Home Lending Powers On (If You Believe The Figures)

The latest credit aggregates from the RBA to June 2017 shows continued home lending growth, up 0.5% in the month, or 6.6% annually. Business lending rose 0.9%, or 4.4% annually, and personal credit fell 0.1% or down 4.4% over the past year. However, they changed the seasonally adjusted assumptions, so it is hard to read the true picture, especially when we still have significant reclassification going on.  In original terms housing loans grew to $1.69 trillion, another record.

Investor home lending grew 0.5% or $3.13 billion, but this was adjusted down in the seasonal adjusted series to 0.2% or $1.13 billion. Owner occupied lending rose 0.9% or $9.83 billion in original terms, or 0.7% or $7.34 billion in adjusted terms. Business lending rose 1.2% of $11 billion in original terms or 0.9% of $7.61 billion in original terms. The chart below compares the relative movements.

The RBA says:

Historical levels and growth rates for the financial aggregates have been revised owing to the resubmission of data by some financial intermediaries, the re-estimation of seasonal factors and the incorporation of securitisation data.

… so here is another source of discontinuity in the numbers presented! The movements between original and seasonal adjusted series are significant larger now, and this is a concern. We think the RBA should justify its change of method. Once again, evidence of rubbery numbers!

The annualised growth rates highlight that investor lending is still strong relative to owner occupied loans, business lending recovered whilst personal finance continued its decline.

The more volatile monthly series show investor loans a little lower, while owner occupied loans rise further, and there is a large inflection in business lending.

We need to note that now $55 billion of loans have been reclassified between owner occupied and lending over the past year – with $1.3 billion switched in June. This is a worrying continued trend and raises more questions about the quality of the data presented by the RBA.

Following the introduction of an interest rate differential between housing loans to investors and owner-occupiers in mid-2015, a number of borrowers have changed the purpose of their existing loan; the net value of switching of loan purpose from investor to owner-occupier is estimated to have been $55 billion over the period of July 2015 to June 2017, of which $1.3 billion occurred in June 2017. These changes are reflected in the level of owner-occupier and investor credit outstanding. However, growth rates for these series have been adjusted to remove the effect of loan purpose changes.

Finally they tell us:

All growth rates for the financial aggregates are seasonally adjusted, and adjusted for the effects of breaks in the series as recorded in the notes to the tables listed below. Data for the levels of financial aggregates are not adjusted for series breaks. The RBA credit aggregates measure credit provided by financial institutions operating domestically. They do not capture cross-border or non-intermediated lending.

So, given the noise in the data, it is possible to argue that either home lending is slowing, or it is not – all very convenient. The APRA data we discussed earlier is clearly showing momentum. Growth is still too strong.

It also makes it hard to read the true non-bank growth rates, but we think they are increasing their relative share as some banks dial back their new business.  Taking the non seasonally adjusted data from both APRA and RBA we think the non-bank sector has grown by about $5 billion in the past year to $115 billion. APRA will need to have a look at this, under their new additional responsibility, as we suspect some of the more risky lending is migrating to this less well regulated sector of the market.

New Home Sales Crash

New home sales in Australia’s largest states hit their lowest level since October 2013 with sales sliding in both the detached house and multi-unit sides of the market according to the latest HIA New Home Sales Report.

HIA says during June, new home sales declined by 6.9 per cent compared with the previous month and were 11.9 per cent lower than the same period last year.

The reduction in new home sales during June 2017 was comprised of a 5.8 per cent reduction in new detached house sales and a 10.7 per cent fall in new multi-unit sales.

There were considerable differences in sales in June around the states with new detached house sales rising both in Victoria (+4.1 per cent) and Western Australia (+21.1 per cent). However, sales fell in New South Wales (-9.7 per cent), Queensland (-29.3 per cent) and South Australia (-23.7 per cent) during the month.

“These results support HIA’s latest set of forecasts that new dwelling commencements are set to continue easing until late 2018″. explained HIA Senior Economist Shane Garrett.

“The reduction in sales of both detached houses and multi-units during the month of June continues the trend underway since sales peaked in early 2015.

“The fall in sales needs to be considered against the backdrop of residential building coming off a record peak of activity in 2016. We project that residential building will still be operating at a historically high level,” concluded Shane Garrett.

 

 

Home Loans Still Rising Too Fast

The latest monthly banking statistics for July 2017 from APRA are out. It reconfirms that growth in the mortgage books of the banks is still growing too fast. The value of their mortgage books rose 0.63% in the month to $1.57 trillion. Within that, owner occupied loans rose 0.73% to $1,017 billion whilst investor loans rose 0.44% to $522 billion.

Investor loans were 35.18% of the portfolio.

The monthly growth rates continues to accelerate, with both owner occupied and investor loans growing (despite the weak regulatory intervention).  On an annual basis owner occupied loans are 6.9% higher than a year ago, and investor loans 4.8% higher. Both well above inflation and income growth, so household debt looks to rise further. The remarkable relative inaction by the regulators remains a mystery to me given these numbers. Whilst they jawbone about the risks of high household debt, they are not acting to control this growth.

Looking at individual lenders, there was no change in the overall ranking by share.

But interestingly, we see significant variations in strategy working through to changes in the majors month on month portfolio movements.

ANZ has focussed on growing its owner occupied book, WBC is still in growth mode on both fronts, whilst CBA dropped their investor portfolio. We also saw a number of smaller lenders expand their books.

Looking at the speed limit on investor loans – 10% is too high -we see the investor market at 5% (sum of monthly movements), with all the majors well below the limit. But some smaller players are still growing faster.

We have to conclude one of two things. Either the regulators are not serious about slowing household debt growth, and the recent language is simply lip service (after all the strategy has been to use households as the growth engine as the mining sector faded), or they are hoping their interventions so far will work though, given time. Well given the recent auction results (still strong) and the loan growth (still strong) we do not believe enough is being done. Time is not their friend.

Indeed, later this week we will release our mortgage stress update. We suspect households will continue to have debt issues, and this will be exacerbated by interest rate rises in a flat income, high cost growth scenario many households are facing. The bigger the debt burden, the longer it will be to work through the system, with major economic ramifications meantime.

The RBA data will be out later, and we will see if there have been more loans switched between category, and whether non-banks are also growing their books. Both are likely.

 

 

Auction volumes increase over the last week of July

From CoreLogic.

The combined capital city preliminary clearance rate was recorded at 70.7 per cent this week, up slightly from last week, when the final clearance rate was recorded at 69.9 per cent.

Auction clearance rates have seen a slight improvement across the combined capital cities over the month of July, with the final clearance rate over the last two weeks just falling short of the 70 per cent mark. Auction volumes were higher this week with 1,957 homes taken to auction across the combined capital cities, up from 1,748 last week, and higher than this time last year when 1,610 auctions were held. Perth and Tasmania were the only cities where auction volumes fell over the week.

There were 943 auctions held in Melbourne this week with a preliminary clearance rate of 77.2 per cent, increasing from a final clearance rate of 73.8 per cent last week across 833 auctions. Over the same week last year, Melbourne’s clearance rate was 75.3 per cent across 754 auctions. Of the 9 Melbourne sub-regions, 5 recorded clearance rates above 80.0 per cent, with the highest clearance recorded across the Mornington Peninsula, with preliminary results showing 87.2 per cent of the 39 results were successful, followed by the North West where 81.3 per cent of auctions cleared.

In Sydney, 704 properties were taken to auction this week with a preliminary clearance rate of 68.0 per cent. Last week, the final clearance rate for the city was 70.3 per cent across 625 auctions, after sitting below the 70 per cent mark for the previous 6 weeks, so it will be interesting to see what the final clearance rate is like on Thursday. One year ago, 509 Sydney homes were taken to auction and the clearance rate was 78.0 per cent. This week, the performance across Sydney’s individual sub regions was mixed. Across the South West region, where 47 of the 50 results have been reported so far, the preliminary clearance rate was 40.4 per cent, while across the Eastern suburbs (90.0 per cent) and Inner West (81.8 per cent) regions, the success rate of reported auctions was much higher.

CBA doubles waiting period for IO switch

CBA has doubled the waiting period for customers seeking to switch to an interest-only repayment loan from 90 days to 180 days. This is a further move to try to reduce the proportion of IO loans held, following regulatory pressure to meet the 30% limit.  CBA has already lifted interest rates, tightened lending criteria and throttled back applications via mortgage brokers.

From The Adviser. As of 31 July, customers with Commonwealth Bank (CBA) will be required to wait 180 days to change to an interest-only (IO) loan, while requests to switch within 180 days of loan funding will be sent on for credit assessment.

In addition, clients with loan-to-value ratios (LVR) of more than 80 per cent will not be able to refinance from a principal and interest (P&I) loan to IO within 180 days of funding.

Effective on the same date, the maximum IO terms have been reduced (over the life of the loan) to five years for owner-occupied home loans and 10 years for investment home loans.

Document identification

CBA is also changing the application identification process for new clients, effective 31 July. Brokers will need to acknowledge that they have viewed original identification documents for all borrowers and guarantors, and brokers must provide clear copies of the original (and sighted) identification documents when the application is submitted.

Furthermore, in the case of multiple applicants, brokers must submit each applicant’s identification documents on separate pages for each loan application.

CBA warned: “Missing documentation or discrepancies may result in delays to the customers’ application.”

Australia’s Proposal to Allow Local Mutuals to Issue Common Equity Tier 1 Capital Is Credit Positive

From Moody’s.

The Australian Prudential Regulation Authority (APRA) announced a proposal to amend the existing mutual equity interest (MEI) framework to allow Australian mutually owned deposit-taking institutions (ADIs) to directly issue common equity Tier 1 (CET1) eligible capital instruments. The current framework only creates CET1-equivalent capital, so-called MEIs, through the conversion of Additional Tier 1 (AT1) and Tier 2 capital instruments at the ADI’s point of non-viability. The amendment is credit positive because it would provide an additional option for mutuals to support balance sheet growth by raising high-quality capital. Australia’s mutuals have relied on retained earnings as their sole CET1 source because their mutual corporate status by definition has not allowed them to raise common equity.

APRA’s proposed amendment would allow mutuals to raise capital outside of extreme circumstances. The amendment also would provide a more efficient capital channel for mutuals to respond to growth opportunities. Mutuals thus far have relied on retained earnings accumulation as their primary source of CET1 capital. We view the proposal as an important step in levelling the playing field between mutuals and listed Australian ADIs, the latter of which have the ability to raise common equity.

We do not expect the amendment, if enacted, to strongly increase common equity issuance to replace retained earnings as a dominant CET1 capital source because of mutuals’ already-strong capitalization and the limits that APRA will set on such instruments. Australia’s mutuals have no urgent need to boost their capital ratios. The exhibit below shows that mutuals have consistently reported higher average CET1 ratios than other ADIs. As of the end of March 2017, their aggregate CET1 ratio was 15.8%, versus 10.3% for all ADIs.

Under the current MEI framework, which has been in place since 2014, Moody’s-rated mutuals have 2% of their total capital as AT1 and Tier 2 instruments. (Moody’s-rated mutuals make up approximately 50% of the mutual sector’s total assets.)

The regulator also limits mutuals’ ability to rely on MEI-created CET1 (either through conversion of AT1 and Tier 2 instruments or direct issuance). Specifically, APRA has proposed a 15% cap on the inclusion of MEIs in CET1 capital, and distribution of profits to MEI investors at 50% of ADIs’ net profit after tax on an annual basis.

We expect that MEIs will continue to account for only a minor share of mutuals’ capital, which alleviates the risk that the APRA proposal will incentivize mutuals to maximize their profitability to meet MEI investors’ dividend payment expectations. This scenario would conflict with mutual ADIs’ traditional business model that de-emphasizes profit maximization, and instead focuses on providing value to members via cheaper loans and higher-yielding deposits.

Income divide between rich and poor Australians widening

From The New Daily.

Income inequality is worsening in Australia, according to comprehensive new research that finds renters, pensioners and students are feeling the pinch while high earners get pay rises.

ME bank’s twice-yearly survey of 1500 households, conducted in June and published on Monday, revealed bigger gaps in income, housing and financial worries across the nation.

In the last financial year, the overwhelming majority of Australian households (68 per cent) saw their incomes stagnate or fall. Only 32 per cent got pay rises – the lowest in three years.

Income inequality was apparent.

Almost half (45 per cent) of households earning less than $40,000 said their incomes went backwards, while almost half (46 per cent) of households on at least $100,000 saw pay rises. These high earners were least likely (17 per cent) to report income cuts.

Meanwhile, the incomes of 46 per cent of the middle class (households earning $75,000 to $100,000 a year) were stagnant in 2016-17, according to the survey.

If the results reflect the nation’s finances, then just over half of all Australians (51 per cent) are living pay cheque to pay cheque, spending all their income or more each month, with nothing leftover.

ME’s consulting economist Jeff Oughton, who co-authored the report, said the findings were relevant to the current debate over inequality because “this is how people feel”.

“The bill shock, the income cuts and the housing stress were quite loud signals,” he told The New Daily.

“There have been different winners and losers here, post the global financial crisis, and different winners and losers from low interest rates.”

The good news was that, overall, those who filled out the 17-page survey were feeling slightly less worried about their finances, perhaps because the global economy appears to be recovering.

ME’s financial comfort index − measured by combining reflections on debt, income, retirement, savings and long-term investments − is now at 5.51 out of 10, up from 5.39 in 2012.

However, vulnerable groups were doing it tough.

Renters were far less financially comfortable (4.52 out of 10) than those paying off a mortgage (5.47) and outright home owners (6.44).

Students were the most worried. Their financial confidence plummeted from just over five to 4.32 over the last year, the lowest since the survey began in 2011. This may have been a response to the government’s increase to university debt repayments.

Single parents improved but still ranked poorly (4.95 out of 10).

Self-funded retirees were the most comfortable (7.12 out of 10) while age pensioners were among the least (5.03).

Households earning over $200,000 recorded a staggering double-digit rise in financial comfort – up 10 per cent to 7.85 out of 10 – while those on $40,000 or less were stuck at 4.43.

Overall, Australians were more confident about their debt levels (6.31 out of 10), income (5.72), retirement (5.18), savings (5.07) and long-term investments (4.99).

The only key measure of financial comfort that worsened was when households were asked to imagine their finances in 2017-18: confidence on that measure fell three per cent to 5.31 out of 10, reflecting a general pessimism in the economy.

According to the report, a key reason many Australians fear the future is that, despite low inflation, the price of fuel, power, groceries and other necessities appear high and rising.

A growing number also expect their ability to manage debt to deteriorate if mortgage interest rates rise significantly.

One in five households said they spent more than half their disposable income on housing payments – with the majority renters.

A third (31 per cent) expected to be worse off financially if the Reserve Bank raised the official cash rate by 100 basis points, from 1.5 to 2.5 per cent, including half (47 per cent) of those with a mortgage.

However, 29 per cent said they would be better off – a reflection of those who own their homes and investors seeking better returns.

Generation X, those born between 1961 and 1981 (41 per cent), and single parents (36 per cent) were those most concerned about rising rates. And owner-occupiers (53 per cent ‘worse off’, 22 per cent ‘better off’) were far more concerned than property investors (35 per cent ‘worse off’, 29 per cent ‘better off’).

Households who expected to benefit from rising rates included outright home owners (38 per cent), those earning $100,000+ (36 per cent) and retirees (32 per cent).

Pleasingly, only three per cent of households said they were behind on their mortgage payments. But this was much higher among single parents (15 per cent) and Australians earning under $40,000 a year (9 per cent).

There was also a spike in those who expected to fail to meet minimum debt repayments in the next 6 to 12 months, up from 5 per cent to 9 per cent.

Further reflecting the divide, all groups of workers – full-timers, self-employed, part-timers and casuals – reported more financial confidence.

But the comfort levels of the unemployed plummeted from 4.5 to 3.12 out of 10, the lowest ever.

The divide was also seen across geographical regions. Metro areas rated their financial comfort 5.66 out of 10, while regional areas were 5.05.

The only state to worsen was South Australia, where financial comfort fell from 5.70 to 5.20 out of 10 over the last year.

As Our Economy Changes, The Government is Backing the Wrong Industries

From The Conversation.

The Australian government is still protecting industries that employ a small number of people. This is while the largest employer, the services sector, is subject to the largest tariffs, a recent Productivity Commission report demonstrates.

As a whole, manufacturing still receives 77% of net assistance, largely due to the remaining small levels of tariff assistance, plus some budget measures, according to the report.

“Input tariffs” increase the costs of imported goods and services that go into making things. This makes a business’ activities more expensive for the consumer. And even though the services sector accounts for around 85% of employment, current government policy is penalising this sector, which has the best prospects for future growth.

However, as the report states, it’s the construction industry that is most affected by input tariffs (A$1.5 billion worse off), followed by property and real estate (A$337 million), then accommodation and food (A$294 million). All of these sectors are labour intensive and employ substantial numbers of people, yet are forced to pay unnecessary tariff costs.

Despite all of this, the government is still protecting primary industries such as horticulture, sheep, beef and grains, and in the manufacturing sector in food and metal production, wood pulp and oil and chemicals. All of these latter industries are basic supply or processing industries, that provide inputs into other industries, but not usually the final products.

Tariffs against foreign goods are reducing and now only provide modest assistance to a few industry sectors. The report says this is worth A$4.6 million to manufacturing, and within that sector food and beverages, metal fabrication, wood and paper petroleum and chemicals enjoy the most protection. Together these industries provide a relatively small proportion of total employment (around 7% or just under 1 million employees).

The popular image of our government protecting the motor vehicle and component industries seems to be less true according to these latest statistics.

In terms of budget assistance from the government, it’s not cars but finance and insurance services that benefit most from the public purse followed by sheep, cattle and grain industries. Vehicle production now receives less than half the budgetary support it received eight years ago – down to approximately A$290 million from A$600 million in 2008-09. The government has given up on the motor vehicle industry and its capacity to provide jobs into the future.
More particularly, the Productivity Commission is critical of governmental assistance to the Spencer Gulf industries in South Australia and to the bail-outs for the Arrium steel works in Whyalla, in the same state, which it considers wasteful and distortionary. Arrium went into voluntary administration before an overseas buyer was procured.

The commission is also hostile to green energy production and storage and to the politically sensitive Northern Australian Infrastructure Facility, which it considers a pork-barrelling exercise open to political pressure. It says this facility is likely to fund non-available projects, that will sit on the public books for years, and this is a misapplication of investment resources.

Finally the wrath of the Commission is piqued by the re-regulation of the sugar industry (another declining industry in employment terms) and especially at the granting of charity status to the main marketing arm, Queensland Sugar Ltd. This body must be one of the last remaining marketing monopolies in the primary industries.

Governments will have to look at winding back the remaining (smallish) tariffs affecting domestic service industry sectors – especially those affecting construction supplies, retail and property, accommodation and food.

These impacts flow into local costs that are making Australia a more expensive place to consume or do business both for Australians and overseas visitors.

Author: John Wanna, Sir John Bunting Chair of Public Administration, Australian National University

Renters Under Pressure – The Property Imperative Weekly 29 Jul 2017

Rental Stress is growing, and more property investors are underwater when it comes to covering their mortgage costs on an ongoing basis, so what are the implications for property investment as mortgage rates continue to rise? Welcome to the Property Imperative Weekly to 29th July 2017.

We start with our research on property investment, which was published this week. We look at this from two perspectives, first from the point of view of those renting, and second, from the perspective of those who are property investors.

Whilst there is considerable discussion about mortgage stress, rental distress hardly gets a mention yet there are more households in rental stress than in mortgage stress according to our analysis. We know their financial confidence on average is lower. First, we need to define rental stress. Whilst some will use a “30% of income to pay the rent” as a benchmark, we do not think it is an adequate measure – 30% is too arbitrary!

So we look at net cash flow. If households, once they pay their rent, tax and other outgoings have close to nothing left, or a small deficit, at the end of the month, they fall into our mild stressed category. Those with a severe cash deficit at the end of the month, are in severe stress.

We start by looking at the causes of rental stress. Using data from our surveys, we find that costs of living, under employment and flat incomes are the main causes.

More than half of renters in NSW are in rental stress (on our definition), and the highest proportion of any state here are in severe rental stress. The proportion of households in stress fades away as we look across the other states and territories. But the three most populous states have the highest rental stress levels.

Looking across our segments, we see that older households are more under stress, and a significant proportion are in severe stress.  Whilst wealthy seniors may hold some savings, stressed seniors do not. Many are reliant on Government support.

Greater Sydney and the Central Coast have the highest representation of stressed renters as a proportion of all households renting.

Looking across our geographic zones (a series of concentric rings around our main urban hubs) we see significant levels of stress in the urban centres, as well as on the urban fringe. The former is being created by high rents – especially in the newly constructed high-rise blocks being thrown up across the eastern states, often occupied by young affluent households; whilst in the urban fringe, it is more about depressed incomes. We see stress rolling out into the regions, but is less apparent in the more rural and remote areas.

All this highlights the issues renters have due to the combination of flat incomes, and rising costs, despite only small rises in rents.

Now, if we look at the other side of the coin, our research shows more investors have a net cash-flow problem, thanks to that flat rental income, whilst mortgage rates continue to rise.

The CPI data released this week by the ABS showed that overall inflation remains low.

But within the series there is a striking contrast. The Housing Group category of data rose 0.3 per cent for the quarter, and 2.4 per cent for the year to June 2017 but rent rose only 0.2 per cent for the quarter, and 0.6 per cent for the year.

It is worth reflecting on this in the light of the out of cycle rate hikes which property investors are experiencing, as the banks improve their margins using the alibi of regulatory tightening. In fact recent hikes being applied not just to new mortgages but to the entire book deliver a significant “bonus” to the banks.

First, let’s be clear rental rates have more to do with income that property prices, and the fact that rental rates have hardly grown reflects the stagnation in wages. Vacancy rates are also rising.

Second, the fact is a greater proportion of property investors are now underwater on a net rental cash flow basis. But the situation varies by state.  VIC and NSW have on average negative net returns. The net rental calculation is before any tax offsets.

Investors seem ok with negative cash-flow returns because in many cases they just offset the losses against tax, and comfort themselves with the thought that the capital value of the property is still rising (in most eastern states at least).

However, the divergent movement of mortgage rates and net rental returns are a leading indicator of trouble ahead, especially if capital growth reverses.

Given flat incomes, we think rentals will not grow much at all for some time, and remember more new properties are coming on stream, so vacancy rates are likely to continue to rise!

So in summary, we think more rental property will be vacant so holding rentals low (despite being expensive for many potential tenants) whilst investment costs will go on rising. As a result, we expect to see weaker demand for investment property, and should capital values start to fall, more owners will try and sell. In fact we think many property investors are in for a rude awaking, sufficient to tip the overall market lower, despite recent quite strong auction clearances.

More broadly the HIA reported that housing affordability declined further in the past quarter,  largely due to a rise in the median dwelling price of 9.1% per cent to a record high of $540,200. They say, NSW was the most significant negative influence on this result with affordability in Sydney now declining past a critical level (Sydney, – 0.7% and the rest of NSW, – 2.2 per cent). Acquiring and servicing a mortgage on a house in Sydney now requires more than two standard Sydney incomes. Sydney is the only market to have achieved this outcome in the 15-year history of their report. Affordability in Melbourne improved marginally in the quarter but remains 6.0 per cent less affordable than this time last year. Of the capitals where affordability worsened, the biggest deterioration was in Perth (-1.3 per cent).

Despite the fact the US Federal Reserve held their cash rate this week, signalling a slower rise in interest rates in America, Westpac lifted a range of their fixed term investor loans, with for example their 2-year fixed rising 31 basis points.  Bank West said  they would impose a 25 basis point increase for interest-only investor home loans; and a 35 basis points increase for interest-only owner-occupier home loans. They did offer small reductions to some owner occupied principal and interest borrowers. We are seeing a small flurry of rate cuts for some new borrowers ANZ for example is offering a 31 basis point drop for new two-year fixed residential investment loan for customers paying principal and interest (P&I), falling from 4.34 per cent per annum (p.a.) to 4.03 per cent p.a.

The round of mortgage rate repricing which we have been tracking for the past few weeks, with investor loan portfolios being strongly repriced, and owner occupied loans less impacted, has created a significant well of opportunity for banks to selectively offer attractor rates to principal and interest borrowers. In addition, funding costs are now lower, and the yield curve is less strongly indicating future increases, thanks to changes in the US financial markets and news that the ECB will continue its bond buying programme. But many existing borrowers are saddled with higher rates.  We expect to see a flurry of selective, targetted offers, aimed at acquiring new business and supporting loan portfolio growth.

Wages growth in Australia will remain muted for some time to come yet and RBA Governor Philip Lowe said that if some of the long standing links between income growth and monetary policy are not working as they did, more monetary stimulus may encourage investors to borrow to buy assets, which poses a medium-term risk to financial stability. In comments after the speech, he also made the point that surging asset prices has led to a growth in inequality across Australia.

We think the policy chickens are coming home to roost.  We have seen a significant decline in home ownership in recent years, from 69.5 per cent in 2002, to 67 per cent at the 2011 census, and to 65.5 per cent last year. This is a direct result of RBA policy, and the household debt bubble, which has pumped property prices way too high.

As a result, many younger Australians are being forced to rent, or take out very large mortgages. This debt burden will suck up much of their disposable income for the next 20-30 years, and will leave them exposed to future rate hikes. In a low interest rate environment, the capital owed does not depreciate as fast, so the burden is longer and heavier.  This has a knock-on effect on their ability to save for retirement, so their entire life may well be debt laden.

On the other hand, households holding property have enjoyed significant paper gains. Whether they keep them will be determined by future property prices, but there are more reasons to think prices will fall than rise.

A generation of poor myopic property driven policy will have significant negative long-term impact on the economy and lays at the heart of the inequality across the country, which was subject to much discussion this week. Prices may not drop much in the short term, but we believe they will correct eventually. The longer that takes, the bigger the fall ultimately will be.

And that’s the Property Imperative Week to 29th July 2017. Do subscribe to get our latest updates, and check back again next week. Thanks for watching.

Why a small rise in interest rates will hurt like the 1980s

From The AFR.

Costs for many homebuyers have jumped by up to 150 basis points over the past 12 months and are expected to continue rising even if low inflation means an official rate hike from the Reserve Bank of Australia is unlikely in the near term.

Owner-occupier borrowers are paying between 30 and 40 basis points more and rates on interest-only and investor loans are up by 70 to 150 basis points, according to consultancy Digital Finance Analytics (DFA).

There has been a small decrease in average principal and interest, owner-occupier loans because of regulatory pressure on lenders to encourage borrowers to reduce debt.

If anything, this week’s inflation data gives households a breathing space in which to pay off debt before rates do rise. Financial and mortgage advisers recommend borrowers review their finances so they’re ready for when rates turn.

“Paying more of your debt off while interest rates are at near record lows is a great way to take control of your debt,” says Tim Mackay, an independent financial adviser with Quantum Financial. “Interest rates will eventually start to rise and every time it happens, it’s a little more out of your pocket. The faster you pay your debt off, the less overall interest you will have to pay over the term of your loan.

Other strategies include locking in a fixed rate loan, ramping up extra payments and reducing other debt.

Wealthy feel the pinch

Affluent households – with two incomes and combined annual salaries totalling more than $150,000 – are increasingly facing financial distress because they have taken out large loans with small deposits to pay huge asking prices for real estate hotspots like Melbourne and Sydney, says DFA.

Debt of more than half the households in NSW is 4.5 times income, says Martin North, DFA principal. The national average is just under half households financing similar debt amounts.

“This is a big deal,” North says. “Especially in a rising interest rate environment. It means households have little wriggle room. Granted, many will be holding paper profits in property which has risen significantly in recent years but this does not help with servicing ongoing debt.”

Financial distress among property buyers has increased by 10 per cent over the last 12 months despite the lowest cash rates on record, according to Consumer Action, a federal government-sponsored financial counselling centre.

Property buyers say rising mortgage payments are the chief reason the family budget can’t cover all expenses.

Consumer Action claims the numbers being counselled are an “iceberg tip” of families around the nation struggling with high costs of living, underemployment, flat incomes and rising mortgage costs. The RBA estimates household debt has blown out to nearly twice annual incomes.

Questionable loans

An estimated $50 billion worth of mortgages, equivalent to about 5 per cent of home loans, would fail the latest round of underwriting criteria introduced in response to regulatory pressure and growing household debt, says DFA.

Many younger buyers, typically aged 25-34 , believe home ownership has slipped beyond their reach and plan to become life-long renters, says the Grattan Institute. This is a big shift in national aspirations and retirement planning, which has traditionally assumed retirees own their homes.

Economists warn about static incomes, the highest underemployment since records began in 1978, rising out-of-cycle mortgage increases and rising property prices in the nation’s most populous states.

For example, house price growth during the past 12 months in Melbourne is nearly 22 per cent, or more than 10 times the official rate of inflation. In Canberra it is more than six times the rate of inflation and Sydney five times.

Prices are falling in Darwin and Perth but the national average is 10 per cent. The wide divergence in prices makes it harder for regulators to impose a single, national strategy.

Mortgage payments required to service the growing debt are rising as lenders respond to regulatory pressure to slow buyer demand with out-of-cycle rate rises.

Mistaken criteria

Lenders are comfortably within the 2.5 per cent buffer between the mortgage rate offered and the rate they use for affordability assessment.

But they are reviewing their assessment of household debt and capacity to repay using more sophisticated analysis of household expenditure and borrowers’ reported expenses.

Regulator the Australian Securities and Investments Commission (ASIC) discovered an improbable correlation between the regulatory standard required by lenders and mortgage brokers and tens of thousands of loan applications, suggesting household expenses were being assessed to qualify for a loan, rather than meet standards.

It revealed lenders were often too generous in their assessment of borrowers’ capacity to pay because original assessments understated spending before deducting mortgage payments.

Unsurprisingly, expenses of more affluent households are significantly higher. “This helps to explain why we are seeing more affluent households getting into mortgage stress territory,” says North.

Toughest conditions in 30 years

Households are on notice that they could face some of the toughest borrowing conditions in nearly 30 years if interest rates rise 200 basis points, or eight typical rate hikes, as floated by the Reserve Bank of Australia earlier this month.

“Record low interest rates have made it possible for households to service much larger mortgages as they’ve chased rising house prices,” says Brendan Coates, a research fellow with the Grattan Institute, an independent think tank.
“Even a relatively small rise in interest rates paid by households would crimp their spending. Our research shows that if interest rates rise by just two percentage points, mortgage payments on a new home will take up more of a household’s income than at any time since the late 1980s.”

A 200 basis point rise would push the headline rate for interest rates to about 7.25 per cent.

The impact on family budgets would be equivalent to a rate of 17 per cent, the highest since Bob Hawke was prime minister.

In 1989 the Australian economy was turning from boom to bust in the wake of a global turndown and local lending excesses after deregulation of the financial sector. It was immortalised by then-Treasurer Paul Keating’s quip about a “recession we had to have” and subsequent mortgage defaults, bankruptcies and a stalled property market.

Median house price in Sydney were about $170,000 and average weekly wages around $500. Since then house prices have increased by more than six times as salaries rose by 2.5 times.

The Grattan Institute’s warning follows the RBA’s signal that the cash rate (at which it lends to commercial banks) could rise by 200 basis points to 3.5 per cent.

“With interest rates across the globe at historic lows, the risk of an interest rate rise is real,” says Coates. “And because wages are not rising fast, households are burdened by big interest payments for much longer.

“While the RBA would lift interest rates cautiously, another disruption to international financial markets like 2008 could sharply increase banks’ funding costs, raising mortgage rates.”