number of customers who open an offset account, with money put in it straightaway, between the broker network and their branch network.

The CBA boss took the question on notice, but provided his thoughts on debt levels and the financial wellbeing of customers.

Mr Narev said: “You are raising a different and very valid point, which is: how much should people borrow? In the context of the broader regulation on general advice versus specific advice, we have a lot of discussion about that at the bank, and it is a very live discussion both through our own channels and through proprietary channels.”

Mr Narev noted that, historically, there has generally been a view that “whatever the bank will lend me, I should borrow”.

While he stressed that CBA lends responsibly for what people can service, Mr Narev said that the question of what level of debt somebody is comfortable with is “very personal”.

“The whole industry — and we are certainly doing it, including through behavioural economics in conjunction with academics from Harvard University — is working through how, within the constraints of the law on advice, we can have richer discussions with people to go down exactly the distinction you’ve drawn.”

Mr Hogan restated his belief that brokers get incentive to put customers in larger loans, saying: “It is obviously in the broker’s interest to get that person to borrow as much money as they can possibly get them to do — which might not necessarily be in the best interest of the customer — and you have an extensive network.”

Outgoing ASIC chairman Greg Medcraft also believes that brokers encourage customers to borrow more. In fact, he even admitted that he would do it himself if he was a mortgage broker.

Speaking at a Reuters Newsmaker event on 12 September, Mr Medcraft touched on a recent report from investment bank UBS, which suggested that around $500 billion of mortgages could be based on inaccurate information.

Mr Medcraft said: “The mortgage commission is based on [the fact that] the larger their loans, the more you get. So, logically, what would you do?

“It’s human behaviour. I’d do it.”

New Small Amount Credit Contract and Consumer Lease Reforms

The Treasury has released exposure drafts for further reform for the Pay Day (SACC) and consumer lease sector (FINALLY)!

The exposure draft of the National Consumer Credit Protection Amendment (Small Amount Credit Contract and Consumer Lease Reforms) Bill 2017 (the Bill) introduces a range of amendments to the Credit Act to enhance the consumer protection framework for SACCs and consumer leases. The amendments contained in the Bill are to be complemented by amendments to the Credit Regulations, which will be consulted on separately at a later date.

The new SACC and consumer leasing provisions will promote financial inclusion and reduce the risk that consumers may be unable to meet their basic needs or may default on other necessary commitments. The Bill implements the Government’s response to the Review of the Small Amount Credit Contract Laws (the Review) that was conducted by an independent panel chaired by Ms Danielle Press. The Review was publicly released in March 2016. The Government’s response to the Review was released by the Minister for Revenue and Financial Services, the Hon Kelly O’Dwyer MP, on 28 November 2016.

The Draft Bill implements the Government’s response to the Review. This includes:

  • imposing a cap on the total payments that can be made under a consumer lease;
  • requiring small amount credit contracts (SACCs) to have equal repayments and equal payment intervals;
  • removing the ability for SACC providers to charge monthly fees in respect of the residual term of a loan where a consumer fully repays the loan early;
  • preventing lessors and credit assistance providers from undertaking door-to-door selling of leases at residential homes;
  • introducing broad anti-avoidance protections to prevent SACC loan and consumer lease providers from circumventing the rules and protections contained in the Credit Act and the Code; and
  • strengthening penalties to increase incentives for SACC providers and lessors to comply with the law.

Deadline for submissions is 3rd November 2017.

Preliminary Auction Clearance Rate Remains Below 70%

From CoreLogic.

The combined capital cities returned a preliminary auction clearance rate of 69.4 per cent this week, marking the 21st consecutive week where the clearance rate has held below 70 per cent.  The trend towards softer auction market conditions has been led by the Sydney market where the final auction clearance rate has remained below 65% since the first week of October.

Auction volumes were similar week-on-week, with 2,471 properties taken to auction, compared to 2,525 last week. This time last year, 2,680 homes were taken to auction and a clearance rate of 78.1 per cent was recorded. Tasmania, the smallest auction market, recorded the highest preliminary clearance rate with 80.0 per cent of the 5 reported auctions recording a successful result, followed by Melbourne with a preliminary clearance rate of 73.3 per cent across 1,030 results.

2017-10-23--auctionresultscapitalcities

Banking Regulators Asleep at the Wheel?

Well, finally, we got an admission from APRA that mortgage lending standards have decayed over the last decade, and that they needed to take action to reverse the trend. And now they are looking at debt-to-income.

Poor lending standards, they say are systemic, driven by completion, and poor bank practices. They recently intervened (a little). And late to the piece (now) debt-to-income is important. Did you hear the door slamming after the horse has bolted?

This is after ASIC called out poor lending practices, and the RBA have been raising concerns about the high household debt, and the downstream risks to growth this represents.

A completed change of tune from the declarations of 2015 when everything was said to be just dandy!

Those following this blog over the past few years will know we have been flagging these concerns, especially as the cash rate was brought to its all time low.  We said DTI was critical, that standards should be tightened, and the growth of debt to income was unsustainable.

These three parties, plus the Treasury form the “Council of Financial Regulators” which is chaired by the RBA are all culpable.  This body, which works behind the scenes, is referred to when hard decisions need to be take. If you look back at recent APRA and RBA statements, the Council gets a Guernsey!

The problem is there has been group-think for year, driven by the need to use households as a growth proxy for the failing mining and resource sector. And no clear accountability.

But too little has been done, too late.  And it is poor old households who, one way or the other will pick up the pieces – not the banks who have enjoyed massive profit and balance sheet growth.

Even now, lending for housing is growing three time faster than incomes or cpi.

Regulators are now lining up to call out the problems. Managing the risk going forwards is a real challenge. Time to review the regulatory structure.

Worth remembering that the Financial System Inquiry recommended the creation of a new Financial Regulator Assessment Board to assess the performance of the regulatory framework, but this was rejected by the Government!

 

ANZ and ASIC Agree to Settle the BBSW case

In a short release, ANZ says it has reached a confidential in-principle agreement with the Australian Securities and Investments Commission (ASIC) to settle court action relating to the Australian interbank BBSW market.

As a result, this morning ASIC has asked the Court to stand down the trial for 48 hours, which ANZ will consent to, so as to progress the in-principle agreement following which ANZ will make a more detailed statement.

Based on the in-principle agreement, the financial impact to ANZ will be reflected in the 2017 Financial Year results and is largely covered by the provisioning held as at 31 March 2017.

APRA Admits Mortgage Lending Standards Have Deteriorated

APRA Chairman Wayne Byers gave the keynote address at the COBA 2017 – Customer Owned Banking Convention in Brisbane. It included some remarks on the state of play of housing lending standards making the point that until recently, systematically, lending standards were eroding, but this is now being reversed. He specifically mentioned a desire for borrower debt-to-income levels to be appropriately constrained in anticipation of (eventually) rising interest rates.

We would say better late than never!

Earlier this year, we announced further measures to reinforce prudent standards across the industry. We did this because, in our view, risks and practices were still not satisfactorily aligning. We remain in an environment of high house prices, high and rising household indebtedness, low interest rates, and subdued income growth. That environment has existed for quite a few years now, and one might expect a prudent banker to tighten lending standards in the face of higher risk. But for some years standards had, absent regulatory intervention, been drifting the other way. Indeed, if we look back at standards that the industry thought important a decade ago, we see aspects of prudent practice that we are trying to re-establish today.

The erosion in standards has been driven, first and foremost, by the competitive instincts of the banking system. Many housing lenders have been all too tempted to trade-off a marginal level of prudence in favour of a marginal increase in market share. That temptation has, unfortunately, been widespread and not limited to a few isolated institutions – the competitive market pushes towards the lowest common denominator. The measures that we have put in place in recent years have been designed, unapologetically, to temper competition playing out through weak credit underwriting standards.

Since we have been focussing on lending standards, APRA’s approach has been consistently industry-wide: the measures apply to all ADIs, albeit with additional flexibility for smaller, less systemic players around the timing and manner in which they have been expected to adjust practices. There is no reason, however, why poor quality lending should be acceptable for some ADIs and not others, or in one geography and not others. Prudent standards are important for all.

At a macro level, our efforts appear to be having a positive impact. As I have spoken about previously, serviceability assessments have strengthened, investor loan growth has moderated and high loan-to-valuation lending has reduced. New interest-only lending is also on track to reduce below the benchmark that we set earlier this year. Put simply, the quality of lending has improved and risk standards have strengthened.

We would ideally like to start to step back from the degree of intervention we are exercising today. Quantitative benchmarks, such as that on investor lending growth, have served a useful purpose but were always intended as temporary measures. That remains our intent, but for those of you who chafe at the constraint, their removal will require us to be comfortable that the industry’s serviceability standards have been sufficiently improved and – crucially – will be sustained. We will also want to see that borrower debt-to-income levels are being appropriately constrained in anticipation of (eventually) rising interest rates.

These expectations apply across the industry, to large and small alike. Pleasingly, the industry is moving in the right direction to achieve that. Improved serviceability standards are being developed, and policy overrides are being monitored more thoroughly and consistenly. The adoption of positive credit reporting, which APRA strongly endorses, will remove a blind spot in a lender’s ability to see a borrower’s leverage. Coupled with the higher and more risk-sensitive capital requirements that I mentioned earlier, these developents should – all else being equal – provide an environment in which some of our benchmarks are no longer needed. The review of serviceabilitiy standards across the small ADI sector that we are currently undertaking will help inform our judgement as to how close we are to that point.

His comments on the role of mutual ADI’s are are worth reading…

ABA Declares Progress On Bank Reforms

The Australian Bankers’ Association has welcomed the latest progress report from former auditor-general Mr Ian McPhee AO PSM, which has found that banks are on track regarding the six reform initiatives.

Mr McPhee stated that since the previous report, a number of initiatives are now being implemented, which is good news for customers and the industry.

Banks have already introduced three initiatives – the appointment of customer advocates who help customers resolve issues and proactively improve customer outcomes, the adoption of new whistleblower protections, and the conduct background check protocol when hiring staff.

The remaining three initiatives are showing good progress.

ABA Chief Executive Anna Bligh said it’s encouraging that the industry’s reform program is starting to gain traction and deliver real benefits to customers.

“Banks across the board are serious about change and rebuilding trust and confidence within the community. Introducing these initiatives will better protect customer interests and increase transparency and accountability,” she said.

“The banking industry is currently undergoing the greatest program of reforms seen in decades. It’s vital that the momentum continues, so banks can meet the needs and expectations of the community.

“The ABA appointed the former Public Service Commissioner Stephen Sedgwick AO to review how bank tellers and other customer-facing bank employees, their managers, and third parties are paid by banks. The industry adopted all the recommendations and are now in the implementation phase,” Ms Bligh said.

“The industry understands that through the combination of leadership, performance management, remuneration structures, behavioural standards and culture, a real difference is being achieved.”

Progress since the last quarter McPhee review includes:

* Adoption of best practice whistleblowing policies by 19 banks (last bank to finalise by end of year).

* The Code of Banking Practice is now with key stakeholders for feedback. The new Code is on track to be finalised by December 2017.

* Four banks have published their overarching principles on remuneration and incentives ahead of the December deadline.

“The determined effort that has delivered the reforms to date is set to continue in coming months as banks finalise their implementation of the industry’s Better Banking program,” Ms Bligh said.

A copy of Mr McPhee’s latest report is available at betterbanking.net.au.