Home Lending Momentum Increases In October

The latest monthly banking statisticsdata from APRA for October 2016 shows the total home lending portfolios held by the ADI’s grew from $1.49 trillion to 1.51 trillion, up 0.62%. Within that, owner occupied loans rose by 0.69% to $970 billion (up $6.6bn) and investment loans rose 0.5% (up $2.6 billion). 35.46% of the portfolio is for investment lending purposes.  Momentum is increasing (and matches the high rate of auction clearances we have seen recently).

apra-oct-2016-all-moveLooking at the individual banks, in value terms, CBA lifted their investment portfolio by $975m, compared with WBC $892m. Bendigo Bank shows an uplift of $1.1bn, thanks to their portfolio acquisition of $1.3bn of loans from WA. Suncorp, Members Equity and Citigroup saw their portfolios fall in value. Macquarie saw a small fall in their investment lending portfolio.

Collectively, the big four grew their investment portfolio by $2.6 billion, and their owner occupied portfolio by $4.5 billion.

apra-oct-2016-port-moveWestpac and CBA remain the largest home lenders.

apra-oct-2016-mix-moveLooking at the APRA 10% speed limit, based on an average annualised 3m growth rate, the market shows a 3.4% growth in investment lending, with CBA, WBC and NAB all growing faster than system, but below the 10% speed limit.

apra-oct-2016-yoy-3mThis data would indicate that i) further rate cuts from the RBA are off the agenda and ii) they should consider further tightening, using either macroprudential controls, or a rate rise.

We will get the RBA aggregates later today, and we will be able to assess the growth in the non-bank sector, as well as look at the changed classification which took place in the month between investment and owner occupied loans.

Remember that default rates on mortgages are already rising, especially in the mining heavy states, although overall provisions are low at the moment. The banks remain highly leveraged to the housing sector.

Major Banks Still Highly Leveraged

APRA has published their quarterly summary of bank performance. Looking at the key metrics of the four major banks, we see growth in home lending and driving total loans higher to $2.4 trillion. Net interest income from home lending rose to 61.9%, up from 59.3% the previous quarter, reflecting changes in mortgage discounts and repricing. 83.2% of all ADI home lending is held by the big four.

apra-adi-sepq16-shareHome lending now comprises 62.8% of all loans with the big four. But in cash terms, lending provisions are lower now than in 2010, despite significantly larger balances.

apra-adi-sepq16-mix-and-provThe ratio of bank share equity to total loans sits at just over 5%, showing again how leveraged the banks are. We also see that CET1 and Basel Capital, whilst higher now than in 2013, has fallen somewhat recently.

apra-adi-sepq16The new Liquidity Coverage reporting shows the big four well above the required 100%.

apra-adi-sepq16-lcrTerm deposits rose compared with on-call deposits, thanks to the LCR requirements making term deposits more attractive to the banks.

More generally, on a consolidated group basis, there were 153 ADIs operating in Australia as at 30 September 2016, compared to 156 at 30 June 2016 and 159 at 30 September 2015.

  • G&C Mutual Bank Limited changed its name from SGE Mutual Limited, with effect from 12 September 2016.
  • Latvian Australian Credit Co-operative Society Limited had its authority to carry on banking business in Australia, with effect from 22 September 2016.
  • MyLifeMyFinance Limited changed its name from Transcomm Credit Co-operative Limited, and changed its classification from ‘Credit union’ to ‘Other ADI’, with effect from 3 August 2016.
  • “Quay Credit Union Ltd had its authority to carry on banking business in Australia revoked, with effect from 12 September 2016.”
  • “Select Credit Union Limited had its authority to carry on banking business in Australia revoked, with effect from 7 July 2016.”
  • “Select Encompass Credit Union Ltd changed its name from Encompass Credit Union Limited, with effect from 13 July 2016.”
  • “Sutherland Credit Union Ltd had its authority to carry on banking business in Australia revoked, with effect from 12 July 2016.”
  • “The Bank of Nova Scotia was authorised to operate as a foreign branch bank in Australia, with effect from 25 August 2016.”Looking at financial performance, the net profit after tax for all ADIs was $27.7 billion for the year ending 30 September 2016. This is a decrease of $9.2 billion (25.0 per cent) on the year ending 30 September 2015.

The cost-to-income ratio for all ADIs was 48.3 per cent for the year ending 30 September 2016, compared to 49.0 per cent for the year ending 30 September 2015.

The return on equity for all ADIs was 9.9 per cent for the year ending 30 September 2016, compared to 14.1 per cent for the year ending 30 September 2015.

The total assets for all ADIs was $4.52 trillion at 30 September 2016. This is a decrease of $58.3 billion (1.3 per cent) on 30 September 2015.

The total gross loans and advances for all ADIs was $3.01 trillion as at 30 September 2016. This is an increase of $105.8 billion (3.6 per cent) on 30 September 2015.

The total capital ratio for all ADIs was 13.7 per cent at 30 September 2016, unchanged from 13.7 per cent on 30 September 2015.

The common equity tier 1 ratio for all ADIs was 9.9 per cent at 30 September 2016, a decrease from 10.1 per cent on 30 September 2015.

The risk-weighted assets (RWA) for all ADIs was $1.97 trillion at 30 September 2016, an increase of $110.1 billion (5.9 per cent) on 30 September 2015.

For all ADIs:

  • Impaired facilities were $15.2 billion as at 30 September 2016. This is an increase of $1.4 billion (10.4 per cent) on 30 September 2015. Past due items were $12.9 billion as at 30 September 2016. This is an increase of $1.2 billion (10.5 per cent) on 30 September 2015;
  • Impaired facilities and past due items as a proportion of gross loans and advances was 0.93 per cent at 30 September 2016, an increase from 0.88 per cent at 30 September 2015;
  • Specific provisions were $7.2 billion at 30 September 2016 (chart 8). This is an increase of $0.9 billion (14.2 per cent) on 30 September 2015; and
  • Specific provisions as a proportion of gross loans and advances was 0.24 per cent at 30 September 2016, an increase from 0.22 per cent at 30 September 2015.

 

 

 

Home Lending Exposures Grow Again

APRA released the latest ADI Property Exposure data to September 2016 today. ADIs residential term loans to households were $1.46 trillion as at 30 September 2016. This is an increase of $106.5 billion (7.9 per cent) on 30 September 2015. The number of loans rose from 5,469,000 to 5,665,000, a rise of 3.6% year on year.

Owner-occupied loans were $949.0 billion (64.9 per cent), an increase of $108.6 billion (12.9 per cent) from 30 September 2015; and investor loans were $512.3 billion (35.1 per cent), a decrease of $2.0 billion (0.4 per cent) from 30 September 2015.

ADIs with greater than $1 billion of residential term loans held 98.7 per cent of all such loans as at 30 September 2016. These ADIs reported 5.7 million loans totalling $1.44 trillion. Of these: the average loan size was approximately $255,000, compared to $244,000 as at 30 September 2015; and $564.8 billion (39.2 per cent) were interest-only loans.

Looking at new approvals, ADIs with greater than $1 billion of residential term loans approved $372.1 billion of new loans in the year ending
30 September 2016. This is an increase of $5.8 billion (1.6 per cent) on the year ending 30 September 2015. Of these new loan approvals: owner-occupied loan approvals were $250.3 billion (67.3 per cent), an increase of $29.9 billion (13.6 per cent) from the year ending 30 September 2015; investment loan approvals were $121.8 billion (32.7 per cent), a decrease of $24.2 billion (16.6 per cent) from the year ending 30 September 2015:

$51.8 billion (13.9 per cent) had a loan-to-valuation ratio (LVR) greater than 80 per cent and less than or equal to 90 per cent, an increase of $2.9 billion (5.9 per cent) from the year ending 30 September 2015

apra-adi-sept16-lvr-80-90$31.5 billion (8.5 per cent) had a LVR greater than 90 per cent, a decrease of $7.7 billion (19.5 per cent) from the year ending 30 September 2015; and

apra-adi-sept16-lvr-90$135.2 billion (36.3 per cent) were interest-only loans, a decrease of $23.9 billion (15.0 per cent) from the year ending 30 September 2015. Major banks are writing the largest proportion of interest only loans.

apra-adi-sept16-ioThe proportion of new loans via brokers continues to grow, with foreign banks having the largest share, but domestic banks are now above 50%.

apra-adi-sept16-broker We note that the number of credit unions and building societies captured in the data has fallen to the point where their discrete data is no longer being reported.

Super Now Worth $2.15 Trillion

APRA has released the latest superannuation statistics to September 2016. Total superannuation assets are worth $2,145.6 billion up +7.4% in the past year. Of this, $1,330.5 billion are in entities regulated by APRA, up 8.7% in the past year.

apra-superSelf managed superannuation balances reached $635.9 billion, up +8.0% in the past year.

apra-super-sept-2016-smsf

Total assets in MySuper products totalled $492.2 billion at the end of the September 2016 quarter. Over the 12 months from September 2015 there was a 13.6 per cent increase in total assets in MySuper products, and a 23.7 per cent decrease in total assets in accrued default amounts to $39.6 billion.

There were $23.2 billion of contributions in the September 2016 quarter, down 4.7 per cent from the September 2015 quarter ($24.4 billion). Total contributions for the year ending September 2016 were $103.1 billion. Outward benefit transfers exceeded inward benefit transfers by $1.0 billion in the September 2016 quarter.

There were $17.0 billion in total benefit payments in the September 2016 quarter, an increase of 6.6 per cent from the September 2015 quarter ($15.9 billion). Total benefit payments for the year ending September 2016 were $65.7 billion. Lump sum benefit payments ($8.3 billion) were 49.1 per cent and pension benefit payments ($8.6 billion) were 50.9 per cent of total benefit payments in the September 2016 quarter. For the year ending September 2016, lump sum benefit payments ($33.0 billion) were 50.2 per cent and pension payments ($32.7 billion) were 49.8 per cent of total benefit payments.

Net contribution flows (contributions plus net benefit transfers less benefit payments) totalled $5.3 billion in the September 2016 quarter, a decrease of 30.4 per cent from the September 2015 quarter ($7.6 billion). Net contribution flows for the year ending September 2016 were $31.7 billion.

 

APRA On Securitisation – Will It Benefit Smaller Players?

APRA says their recent changes to securitisation will enable a much larger funding-only market and so provide ADIs the opportunity to strengthen their balance sheet resilience by accessing new sources of term funding, hopefully at relatively attractive pricing. In addition, with the more straight-forward approach to achieving capital relief, securitisation can also be valuable for capital management purposes, perhaps this is particularly so for smaller ADIs and this may bring benefits to the competitive environment. So said Pat Brennan, Executive General Manager APRA,  when he spoke at the Australian Securitisation Forum Conference, Sydney and discussed the recent changes to the updated prudential standard APS 120 Securitisation (APS 120), and an associated prudential practice guide.

apra-pic

This marks the culmination of some five years of policy formulation, and APRA’s updates on progress over this period have featured prominently at previous ASF gatherings.

In all prudential policy development APRA is guided by its statutory mandate: to balance the objectives of financial safety and efficiency, competition, contestability and competitive neutrality – and in doing so, promote financial system stability.  In addition, when finalising the prudential settings for securitisation APRA also remained true to the principles that guided the policy development process throughout:

  • to facilitate a much larger, simple and safe, funding-only market;
  • to facilitate an efficient capital-relief securitisation market; and
  • to have a simpler and safer prudential framework.

Over the last five years APRA’s policy deliberations were greatly assisted by the active engagement of industry in the consultation process. This was both through the ASF and bi-laterally, through formal submissions and informal meetings.  It seems fitting at this point to reflect back on this process and note some key aspects of how policy evolved through the consultation process. I will then make a few comments thinking of the role of securitisation looking forward.

Funding only securitisation

Let me start with the subject of the first principle I noted – funding-only securitisation – that is where an Authorised Deposit-taking Institution (ADI) is not seeking capital relief, rather the focus is on accessing term funding to support their lending activities.

Early in the consultation process APRA had serious reservations regarding date-based calls when combined with a bullet maturity structure. Whilst contractually in the form of an option, such a feature may create an expectation that repayment will definitely occur on the stated date regardless of circumstances. This represents a prudential risk should investors be allowed the ‘best of’ either repayment from the underlying pool of loans or from the originating ADI. This type of arrangement is allowed in the case of covered bonds, but controlled within a legislative limit. To allow a proliferation of other covered bond-like arrangements would be imprudent.

Through consultation industry clearly articulated the benefits of bullet maturity structures:

  • with their more certain cash-flow structures, a much broader range of investors can be accessed;
  • hedging costs for ADIs are reduced, possibly materially so; and
  • these factors clearly support a much larger funding-only market.

Industry also accepted that the prudential risk can be managed by the requirements of APS 120, but also through the approach taken by ADIs. Specifically, an ADI should create no impression that the call is anything other than an option for the ADI, and that a call is only exercised when the underlying assets are performing. To put it plainly: an ADI must never bear losses that are attributable to investors.

The finalised APS 120 therefore facilitates bullet structures – this is probably the most significant single development in APRA’s securitisation reforms and is the product of constructive consultation and careful consideration by APRA of how to strike the best balance of the various elements of its mandate.

Tranching

Moving on, many in this room will recall APRA’s early aspiration for a simple, two-class structure with substantially all the credit risk contained in the lower ranking tranche. Such a structure would avoid the problems of complexity and opaqueness associated with securitisation – problems that manifested so clearly through the global financial crisis.

In a general sense simplicity is good – but finance is often not simple. Industry feedback was clear – the concept of a two-class structure has significant shortcomings as the risk preferences of investors in subordinated tranches are varied, and to have an active capital-relief securitisation market greater risk-differentiation, and therefore tranching, is necessary. APRA heard this not only from ADIs but other industry participants as well, including investors – and we were convinced.

As a result APRA has relaxed its approach regarding the number of tranches, though we hope industry will not pursue complexity for complexity’s sake – this is a trap structured finance has fallen into before, with unhappy outcomes.

As a side note, and one that applies much more broadly than securitisation, at times there is a need to consider how things may be, and not be unnecessarily anchored to the current reality we are familiar with. When APRA embarks on this type of consultation it can, on occasion, open possibilities for better outcomes, outcomes that were not previously contemplated, perhaps also bringing opportunities for industry innovation. Policy reform by its very nature is about changing the status quo and industry needs to acknowledge that just because something has traditionally been done a certain way is not, in itself, an argument that it should always be so.

Risk retention

Risk retention is another area where consultation lead to a significant change in APRA’s thinking. Whilst the originate-to-distribute model has not been prevalent in Australia, APRA’s early view was that if there was to be a risk retention requirement it should be set at a level that will truly make a difference and bring alignment of interests between originators and investors.  We proposed a level of 20 per cent. At the time there was also an expectation that international practices would be broadly consistent.

As time progressed a variety of skin-in-the-game requirements emerged internationally, generally set at lower levels. Assisted by industry feedback APRA reflected that an Australian requirement, in addition to the varied international requirements, would add regulatory burden for limited prudential benefit. So when balancing APRA’s mandate in the context of the feedback received through consultation, we placed greater weight on efficiency considerations and hence did not implement a risk retention requirement.

Capital requirements

Whilst APRA’s securitisation reforms relate mainly to ADIs as issuers, we are also naturally interested in the amount of capital ADIs hold for their securitisation exposures. We have updated capital requirements following the Basel Committee’s framework, but with adjustments reflecting the Australian context and in light of APRA’s objectives.

Once such adjustment is that APRA has not implemented the approach involving the use of internal models for setting regulatory capital requirements. Instead APRA has implemented the remaining two approaches from the Basel framework: an approach based on external ratings and a standardised approach. Whilst many in industry would have preferred APRA to allow the use of internal models, as we have implemented the risk weight floor of 15 per cent this considerably limits the potential differences in outcomes. This is because a floor of 15 per cent is likely to have been applied to the majority of securitisation exposures if internal models were used, reflecting the relatively high credit quality of the underlying loans. In addition, not implementing the internal models approach is consistent with the objective to have a simpler and safer prudential framework.

A second adjustment is APRA’s requirement that an ADI deducts holdings of subordinated tranches from their own capital. There is frequent comment on APRA’s conservative approach to capital settings throughout the prudential framework. The Basel framework sets minimum standards and the relevant authorities around the globe are expected to set higher standards where they see this as being appropriate – Australia is not alone in setting conservative standards. In the Australian context, with the majority of ADI assets being residential mortgage loans, APRA’s view is there is substantial potential risk in having any incentive in the prudential framework for ADIs to hold the more risky tranches of other originator’s securitisations.

After the lengthy and detailed consultation, APRA is firmly of the view the principles underlying these adjustments are appropriate. I note that, as a result of the consultation process, APRA did relax the level at which the deduction approach applies as industry outlined that with limited additional risk certain common securitisation structures will be viable for ADIs to use if such a relaxation was applied.

Warehouse arrangements

Throughout the process of reforming APRA has been motivated to remove the current unsustainable situation that can arise through warehouse arrangements where capital leaves the banking system with no reduction in risk in the system. In 2014 APRA proposed that a concession remain, but be limited in time to a period of one year.  This proposal proved unpopular with industry, which APRA found a little surprising at the time given it was designed to retain the concession in full for a year, and we anticipated this would be economically attractive over at least a two year period. Nevertheless, industry feedback was clear and negative.

In 2015 we put this subject back to industry to propose potential solutions, noting that in the absence of any viable option being identified APRA would simply treat warehouses as any other securitisation – either capital relief or funding only depending on the degree to which each arrangement meets the relevant requirements.

The feedback we received generally asked for the existing concession to remain indefinitely, and as APRA had said, that was unsustainable. So on warehouses, the consultation process did not offer any viable alternatives.

The final APS 120 accommodates warehouses, but with no special treatment when compared to other forms of securitisation. APRA hopes that efficient funding structures are agreed between market participants so the benefits of warehouse arrangements can continue.

From these examples you can see that the final form of APS 120 is different to how it would have appeared if it was finalised even just two years ago, and very different to how it would have appeared if it was finalised a year or two prior to that. APRA has materially changed some policy positions and modified others as a direct result of consultation. In a few areas, where the prudential stakes were sufficiently high, APRA did not change its basic position – though the consultation process brought healthy challenge to APRA’s approach and caused us to consider aspects of the policy from a new perspective. In both cases – where policy was changed and where it was not – a constructive consultation process proved essential to arrive at the best possible prudential policy.

Looking forward we all hope to see the Australian securitisation market grow and prosper. Having a much larger funding-only market would provide ADIs the opportunity to strengthen their balance sheet resilience by accessing new sources of term funding, hopefully at relatively attractive pricing. With the more straight-forward approach to achieving capital relief, securitisation can also be valuable for capital management purposes, perhaps this is particularly so for smaller ADIs and this may bring benefits to the competitive environment.

APRA is soon to finalise the Net Stable Funding Ratio (NSFR) to be applied to 15 larger, more complex ADIs, and this is expected to be implemented in 2018 alongside the securitisation reforms. The Australian banking system has some notable features that are not very common around the globe. On the asset side the banking system essentially funds lending for housing on its collective balance sheet, whilst on the liability side the Australian banking system has a relatively low deposit to loan ratio. Whilst the affected ADIs are reasonably well placed to meet the NSFR requirement, new opportunities to strengthen funding profiles will assist in strengthening this measure over time – and this strengthening will make the system more resilient.

Whilst a much larger Australian securitisation market depends on market forces, which have ebbed and flowed considerably in recent years, it seems certain that over time opportunities to grow the market will present themselves.  The updated prudential framework, and accommodating bullet maturity structures in particular, places ADIs well to take advantage of those opportunities as they arise.

APRA To Publish Additional Liquidity Statistics From End November

APRA published the outcomes from their consultation relating to publishing additional ADI liquidity data each quarter.  They say that on the basis that submissions were broadly supportive of the proposal to publish additional liquidity statistics, APRA will incorporate the expanded liquidity statistics for the September 2016 edition of QADIP, to be released 29 November 2016.

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These expanded statistics will promote understanding of the ADI industry and provide users of APRA’s statistics with additional information to make well-informed decisions.

To provide users with additional information, and to ensure that the new statistics are not misused or misinterpreted, APRA will also release an explanatory note that explains how the liquidity statistics should be interpreted and used.

The September 2016 edition of QADIP as well as the explanatory information will be available from 29 November 2016

APRA says it seeks to publish as much of the data collected as is considered useful, subject to APRA’s confidentiality obligations with respect to individual institutions’ data. APRA intends to consult ADIs and other interested parties in 2017 about the segments in its ADI statistics to ensure that the statistics APRA produces meet user needs and are not likely to be misinterpreted or misused.

While APRA currently publishes financial performance and financial position statistics for mutual ADIs, prudential statistics are not published for mutual ADIs. APRA does not intent to publish liquidity statistics for mutual ADIs at this stage.

Institution-level liquidity statistics are generally protected by the secrecy provisions in section 56 of the Australian Prudential Regulation Authority Act 1998. APRA says it will consider the suggestion of publishing institution-level liquidity statistics and welcomes feedback from ADIs.

We think individual institution level data should be published, because better transparency should be encouraged, and whilst the “smoke-screen” of commercial confidentially will be cited, we think public interest should carry more weight. Relative to a number of other countries, we are more reticent in Australia to disclose. There is a strong case to change this.

APRA Re-Calibrates IRB Bank Capital

Wayne Byres APRA Chairman spoke at Finsia’s ‘The Regulators’ event, Melbourne. He discussed risk culture, profitability and returns in the financial system, and Basel risk capital. We focus on the capital discussion, because he warned that the IRB banks are re-calibrating their models to get closer to the 25% risk weighting. As a result there could be some “noise in the system”. Also it appears Basel III won’t really be complete in 2017.

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The Basel Committee needs to complete the final work on Basel III. All the key components of the capital framework are still under review in one way or other, with the ambitious goal to:

  • improve the risk sensitivity of some parts of the framework;
  • reduce excessive variability in others; and
  • not significantly increase capital requirements overall.

If the Committee achieves all these things to everyone’s satisfaction, it will be a miracle!

I’ll be happy to just get some finality to the deliberations. The Committee meets again in a couple of weeks, and hopefully an agreement will be reached that will allow the complete package of reforms to be endorsed by the Governors and Heads of Supervision of Basel Committee member countries in January. If that happens, our return to work in the New Year should be accompanied by the revised international capital framework. That process sounds relatively orderly, but behind the scenes there is still much horse trading to do.

However, the Basel framework doesn’t purport to deliver ‘unquestionably strong’ capital. It is simply the minimum international standard. In Australia, we have long applied more robust requirements1 – an approach that has stood us in good stead. Even without the reinforcing view of the FSI, there’s no reason why we would take a different path now. I mention this to dampen any enthusiasm that might be generated when the new rules are released, by calculating what would happen if APRA was to simply apply the new Basel framework to Australian ADIs. I can tell you the answer now – it would produce a material reduction in capital requirements. Before anyone gets too excited by that, I can also tell you we won’t be pursuing that course.

Once the Basel Committee has set out the minimum requirements, the task for APRA is to think through how and where we build further resilience into the new Basel framework to deliver ‘unquestionably strong’ capital ratios. But that’s not our sole objective. As we make policy choices, we’ll also be considering:

  • how we make the framework more flexible, so that it is better able to respond to business and financial cycles;
  • how to improve transparency, so that investor understanding of capital strength is enhanced; and
  • heeding the message of the FSI, how to take account of the competitive impacts of differing approaches (albeit that any differentiated approach will inevitably lead to different capital requirements at a product level).

The key issue, of course, is how we might calibrate the new requirements. The FSI gave us one guidepost – top quartile positioning relative to international peers – but we’ll also use others. For example, we’ll assess capital positions against rating agency measures of capital strength. The results of stress tests are also informative: banks that have difficulty demonstrating their ability to survive plausible adverse scenarios without severely curtailing lending and/or emergency capital raisings are unlikely to be seen as unquestionably strong. As with top quartile positioning, none of these are intended to be definitive benchmarks, but they do give some useful guidance against which to calibrate the final requirements.

I’ll just say a quick word on timing. Given the number and potential impact of the changes that will be proposed, 2017 will be a year of consultation. We don’t expect to have final standards before this time next year. And even if that is the case, they would not take effect until at least a year after that. But while there’s time for the changes to be worked through, that shouldn’t lead to complacency in the current environment. In that sense, the message I’ve given previously still holds: capital accumulation remains the appropriate course for most ADIs, but with sensible capital planning the actual implementation of any changes should be able to be managed in an orderly fashion.

Before I conclude on capital altogether, I want to say a few words on the FSI recommendation regarding mortgage risk weights. In July 2015, we announced higher mortgage risk weights for banks using internal model-based approach to capital. This was an interim step, but a step we were comfortable we wouldn’t need or want to materially unwind, regardless of the outcomes in Basel.

All other things being equal, we expected to raise the average mortgage risk weights for banks using internal models from around 16 per cent to at least 25 per cent. Unfortunately, in the world of internal models, all other things are rarely equal. Banks constantly refine their models, often at their own initiative but also sometimes at the request of APRA. We noted earlier this year that the impact of a range of modelling changes in the pipeline, when combined with the adjustment proposed in July 2015, would have produced an average risk weight well in excess of our interim objective of 25 per cent. So we’ve had to slightly recalibrate the adjustment, with a view to ensuring the outcomes were broadly consistent with the target we announced.

I mention this because, for those who follow these numbers closely, there will be some noise in the system over the next few quarters. As various modelling changes come on stream, the average risk weight across all IRB banks will fluctuate somewhat, and will impact different banks at different times. But these differences will narrow over time.

APRA Updates Securitisation Guidelines

New securitisation guidelines from APRA may benefit competition, provide improved prudential outcomes, provide efficiency offer a stable long term funding source.

In Australia, securitisation has typically been a material share of funding for a number of ADIs. Smaller ADIs e.g. domestic banks (other than the major banks), credit unions and building societies (CUBS), in particular, use securitisation to generate a greater proportion of funds than larger ADIs.

apra-sec-chartSecuritisation of loans and other assets can be an important and cost-effective mechanism by which an ADI can obtain funding for its business. Australian ADIs have used securitisation successfully for many years to diversify their funding base and make efficient use of capital.

APRA has been working to update its regulatory framework for securitisation to incorporate the most recent internationally agreed regulatory reforms, as well as to reflect the lessons of the global financial crisis and provide a more sustainable basis for the securitisation market going forward.

APRA has now released details of its changes to the securitisation guidlines for Australian ADI’s.   The revised APS 120 will take effect from 1 January 2018.

APRA’s reforms to apply simpler approaches to assigning regulatory capital for securitisation exposures will reduce the differential treatment of ADIs using advanced and standardised approaches to regulatory capital for credit risk, which may benefit competition.

The main amendments to the draft revised APS 120 and APRA’s clarifications relate to:

  • reducing the scope of exposures where a Common Equity Tier 1 Capital (CET1) deduction is required;
  • including more flexible arrangements in regard to funding-only securitisations; and
  • additional flexibility for ADIs making use of warehouse arrangements that may qualify for regulatory capital relief.

APRA also decided not to modify its proposals in several areas, after considering industry submissions. APRA proposals that remain unchanged include:

  • removal of the advanced modelling approaches to calculating regulatory capital requirements;
  • treatment of securitisations of revolving credit facilities, ABCP, and synthetic securitisations; and
  • the treatment of shared collateral.

The final revised APS 120 also reflects APRA’s implementation of the Basel Committee’s revised securitisation framework (Basel III securitisation framework), with appropriate Australian adjustments.

To better reflect underlying risk, and to address the lessons learned from the global financial crisis, APRA’s initiatives and the Basel III securitisation reforms include more conservative regulatory capital requirements for some types of securitisation exposures. However, the underlying operational requirements for securitisation are either unchanged or have been simplified.

In responding to submissions on the revised APS 120, APRA has sought to reach an appropriate balance between the objectives of financial safety and efficiency, competition, contestability and competitive neutrality, whilst promoting financial stability. APRA considers the final revised APS 120 will, on balance, provide improved prudential outcomes and provide efficiency and competitive benefits to ADIs.

The explicit recognition of securitisation for funding purposes in the prudential standard is expected to improve the ability of ADIs to secure long-term, stable wholesale funding.

APRA’s reforms to apply simpler approaches to assigning regulatory capital for securitisation exposures will reduce the differential treatment of ADIs using advanced and standardised approaches to regulatory capital for credit risk, which may benefit competition. Further, APRA’s clarification of the regulatory capital requirements for warehouse arrangements may also assist smaller ADIs in improving access to term wholesale funding, without creating undue prudential risk.

The revised APS 120 will take effect from 1 January 2018. APRA is currently consulting on the draft revised APG 120. In the coming months, APRA will separately consult on revised reporting requirements for securitisation that would take effect at the same time as the revised prudential standard and prudential practice guide.

The Interest-Only Loan Debt Trap

Today we discuss some specific and concerning research we have completed on interest-only loans.  Less than half of current borrowers have complete plans as to how to repay the principle amount.

Interest-only loans may seem like a convenient way to reduce monthly repayments, (and keep the interest charges as high as possible as a tax hedge), but at some time the chickens have to come home to roost, and the capital amount will need to be repaid.

Many loans are set on an interest-only basis for a set 5 year term, at which point the lender is required to reassess the loan and to determine whether it should be rolled on the same basis. Indeed the recent APRA guidelines contained some explicit guidance:

For interest-only loans, APRA expects ADIs to assess the ability of the borrower to meet future repayments on a principal and interest basis for the specific term over which the principal and interest repayments apply, excluding the interest-only period

This is important because the number of interest-only loans is rising again. Here is APRA data showing that about one quarter of all loans on the books of the banks are interest-only, and that recently, after a fall, the number of new interest-only loans is on the rise – around 35% – from a peak of 40% in mid 2015. There is a strong correlation between interest-only and investment mortgages, so they tend to grow together. Worth reading the recent ASIC commentary on broker originated interest-only loans.

interest-only-apraBut what is happening at the coal face? To find out we included some specific questions in our household survey, and today we present the results.

We were surprised to find that around 83% of existing interest-only loan holders expect to roll their loan to another interest-only loan, and to keep doing so.  More concerning, only around 44% of borrowing households had an explicit discussion with the lender (or broker) at their last loan draw down or reset about how they plan to repay the capital amount outstanding.  Some of these loans are a few years old.

interest-only-surveyAround 57% said they knew the capital would have to be repaid (we assume the rest were just expecting to roll the loan again) and 26% had no firm plans as to how to repay whereas 39% had an explicit plan to repay.

Many were expecting to close the loan out from the sale of the property (thanks to capital appreciation) at some point, from the sale of another property, or from another source, including an inheritance.

Thus we conclude there is a potential trap waiting for those with interest-only loans. They need a clear plan to repay, at some point. It also highlights that the quality of the conversation between borrower and lender is not up to scratch.

We think some borrowers on an interest-only loan may get a rude shock, when next they try to roll their interest-only loan. If they do not have a clear repayment plan, they may not get a new loan. There is a debt trap laid for the unwary and the APRA guidelines have made this more likely.

Next time we will delve further into the interest only mortgage landscape, because we found the policies of the lenders varied considerably.

 

Investment Lending On Again

The latest data from APRA for September shows the portfolios of individual banks in Australia as well as details of total loan exposures.

Total lending for housing went to $1.5 trillion, up 7 billion in the month. Of that $5.2 billion was for owner occupation and $1.8 billion for investment loans. As a result 35.5% of loans are for investment purposes.

Looking at the portfolio data, we see that Westpac and CBA had the bulk of the growth, across both owner occupied and investment loans. NAB grew in both categories, whereas ANZ dialed back their investment lending (perhaps from reclassification?). It is worth noting that ING is also growing their owner occupied portfolio and Members Equity Bank grew strongly.  Pressure on some of the regional banks continues.

apra-adi-sept-portfolioThis has done little to change the relative market shares, with CBA in first place on owner occupied loans, and Westpac first on investment lending, but with CBA now nipping at their heals.

apra-adi-sept-sharesFinally, here is the relative investment lending portfolio growth. On a 3 month annualised basis, the total market grew 2.8%, but now three of the major players are operating above system growth, though still below the 10% speed limit imposed by APRA last year.

apra-adi-sept-trends There has clearly been a focus on energising investment lending, as we predicted in our Property Imperative report.  We expect momentum to continue for some time to come, hampering the RBA’s ability to cut the cash rate if they needed to.  We still believe further macroprudential measures are needed.