Digital Finance Analytics (DFA) Blog
"Intelligent Insight"
S&P Ratings released their SPIN to December 2018, an assessment of the risks in Australian Residential Backed Mortgage Securitisation Pools.
Overall we see a further rise in delinquencies, other than in Tasmania.
Significantly the 90 day plus arrears are rising, as predicted by our mortgage stress analysis as the slow roasting of mortgage borrowers continues.
Regional banks are also impacted.
Expect more ahead as the pressure continues.
APRA has provided a justifying summary of their actions relating to home lending regulation, but warns that “many of the underlying structural risks associated with high household debt remain and will do so for some time”.
Despite this, they have chosen to keep the countercyclical capital buffer at zero. Housing credit growth is slowing, but there is nothing in this document to suggest APRA intends to loosen the requirements relating to home lending further – (unlike some of the commentators have been suggesting they should reduce the 7% floor rate).
So, as credit availability drives home prices, as we recently discussed, and underwriting is now in a new normal, we should expect more home price falls ahead. We discussed this is our recent video. And this before the Royal Commission reports!
The Australian Prudential Regulation Authority (APRA) has announced its decision to keep the countercyclical capital buffer (CCyB) for authorised deposit-taking institutions (ADIs) on hold at zero per cent.
The CCyB is an additional amount of capital that APRA can require ADIs to hold at certain points in the economic cycle to bolster the resilience of the banking sector during periods of heightened systemic risk. APRA reviews the buffer quarterly. It has been set at zero per cent of risk-weighted assets since it was introduced in 2016.
In its annual information paper on the CCyB released today, APRA outlined the core economic indicators that contributed to the decision, including:
Also influencing APRA’s judgement that a zero per cent CCyB setting remained appropriate has been the impact of measures that APRA has taken since 2014 to address systemic risks related to residential mortgage lending standards.
In a separate but related information paper also released today, APRA detailed its objectives for its interventions in the residential mortgage lending market in recent years, which were aimed at reinforcing sound mortgage lending standards and increasing the resilience of the banking sector in the face of heightened risks. These risks included an environment of rising household debt, subdued wage growth, rising house prices, and an erosion of bank lending standards at a time of historically low interest rates. Concerned that the banking sector may be increasing its vulnerability to future shocks, APRA’s response was to undertake a program of work to strengthen and embed sound lending policies and practices, particularly in relation to borrower serviceability, supported by temporary benchmarks to incentivise lenders to moderate the growth in lending to investors and the volume of interest-only lending.
Some of the key findings within the paper include:
Chairman Wayne Byres said that after the announcement of the removal of the investor and interest-only benchmarks last year, it was appropriate for APRA to review the impact of its regulatory actions, and reflect on whether their objectives had been achieved.
“APRA could have chosen to utilise the countercyclical capital buffer as a means of building resilience in the banking system. However, APRA took the view that the better course of action was to address, through targeted measures, the underlying concern – the erosion in lending standards driven by strong competitive pressures amongst housing lenders.
“APRA’s assessment is that, collectively, its interventions achieved the necessary objective of strengthening lending standards and reducing a build-up of systemic risk in residential mortgage lending. The review provides some valuable insights on the impact of the measures, which have necessarily involved some trade-offs and judgement in the process of strengthening the resilience of the banking sector.
“Importantly, while the temporary lending benchmarks are being removed, the changes we have made to lift lending standards are designed to be permanent, continuing to support the resilience of the banking system and ultimately the protection of bank deposits,” Mr Byres said.
In conjunction with the other agencies on the Council of Financial Regulators, APRA will continue to closely monitor economic conditions, and will adjust the CCyB if future circumstances warrant it. Separately, APRA is also considering setting the buffer at a non-zero default rate as part of its ongoing review of the ADI capital framework.
The countercyclical capital buffer information paper, and the review of APRA’s prudential measures for residential mortgage lending risks can be viewed on the APRA website at https://www.apra.gov.au/information-papers-released-apra.
AFG reported an 8% fall in loan applications compared with the prior quarter, according to their quarterly index, released today. Whilst it only represents the activity though AFG, it is a useful bellwether.
The trajectory of the market is clear, as the volume of investor loans and interest only loans remain significantly lower than before the regulatory intervention. More households are choosing to fix their loan interest rate. NAB lifted their rates today!
AFG used the release as an opportunity to reinforce the role of mortgage brokers (remembering the Royal Commission, out soon, will likely opine on broker commissions).
They said:
Australia’s home loan market is enjoying record levels of competition driven by mortgage brokers, with new lending data released today revealing the market share of non-bank lenders is higher than ever.
And latest industry figures reveal consumers are increasingly relying on mortgage brokers for help, with three out of every five mortgages in Australia now generated through mortgage brokers.
As the financial services sector prepares for next month’s release of the Financial Services Royal Commission’s final report, the AFG quarterly Mortgage Index confirmed the crucial role played by mortgage brokers in creating a competitive home loan market.
It also provides a timely warning to policymakers of the importance of ensuring the availability of credit and consumer choice do not become sacrificial lambs in the regulatory response to the Royal Commission
recommendations.
AFG lodged $13 billion in home lending applications for the final quarter of 2018, down 8% on the prior quarter.
Credit tightening is having an impact on volumes in every state – however, the Sydney and Melbourne property markets have been the most significantly impacted.
“Customers must be kept first and foremost in any discussion of changes to the financial sector,” said AFG Chief
Executive Officer David Bailey. “Although overall volumes are down our brokers still lodged over 25,000 applications for borrowers during the quarter. This is a fraction of the number of consumers they help with post-settlement and ongoing reviews and support.
“AFG now has more than 50 lenders on our panel and in clear evidence of the vital role mortgage brokers play in delivering a competitive home loan market, non-major lenders’ market share is at a record high of 42.1%.
“The non-majors are becoming an increasingly important part of the assistance brokers provide to customers. Penetration has increased across all categories of borrowers, with non-major market share gains recorded for Refinancers (now 46.8%), Upgraders (42%), First home buyers (32.1%) and Investors (43.4%).”
New Mortgage & Finance Association of Australia (MFAA) data shows mortgage broker market share has grown to 59.1%, reinforcing that consumers are increasingly turning to brokers for their expertise as the market becomes increasingly complex.
The record market share for mortgage brokers was the strongest evidence that consumers were more than satisfied with the customer service provided by brokers, Mr Bailey said.
“A spike in those choosing to fix their interest rates indicates borrowers are bracing for more bank-led rate rises, with quarterly volumes increasing from 19% to 23.1%.
“Notably, the major lenders’ market share of Interest Only and Investment lending has stabilised after APRA’s easing of caps.”
January 24th 2019
According to Moody’s on 15 January, UK Financial Conduct Authority (FCA) chief Executive Andrew Bailey, reiterated the organisation’s intention to improve so-called mortgage prisoners’ access to refinancing by relaxing current mortgage affordability regulations that preclude them refinancing into cheaper mortgage deals because they fail to meet affordability standards that were tightened in 2016.
Relaxing the mortgage affordability parameters for refinancing such borrowers’ mortgages would be credit positive for more than 60 UK RMBS securitisations containing pre-crisis assets, which equate to more than £29.0 billion of outstanding bonds.
The FCA has suggested that authorised UK lenders would be willing to refinance such mortgage prisoners if the borrower qualified for refinancing under the new rules, which would require the new mortgage installments to be lower than previous installments and for the borrower to be up to date with their payments. The new rules would replace current affordability tests for these borrowers, which make sure a borrower has enough money left to pay their mortgage installments in a stressed interest rate environment after covering all other basic needs (e.g. bills, food, childcare).
At present, a borrower refinancing with its current lender does not always require affordability re-testing, but some lenders, such as Southern Pacific Mortgage Limited and Bradford & Bingley plc, have stopped originating loans in recent years. Furthermore, a significant number of mortgage loans were sold to entities that are not authorised lenders, such as private equity firms or investment banks. In both cases, those affected borrowers can only refinance with new lenders, thus falling under the stricter affordability testing introduced post- crisis. FCA estimates that there are about 140,000 affected borrowers, 120,000 whose loans are owned by firms not authorised to lend and 20,000 borrowers whose lenders are inactive.
Moody’s expect performance to improve for securitisations containing legacy assets if the changes are enacted. The majority of mortgage prisoners’ installments accrue interest at relatively high floating rates. Therefore, their mortgage installments will increase in the event of an increased base rate, as is currently expected in the UK. Higher rates make affordability more challenging and have the potential to cause additional defaults.
If those borrowers can refinance at a lower interest rate, the mortgage loans instead exit the securitisation pools early, leading to increased credit enhancement for remaining noteholders and reduced future losses.
The exemption will have the greatest positive effect for more recent securitisations of pre-crisis mortgage loans because the majority of recent securitisations of legacy assets have been cleaned of arrears loans.
Transactions that closed prior to 2009, while also benefiting from the early repayment of loans and increased credit enhancement, are typically smaller in size and also usually already contain a high proportion of loans in arrears. Hence the redemption of loans by mortgage prisoners will tend to concentrate the pools’ exposure to loans with borrowers having real affordability problems.
Fitch published their Global Home Housing And Mortgage Outlook for 2019. The story appears to one of falling values in some major centres and more uncertainty economically and politically. For Australia, they expect a national peak-to-trough home price drop of 12% in Australia with Sydney and Melbourne posting larger declines in 2019.
They say overheated home prices in several major cities have been a key theme in recent years. But prices fell or stalled in 2018 in Melbourne, Stockholm, Sydney, Toronto and Vancouver due to government actions to reduce foreign purchases, macro-prudential measures and/or stretched affordability. Fitch Ratings forecasts home prices to fall in Australia and Sweden in 2019 before stabilising in 2020, modest corrections in China and South Korea, and stalled growth in Canada. We have also seen regulators actively managing markets through the tightening and loosening of lending rules.
High Household Debt Amplifies Risks
Fitch says household debt-to-GDP ratios are at or over 100% in Australia, Canada, Denmark, the Netherlands and Norway, and over 85% in New Zealand, South Korea, Sweden and the UK. High household debt makes the wider economies more vulnerable to shocks in the financial sector and borrowers more exposed to downturns. Household debt growth has stalled in Denmark and the Netherlands due to affordability constraints and regulatory intervention. The household debt-to-GDP ratios in Australia,
Canada and Norway have stabilised after sharp growth while they have continued to grow in China and South Korea, albeit at a slower pace.
Political Uncertainty Affects Housing
Fitch highlights several cases of political risks in the report, including Brexit, a political appointment to oversee Fannie Mae and Freddie Mac, and new governments in Latin America. Their impact varies: our no-deal Brexit scenario analysis suggests price drops in the UK and much slower price growth in Ireland while uncertainty is already contributing to price falls in London; less government participation in the US mortgage market could
increase mortgage pricing and lead some lenders to reduce product offerings; in Brazil, there is uncertainty regarding the new government’s ability to enact market-friendly policies that would support home price growth.
Cracks Appear in Economic Growth Outlook
Fitch notes in its Global Economic Outlook that cracks are starting to appear in the global growth picture, with China and the eurozone slowing, further rate increases expected in the US, stubbornly low core inflation in the eurozone and Japan, and the dollar’s strength putting pressure on emerging markets.
These factors contribute to Fitch’s view that economic growth is slowing, albeit to a moderate degree and in many cases from a position of strength. However, our macroeconomic outlooks to 2020 for the 24 countries in this report are still mainly stable or improving, which supports our mostly stable housing and mortgage market evaluations.
Arrears Concerns Beyond 2020
Fitch does not forecast material increases in arrears in 2019 and 2020 for any country in the report. We expect the impact from weaker growth and generally slow mortgage rate rises to be relatively benign. But there is downside pressure in the medium term from rising rates, fading fiscal stimulus in the US and weaker growth in China, in the context of still high global debt. A faster-than-expected tightening in global financial conditions could worsen mortgage performance.
Mixed Impact from Rising Rates
The speed of mortgage rate rises will vary with North America expected to post the fastest increases and Japan and the eurozone the slowest. The impact will depend on whether mortgages have long-term fixed rates and the macroeconomic backdrop. Highly leveraged markets with large numbers of variable-rate loans, such as Australia, Norway, Sweden and the
UK, could see marked deterioration in loan performance should rates rise quickly. Markets with long-term fixed-rate loans, such as Belgium, France, Latin America, the Netherlands and the US, may see lenders gradually increase their appetite for higher-risk borrower and loan characteristics as their profitability suffers and competition intensifies.
Price Declines Set to Continue In Australia
Fitch forecasts a national home price decline of an additional 5% in 2019 before above-trend GDP growth and strong net migration should stabilise prices in 2020. The peak-to-trough decline of 6.7% as of December 2018 has been driven by lower investor demand reflecting macro-prudential limits on interest-only and investment lending, and tighter enforcement
of lending standards.
They expect price declines to continue at a similar pace in 2019 in Sydney and Melbourne, where larger falls have occurred (peak-to-trough declines of 11.1% and 7.2%, respectively, as of December 2018). The most expensive quartile of properties has experienced the largest declines with falls of 9.5%.
GDP Growth Supports Performance
They forecast loans in arrears over 90 days to increase slightly to 70bp by 2020. Properties in possession will take longer to sell as home prices fall, so loans will remain delinquent for longer. Early-stage mortgage arrears (30 to 90 days in arrears) will be broadly stable in 2019 at 60bp even though lenders have modestly raised mortgage rates for investment and interest only loans despite no policy rate increases. Mortgage performance will be supported by slowing but still solid economic growth, decreasing unemployment and only gradually rising policy and mortgage rates. Risks remain, stemming from the highest household-debt-to-GDP ratio in this
report at 121% as of 2Q 2018.
Credit Growth to Remain Low
Housing credit growth is projected to ease further in 2019 to 3.5% from 5.1% yoy growth in October 2018. This is due to tightened macro-prudential limits and a more conservative interpretation of regulatory guidelines for mortgage servicing in light of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry. Fitch believes
the commission’s final recommendations, due in February, may further reduce credit availability.
Investment loan origination has been hit by a limit to investment loan growth of 10% (introduced in 2014 and removed in July 2018 for lenders that can prove they have met regulatory requirements for the past six months) and a limit of interest-only origination to 30% of new lending (introduced in 2017 and removed from January 2019 for lenders that have
met regulatory requirements for the past six months) along with foreign investor levies and taxes from state governments.
The latest data from our surveys indicates that around 40% of loan applications for mortgages were rejected in December 2018, compared with 8% a year prior, though on significantly lower absolute volumes. Households often made multiple applications when seeking a loan.
The volume of applications across all segments fell in the lead up to the holidays, and the proportion of rejections fell from 48% the prior month, which was a record.
The fall in investor applications is significant, as appetite for investment property eases. The relative volume of refinance applications remained quite high, as people are seeking to reduce their monthly repayments.
Non Bank rejections are running a much lower rates than bank rejections.
The second wave of out-of-cycle mortgage rate hikes has continued, with another lender announcing increases of up to 20 basis points, via The Adviser.
NAB-owned lender UBank has announced that it has increased interest rates on its fixed rate investor home loan products by 20 basis points, effective for new loans issued as of 14 January.
The lender’s investor mortgage rate increases are as follows:
UBank is the latest lender to increase its home loan rates, after the Bank of Queensland (BOQ) and Virgin Money announced rate increase of up to 18bps and 20bps, respectively.
Both BOQ and Virgin Money attributed their decisions to lift home loan rates to the sustained rise in wholesale funding costs.
The out-of-cycle interest rate rises have prompted calls from some market analysts for a cut to the official cash rate form the Reserve Bank of Australia (RBA) amid weakening housing market conditions and a rise in mortgage stress.
Speaking to The Adviser’s sister publication, Mortgage Business, principal of Digital Finance Analytics (DFA) Martin North said that he expects mortgage stress to continue mounting in the short to medium term, particularly off the back of out-of-cycle interest rate hikes.
Digital Finance Analytics (DFA) has released the December 2018 mortgage stress and default analysis update.
The latest RBA data on household debt to income to September fell a little to 188.6[1], but still remains highly elevated. The housing debt ratio continues to climb to a new record of 139.6, according to the RBA. This shows that household debt to income is still increasing.
This high debt level helps to
explain the fact that mortgage stress continues to rise. Across Australia, more
than 1,023,906 households are estimated to be now in mortgage stress (last
month 1,015,600), another new record. This equates to 31% of owner occupied
borrowing households. In addition, more than 22,000 of these are in severe
stress. We estimate that more than 62,000 households risk 30-day default in the
next 12 months. We continue to see the impact of flat wages growth, rising
living costs and higher real mortgage rates. Bank losses are likely to rise a little ahead.
Our analysis uses the DFA core market model which combines information from our 52,000 household surveys, public data from the RBA, ABS and APRA; and private data from lenders and aggregators. The data is current to the end of December 2018. We analyse household cash flow based on real incomes, outgoings and mortgage repayments, rather than using an arbitrary 30% of income.
Households are defined as “stressed” when net income (or cash flow) does not cover ongoing costs. They may or may not have access to other available assets, and some have paid ahead, but households in mild stress have little leeway in their cash flows, whereas those in severe stress are unable to meet repayments from current income. In both cases, households manage this deficit by cutting back on spending, putting more on credit cards and seeking to refinance, restructure or sell their home. Those in severe stress are more likely to be seeking hardship assistance and are often forced to sell.
The accumulation of larger mortgages compared to income whilst costs are rising and incomes static explains the issues we are now seeing. Continued rises in living costs – notably child care, school fees and fuel – whilst real incomes continue to fall; and underemployment are causing significant pain. Many are dipping into savings to support their finances. The latest ABS GDP numbers confirmed the falling savings ratio.
Indeed, the fact that significant numbers of households have had their potential borrowing power crimped by lending standards belatedly being tightened, and are therefore mortgage prisoners, is significant. More than 49% of those seeking to refinance are now having difficulty. This is strongly aligned to those who are registering as stressed. These are households urgently trying to reduce their monthly outgoings”.
The next question to consider is which households are being impacted. In fact, negative equity is touching “lots of different segments” of the market for different reasons, but collectively it is an “early warning sign” for what is to come.
Probability of default extends our mortgage stress analysis by overlaying economic indicators such as employment, future wage growth and cpi changes. Our Core Market Model also examines the potential of portfolio risk of loss in basis point and value terms. Losses are likely to be higher among more affluent households, contrary to the popular belief that affluent households are well protected. This is shown in the segment analysis below:
Stress by the numbers.
Regional analysis shows that NSW has 278,959 households in stress (281,275 last month), VIC 285,723 (283,395 last month), QLD 180,794 (181,156 last month) and WA has 135,548 (132,135 last month). The probability of default over the next 12 months rose, with around 11,650 in WA, around 11,600 in QLD, 15,600 in VIC and 16,600 in NSW.
The largest financial losses
relating to bank write-offs reside in NSW ($1.1 billion) from Owner Occupied
borrowers) and VIC ($1.48 billion) from Owner Occupied Borrowers, though losses
are likely to be highest in WA at 3.6 basis points, which equates to $1,022
million from Owner Occupied borrowers.
A fuller regional breakdown is set out below.
[1] RBA E2 Household Finances – Selected Ratios September 2018
You can request our media release. Note this will NOT automatically send you our research updates, for that register here.
[contact-form to=’mnorth@digitalfinanceanalytics.com’ subject=’Request The December 2018 Stress Release’][contact-field label=’Name’ type=’name’ required=’1’/][contact-field label=’Email’ type=’email’ required=’1’/][contact-field label=’Email Me The December 2018 Media Release’ type=’radio’ required=’1′ options=’Yes Please’/][contact-field label=”Comment If You Like” type=”textarea”/][/contact-form]
Note that the detailed results from our surveys and analysis are made available to our paying clients.
Bankwest has reduced owner occupier rates on its Complete Variable, Premium Select and Complete Fixed Home Loans, as of today (8 January) for new borrowers with deposits of more than 20%, via Australian Broker.
It has also introduced a new pricing tier for borrowers with a deposit of up to 10%.
The interest rates have reduced by up to 18 basis points and are for new borrowers with principal and interest repayments.
For borrowers taking out a Complete Variable Home Loan and a loan to value ratio of less than 80%, the variable rate has dropped from 3.85% per annum to 3.72%.
Borrowers with a loan to value ratio of between 80.01% and 90% will not see any change and will therefore now have a higher interest rate of 3.85%.
For new borrowers taking out a Premium Select Home Loan, the interest rates have also only changed for borrowers with loan to value ratios of less than 80%.
If the loan amount is between $20k and $499k, the interest rate has dropped from 4.00% to 3.82%.
For loans of more than $500k, the loan has also dropped to 3.82%, from an original rate of 3.94%.
The new pricing tier for borrowers with a loan to value ratio of up to 90% on a two-year term Complete Fixed Home Loan sees the interest rate drop from 3.88% to 3.75%.
Bankwest also started the new year implementing its decision to remove reverse mortgages from its offering from 1 January.
Other banks which have decreased interest rates at the start of 2019 are IMB and P&N Bank, both of whom are still offering reverse mortgages.
IMB dropped its variable interest rates for owner occupiers by up to 43 basis points.
P&N Bank dropped its fixed rates for owner occupiers by up to 36 basis points and also for investors by up to 49 basis points.
I discussed the Treasurer’s comments today, that the banks should be lending more, on ABC News 24. It came directly after a package on his announcement.