We will delve into the detail later, but three charts tell the story, looking across the market of ADI’s with more than $1 billion of loans.
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First, the number of loans being approved outside current serviceability standards has lifted to around 5% of all new loans. This reflects tighter controls in the banks, so they narrowed the serviceability aperture. But is also suggests that some loans are still getting funded under questionable parameters. Remember loan underwriting standards continue to tighten, so this will be an important measure to watch ahead.
Second, the volume and share of loans via brokers, having reach a peak last year look to be falling, reflecting first lower absolute volumes of new loans, and second a preference by the banks to use their own channels. We will be watching the mix by channel in the months ahead, our thesis is mortgage brokers are going to have to work a lot harder down the track!
And third, the doozy, the share of interest only new loans have fallen to 15% of loans, and the value written in also down. So the APRA inspired intervention (better late then never) is hitting home. Again we need to watch whether there is a rebound as settings are tweaked to try and keep home prices falling further.
OK, I lied, there is a fourth slide. Despite all the tightening, the total balances grew again in March to $1.6 trillion, despite investment loans falling to 33.8% of the portfolio. So lets be clear, household debt is still rising, with investment loans rising 0.4% in the quarter and owner occupied loans rising by 2%. Or over the past year, 2.6% and 8% respectively. Still too hot in the current climate, in my view. So more tightening is needed, and I suspect a harder Debt to Income hurdle of 6% is where it will bite.
AFG has released their latest market report to May 2018. This may be a somewhat myopic picture, given it looks at business written via AFG. It also only gives a relative share so tells us nothing about total volumes written (which will be down across the board in our view). AFG white label products continue to grow to 11.7% of their flows in May, ahead of Westpac (9.4%) and NAB (9.5%).
The AFG Competition Index released today shows further evidence of a structural shift in the Australian lending market as non-major lenders again seize market share from the majors. Non-major lenders have seen their overall market share of new loans hit a record 40.97% in May 2018.
AFG General Manager – Broker & Residential, Mark Hewitt explained the results: “The major lenders’ share of new business is declining, with their overall market share continuing a five-month slide to be sitting at 59% at the end of last month.
Among the majors Westpac and its subsidiaries Bank of Melbourne, Bank SA and St George have been hardest hit, with each of their brands recording a drop in market share.
The borrowers turning to non-major lenders in greatest numbers are those seeking to fix their interest rates, with market share for the non-majors in this category steadily increasing to finish the quarter at 32.57%.
“ING and Suncorp are the non-major lenders of choice for fixed products, with their share of the fixed rate market sitting at 6.08% and 5.39% respectively.
“The major lenders have been pulling back from the investor market to meet regulatory caps and as a result the non-majors are filling the gap in the market,” said Mr Hewitt. “Non-major market share among investors rose from 33.52% in February to 42.35% at the end of the quarter – an increase of 26%.
“Macquarie is proving popular with those looking to refinance, recording a market share overall of 5.63% but 8.33% in the refinancing category. Virgin Money has made rapid inroads in the short time they have been on AFG’s panel, with their share of the market in the same category rising from 0.1% to 0.86% in three months.
DFA analysis of the AFG data also shows the non banks like Pepper Money are growing relative to other players, which confirms our thesis that the non-banks are making hay as the markets rotate.
“First home buyers looking for a simple, low cost mortgage product have found it in AFG Home Loans with market share for AFG’s white label products rising across the quarter for this category from 4.76% in February to finish at 6.3% by the end of May. Teachers’ Mutual Bank also recorded an increase in market share among first home buyers, lifting from 2.8% to 3.14% for the quarter.
These figures show that competition is alive and well in the Australian lending market. The continued preference by consumers for mortgage brokers and the choice they deliver over major bank branches, demonstrates that brokers are delivering the right consumer outcomes,” he concluded.
Mortgage Choice, the ASX-listed broking group has responded to media criticism regarding a high-sales culture and poor remuneration structures for franchisees, saying that it is working closely with franchisees to assist them in growing their business.
Mortgage Choice responded to the reports from the Sydney Morning Herald and the ABC’s 7:30 program, suggesting that its franchise system — which was introduced 25 years ago when the group was established by multimillionaire brothers Peter and Rodney Higgins — was in need of update.
“The market has evolved, with other business models being introduced, specifically aggregator models that have higher payouts but don’t offer the same level of support services,” Mortgage Choice said in a statement.
The brokerage acknowledged that the balance between services offered and remuneration “needs adjusting” to encourage franchisees to invest in their businesses. As such, the group has said that it will be undertaking a review of its franchisee remuneration structure, with a view of implementing a “more competitive” model.
Mortgage Choice has been consulting with its franchisees regarding a new remuneration model “to underpin long-term sustainable growth” and attract “new high-quality businesses to the franchise network”.
The company has reportedly been undertaking a “confidential and collaborative process” to update the remuneration model, which has included numerous workshops across Australia with franchisees and reviewing more than 30 different remuneration structures.
Subject to discussions with its franchise network and board approval, the new remuneration model would be introduced by August 2018.
Speaking following the media reports, Mortgage Choice CEO Susan Mitchell said: “We acknowledge that our model is outdated, it needs to be more flexible, it needs to be less volatile in the way it pays our franchisees.”
She continued: “Our business was started as a full service model. All the services that were need to help a broker start their own business, providing brand, marketing, IT, compliance, training and all those sorts of things.
“Over the years, since the introduction of the Mortgage Choice model, there have been other models that have been introduced — aggregator models — that pay out a higher proportion of income but don’t offer the same level of service. So what’s happened is, I believe, our balance between remuneration and provision of service has gotten out of kilter, so we just need to address that balance between remuneration and service provision.”
The new CEO said that one of the most important things she wanted to do as CEO was to “drive a change process”, and her “first priority was to change this model”.
Indeed, the need for updating the commission model has been further emphasised by the findings of the 2018 Momentum Intelligence Broker Group of Choice: Switching Aggregators report.
Based on a survey of mortgage brokers from across Australia, Mortgage Choice was rated the lowest of nine groups, with 90 per cent of Mortgage Choice brokers saying that the number one reason they would leave the group would be because of its commission structure.
However, the group did score highly for it compliance assistance.
Allegations of poor behaviour “strongly refuted”
Addressing some of the allegations in the 7.30 report, the CEO said that the company “strongly refutes allegations in the media that its current model encourages poor behaviour or practices”. It added that the company has in place “robust” compliance processes and credit policy controls, which franchisees must adhere to.
Ms Mitchell said: “Our franchisees are very diligent and want to do the right thing for their customers. We take any allegation of fraudulent behaviour extremely seriously and we have a very thorough and structured compliance regime in place.”
Several commentors on The Adviser website have also voiced their frustration with the misrepresentation, with Renee saying: “I have owned a Mortgage Choice franchise for nearly four years and the model has assisted me in building a successful business that I am very proud of.
“These recent media allegations are not a reflection of my experience with Mortgage Choice or a reflection of how I do business, and it’s disappointing that I am put in a position to have to defend this. Doing the right thing by our customers, and being known for this, is how my business has grown, and this will continue to be our priority.”
Likewise, Mortgage Choice franchise owner Maria Zappia said that while she supports the right to “demand a more consistent payment model”, she absolutely “refute[s] out of hand any suggestions displayed in recent media reports that ‘desperate times have called for desperate measures’ in terms of fraud or any other wrongdoing”.
The commenter said: “I have been with this business 15 years and have worked hard to build a strong vibrant business, as so many of my fellow franchise owners have done. I can assure you we have (and have had for quite some time) one of the most stringent compliance regimes of any aggregator in this country. We are well known among our panel of lenders, including all of the major banks, for the high quality of our loan submissions. Very importantly, we are well known among our many thousands of customers for our incredible levels of customer service.
“The challenges of running a small business in this industry are many, but those of us who choose this path do so with the utmost integrity and always in the best interests of our clients.”
She continued: “At Mortgage Choice, we are in the midst of great change and I’m convinced that our CEO Susan Mitchell, together with the executive team and our board, ha[s] matters well in hand and [is] committed to delivering a remuneration solution that will benefit all franchise owners. Let’s give them every opportunity to finish the job.”
Noting some of the suggestions that brokers have been affected by stress-induced health issues as a result of financial distress from running a franchise, Ms Mitchell said that she did not believe it was a “fair representation” of Mortgage Choice.
The CEO said: “It’s very difficult to run a small business in Australia today, and one of the reasons why you would join a franchise organisation like Mortgage Choice is we help you do that, and you have a higher chance of success by doing that.
“Having said that, as CEO, there have been circumstances where I worked one on one with franchisees on a confidential basis to help them when they had hardship or health issues.
“So, I think the important thing is we want to help franchisees through their issues. They just need to come and talk to use about them, and we’ll proactively work with them for a solution tailored to their needs.”
Ms Mitchell continued: “The wellbeing of our franchisees is our number one concern.
“We provide any business owner experiencing hardship with personalised support, including from our field‐based teams.”
She concluded: “We are well progressed in consulting with franchisees on a new remuneration model that will help them to succeed and invest in growing their businesses.”
According to the SMH, a joint media investigation by Fairfax and ABC’s 7.30 can reveal scores of current and former franchisees have been financially devastated after signing up to the high profile brand.
One of the country’s biggest mortgage brokers, Mortgage Choice, is in damage control as it faces an uprising from its franchisees on the back of a business model that is pushing many into financial ruin, depression and cutting corners on arranging loans.
Confidential documents show as many as 173 franchisees, almost half the franchisees in the system, are considering setting up a fighting fund to take legal action if the company doesn’t make the relationship fairer. Late last year they agreed to commit almost $200,000 to set up the fund if their demands aren’t met.
The investigation can reveal that a harsh business model and remuneration structure is pushing franchisees to cut corners, including churning customers, writing inflated loans to meet aggressive targets and in some cases committing fraud.
Mortgage Choice, which has a loan book worth $54 billion, has been making record profits for its shareholders, which include Commonwealth Bank and the founders, the Higgins brothers, who also sit on the board.
On Monday, shortly after being contacted by the joint investigation, Mortgage Choice issued a statement to the ASX saying it was reviewing its franchisee remuneration structure. It says the purpose of an “updated remuneration model was to increase franchisee remuneration and reduce franchisee income volatility to allow them to grow their businesses and assist more customers with their home loan needs.
Mortgage Choice has announced that it has been consulting with its franchisees regarding a new remuneration model “to underpin long-term sustainable growth” and attract “new high-quality businesses to the franchise network”.
Subject to discussions with its franchise network and board approval, the new remuneration model would be introduced in the 2019 financial year (FY2019).
According to Mortgage Choice, the new model is aimed at increasing remuneration and reducing the income volatility of its franchise network.
The brokerage also stated that its management is conducting a further series of state-based workshops with its franchise network over the coming weeks to discuss the merits of the new model.
Mortgage Choice claimed that it has considered a number of remuneration alternatives off the back of independent market analysis.
The financial services provider also stressed that it will continue providing technological, marketing, compliance and training services to its franchisees.
Further, Mortgage Choice is set to initiate a training program to improve operating efficiencies across its business in order to partially offset any increases to the average payout to franchisees.
Additionally, the brokerage noted that it will continue to invest in new technology to boost franchisee productivity and enhance the customer experience.
“These changes are designed to support the long-term sustainable growth of Mortgage Choice, increase franchisee remuneration and attract new high-quality franchisees to our network,” CEO of Mortgage Choice Susan Mitchell said.
“We want to continue to help Australians with their financial services needs for many years to come, and having thriving, growing franchises that have confidence to invest in their business is critical to achieving this.”
The financial services provider expects to finalise its new remuneration model in July 2018 and to implement the model across the network on an opt-in basis in August 2018.
Mortgage Choice added that it would inform the market on key features of the revised remuneration structure once it has been determined and approved.
The brokerage insisted that a change in its remuneration model would not affect the FY2018 cash result, but it noted that market updates would include guidance on a one-off adjustment to the FY2018 IFRS result based on the change to the average payout rate to the franchisees once it is identified.
The enhanced focus on mortgage lending serviceability means that a consideration of the loan to income ratio or LTI is ever more important.
In the UK, where LTI calculations are the norm, the Bank of England first introduced limits on high LTI mortgages in 2014. These measures meant that no more than 15 per cent of mortgages issued should exceed a loan-to-income ratio of 4.5. The actions were not retrospective and few British lenders were impacted by the curbs.
The UK’s 4.5 LTI cap on 85 per cent of new lending is still in place. In June last year, Bank of England governor Mark Carney announced that the 4.5 ratio “insurance measures” will become “structural features of the UK housing market.
Last month, APRA, the prudential regulator announced that it would remove its 10 per cent benchmark on investor loan growth for banks that could confirm that their policies and practices meet a range of expectations.
But one of APRA’s expectations for banks is a commitment to develop
internal risk appetite limits on the proportion of new lending at very high debt-to-income levels (where debt is greater than six times a borrower’s income) and policy limits on maximum debt-to-income levels for individual borrowers.
So, it should be of no surprise to note that the Commonwealth Bank of Australia has announced that it has brought in its new debt-to-income measurement for borrowers.
CBA, who is the largest owner occupied mortgage lender in Australia has disclosed that it will now “monitor” loan applications with a debt-to-income ratio higher than 4.5 and will also bring in a new e-learning requirement for brokers that have not settled a CBA loan for more than a year. Applications with a DTI higher than 7.0 will be subject to a manual credit approval check.
The new measure will reportedly help the bank get a clearer picture of what its book looks like and to understand trends. Speaking of the decision, Daniel Huggins, CBA’s executive general manager, home buying, said:
At the Commonwealth Bank, we constantly review and monitor our home loan processes and policies to ensure we are maintaining our prudent lending standards and meeting our customers’ home buying needs. Our decision to implement a new debt-to-income measure is just another example of our ongoing commitment to responsible lending and meeting our regulatory commitments.
Last year, NAB introduced an LTI ratio calculation of 8 for all home loan applications. In February, this year, it was reduced to 7 a still generous 7 times.
The bank said at the time.
NAB is committed to lending responsibly and ensuring our customers can meet their home loan repayments today and into the future.
Now we have been looking at the current portfolio view of all mortgages in Australia from an LTI perspective using data from our core market model. This is based on our rolling survey of 52,000 households each year.
The relative distribution across the LTI bands highlights relative risks in the system.
We took a cut off of 6 times, in line with the APRA guidelines. On an all portfolio basis, across the country around 7.9% of all loans have a current loan to income ratio of 6 times or more. This is based on current loan values and current incomes, not those considered at the inception of the loan.
But there are some significant state variations, for example, loans in Western Australia have 6% of loans with an LTI of 6 or above. In the west the proportion is rising as incomes remain constrained, despite loans growing a little. This is thanks partly to capital being released via refinancing.
In South Australia, only a very small proportion of loans have a loan to income of 6 times or more.
In Queensland, the total proportion above 6 times is 2.8%.
However things get more interesting in the eastern states, with 7.1% of households in Victoria holding a loan to income ratio of 6 times or higher.
But the prize goes to New South Wales with a massive 15.8% of households currently holding loans with a loan to income ratio of 6 or more. This is of course explained by the high prices, big mortgages, and lose lending standards.
This analysis provides some insights into the pressures on households, as this higher multiples are indicative of larger payments being made to service the loan.
Thus we conclude the most severe issues will be found in NSW, where of course house prices are now firmly on the slide.
We will publish our latest mortgage stress data, to the end of May early next week. Finally, consider this, when I was a banker, the rule of thumb was 3 times one income plus 1 time the second. How the world has changed!
The CEO of online mortgage lender Tic:Toc Home Loans says that no human judgement need enter the equation when it comes to assessing the expenses of a mortgage applicant.
With the first weeks of the banking royal commission now behind us, Tic:Toc founder and CEO Anthony Baum believes it has become clear that there is an opportunity for the mortgage industry to reconsider how customers are assessed for finance.
“One key flaw that’s been exposed is the failure to conduct basic checks and balances on the applicants’ household expenses. This includes instances where judgement on a customer’s borrowing capacity has been handed to a raft of questionable third parties,” the CEO said.
“The truth is, no human judgement need enter the equation when it’s possible to check up to a year of personal expenses at the click of a button. There’s no grey area for the vast majority of cases.
“It really is that simple — and quick. For the exceptions, a combination of digital and human assessment is the most efficient and responsible way to assess a customer. Plus, automated assessment makes the whole approval process far cheaper, and faster, for a bank than the current process.”
Tic:Toc Home Loans is one of a growing number of new entrants aiming to simplify the mortgage process by harnessing digital technologies and online channels.
Unlike some fintech players looking to disrupt the home loan market, Mr Baum has extensive industry experience, having led Bendigo and Adelaide Bank’s third-party business for close to four years.
The threat of digital disruption has increased for brokers in recent years. However, many still believe that face-to-face contact with a mortgage professional will continue to be the preferred choice for Australian borrowers.
“My opinion is home loans are not actually as complicated as the industry makes out,” Mr Baum said. “They are really a means to an end, which is more a utility-style product.
“As the CEO of an online home loan company that bases its work on the latest financial technology, I find it hard to get behind the idea that generic reference points, such as the Household Expenditure Measure, and personal judgement are being used as an integral part of the approval process, especially now we are hearing about the true cost for those on the receiving end of the so-called ‘Liar Loans’.
“The royal commission is looking at historical banking issues. And while it is vitally important we expose nefarious practices to sunlight, my concern is that there will be no industry-wide visionary leadership and legislative framework as an outcome. This is the industry’s opportunity to create a future strategy that leverages the data and technologies available to the benefit of the customer, increases the relevance of Australian financial services globally, and protects everyday Australians in the process.”
Mr Baum believes that the onus is on industry players, banks, technology providers and the government to ensure real change is enacted.
“I may make myself deeply unpopular for saying this, but that needs to include far tighter compliance, regulation and independent oversight,” the CEO said, adding that Tic:Toc would like to see legislation around data capture, storage and usage within an institutional environment.
“Data is the new cash in a banking environment, yet, other than privacy, there’s limited regulation to guard it in the same way as we do a vault. Plenty of companies are doing the right thing, but until there’s a compliance structure in place, many players, large ones included, will continue to flaunt the guidelines for their own gain.”
From Guest Blogger Alex Petrovic – currently working as finance content contributor.
Australia’s gig economy has been on the rise for a number of years, and new data by the Australian Bureau of Statistics (ABS) reveals that the number of workers considered to be part of this economy is still growing. From Deliveroo to Uber and Upwork, people are increasingly turning to jobs that offer a better work-life balance.
But what does this mean for gig economy workers seeking a home loan? With more Australians becoming self-employed, demand from these borrowers is set to increase, and lenders will need to adapt to meet their needs.
The rise of the gig economy
Gig economy work is growing around the world, not just in Australia. With the spread of mobile internet connectivity and platform websites such as 99designs, Airtasker, and Freelancer, people can now work from anywhere they like, whether that’s at home or from their local café.
It’s an attractive option for many people who are seeking a better work-life balance, yet doing short spells of contract work or completing work for a range of employers can make things more challenging when it comes to securing a home loan.
The difficulty of securing a home loan
Following the global financial crisis, self-employed borrowers faced even more significant challenges securing a mortgage. When you’re your own boss, income isn’t always steady, and without a history of up to three years’ worth of accounts or payslips, it can be far more difficult to obtain verification.
Banks became far less willing to lend to those they regarded as being riskier than your more traditional borrower with a standard income. For a potential borrower with enough savings and income to pay their deposit and keep up with repayments, being refused merely for having a non-standard income can be incredibly frustrating.
While self-employment has been on the rise for some time, securing a home loan is still proving difficult for many Australians. In fact, a recent survey revealed that one in five have been turned down for a loan, and of these, 26% were declined because they were self-employed or working part-time.
What is perhaps more worrying, is that more than half of those who were declined for a loan at a bank were not aware that other options are available. Non-bank lenders can help sole traders when it comes to securing a mortgage. By assessing applications on a case-by-case basis and having a more flexible approach to the type of documentation they can use to conduct their lending assessments, they may be able to help where other lenders cannot.
This flexibility isn’t just about giving borrowers other options; using documentation such as accountant letters, bank statements, and business activity statements can actually provide lenders with a more current picture than some traditional forms of documentation might.
While some may have concerns that these types of lenders will charge much higher interest rates, what you’ll find is that they actually offer very competitive rates. For example, the lowest interest rate from Commonwealth bank is 3.79%, although rates do vary depending on the loan to valuation ratio (LVR).
Time for a change
What the larger financial institutions have done is essentially create a void by only focusing on one type of customer. Old style policies must be adapted to suit newer generations and those working in the gig economy.
Banks should follow the lead of non-bank lenders, who offer a more flexible approach and look at the whole picture of an individual’s circumstance to gain a better understanding of potential borrowers. There is no need to loosen lending criteria; it’s about staying current and helping this underserviced market find a solution that meets their needs.
APRA has released their monthly banking statistics for ADI’s to April 2018. And now we are really seeing the tighter lending standards biting. In fact, Westpac apart, all the majors have reduced their investor property lending.
APRA reports for each lender the net total balance outstanding at the end of each month and by looking at the trends we see the net of loan roll offs and new loans. This is important, as we will see.
At the aggregate level, total lending for mortgages from ADI’s rose 0.2% in the month, up $3.0 billion to $1.62 trillion. Within that owner occupied loans grew by 0.29% or $3.1 billion to $1.07 trillion while investment loans fell slightly, down 0.01% of $42 million. As a result the relative share of investment loans fell to 34.14%.
The trend movement highlights the significance of the fall (the August 2017 point is an outlier thanks to reclassification), this is the weakest result for years. At an aggregate level, over 12 months this would translate to a rise of just 2.3%, significantly down from the 5-6% range of recent months.
Turning to the individual market shares, at the aggregate level there was little change, other than Westpac’s share of investor loans grew to 27.6%, up from 26.1% in January 2016
Here is the trends from the big four. Westpac has continued to increase share of investor loans. CBA has fallen away the most significantly.
There has been almost no shift in owner occupied loan shares.
The monthly changes in value tell the story, with Westpac and Macquarie growing the value of their portfolios, across both owner occupied and investment lending. We see falls in net investor lending elsewhere.
We conclude that Westpac executed a different strategy in terms of mortgage origination compared with its competitors. They may be offering selective discounts to attract particular types of business, or they may have different lending standards, or both.
It is quite possible we will see other lenders trying to compete relative to Westpac in the investment loan domain ahead, as lending growth is needed to sustain profitability. But demand is also falling, so we expect lending momentum to continue to weaken, with the consequential impact on home prices and bank profitability. We are entering credit crunch territory!
At first blush the news at home and abroad appears to be steering us towards our most risky – scenario 4 outcome, where global financial markets are disrupted and home prices fall by 20-40 percent or more as confidence wains.
Some would call this GFC 2.0. So let’s looks at the evidence.
In Australia, as we predicted, a massive class action lawsuit is being planned on behalf of “Australian bank customers that have entered into mortgage finance agreements with banks since 2012”.
Law firm Chamberlains has been appointed to act in the planned class action lawsuit, which has been instructed by Roger Donald Brown of MortgageDeception.com in the action that aims to represent various Australian bank customers that are “incurring financial losses as a result of entering into mortgage loan contracts with banks since 2012”.
As the AFR put it – Lawyers’ representing up to 300,000 litigants are planning an $80 billion action against mortgage lenders, mortgage brokers and financial regulators in a class action that would dwarf previous actions. Roger Brown, a former Lloyds of London insurance broker, said he already has about 200,000 borrowers ready to join the action and has $75 million backing from UK and European investors. There has been a scam, he said about mortgage lending to Australian property buyers. “But the train has hit the buffers and there needs to be recompense.
As we discussed before, if loans made were “unsuitable” as defined by the credit legislation, there is potential recourse. This could be a significant risk to the major players if it gains momentum. And more will likely join up if home prices fall further and mortgage repayments get more difficult. But we think individuals must take some responsibility too!
Next, we now see a number of the major media outlets starting to blame the Royal Commission for the falls in home prices, tighter lending standards and even damage to the broader economy. Talk about shoot the messenger. The fact is we have had years of poor lending practice, and poor regulation. But the industry and regulators kept stumn preferring to enjoy the fruits of over generous lending. The Royal Commission is doing a great job of exposing what has been going on. In fact, the reaction appears to be that what had been hidden is now in the sunshine, and it is true the sunlight is the best disinfectant. Structural malpractice is being exposed, some of which may be illegal, and some of which certainly falls below community expectations. But let’s be clear, it’s the poor behaviour of the banks and the regulators which have placed us in this difficult position. Hoping bad lending remans hidden is a crazy path to resolution. At least if the issues are in the open they stand a chance of being addressed.
But it is also true that just a lax lending allowed households to get bigger mortgages than they should, and bid home prices higher, to be benefit of the banks, and the GDP out-turn, the reverse is also true. Tighter lending will lead to less credit being available, which in turn will translate to lower home prices, and less book growth for the banks. But do not lay this at the door of the Royal Commission. They are actually doing Australia a great service, in a most professional manner.
But that does not stop the rot. UBS came out today with an update saying that the housing market is slowing, with house prices falling and credit conditions tightening. Given the number of headwinds the market is facing; many investors are now questioning whether the housing correction could become disorderly. We expect credit growth to slow sharply and believe the risk of a Credit Crunch is rising.
They walk through the main areas, including tighter lending, interest only loans and foreign buyers. Specifically, they highlight that approved foreign investment in housing is down -65%. The Foreign Investment Review Board just released data for 16/17. The value of approvals to buy residential housing collapsed 65% y/y to $25bn in 16/17, the lowest level since 12/13, and mostly reversing the prior ‘super boom’. The fall was across both new (-66% to $22bn) and established housing (-59% to $3bn) – led by total falls in NSW (-66% to $7bn) and Victoria (-61% to $11bn.
They say that the collapse in 16/17 may be overstated because of the introduction of application fees in Dec-15 – meaning the fall in transactions is less pronounced. But, there is still likely to have been a drop in transactions, reflecting more structural factors including – the lift in taxes on foreigners; domestic lenders tightening standards for foreign buyers (effectively no longer lending against foreign sources of income or collateral); as well as tighter capital controls especially from China.
Their base case is for a small fall in prices ahead, and assumes house prices fall by 5%+ over the coming year and that bad and doubtful debts increase only modestly given the current very benign credit environment. but they also talk about a downside scenario which reflects a more disorderly correction in the housing market (ie a Credit Crunch) and could result in approximately 40% reduction in major bank share prices. This is likely due to credit growth falling more substantially, by ~2-3% compound and credit impairment charges rising significantly as the credit cycle turns. This scenario would put pressure on bank NIMs. Litigation risk from class actions for mortgage misselling is also a tail risk. Dividends would need to be cut in this scenario. Given the leverage in the banking system, accurately predicting the extent of a downturn is very difficult, as was seen in 2008.
And the reason they still hold to their milder view is the expectation that the Government will step in to assist, and slow the implementation of recommendations from the Royal Commission. To quote Scott Morrison on 2GB radio on 23d March.
If banks stop lending, then what do people think that is going to mean for people starting businesses or getting loans or getting jobs or all of this. In the budget papers, the Treasury have actually highlighted this as a bit of a risk with the process we are going through. We have got to be very careful. These stories are heartbreaking, I agree, but we have to be also very cautious about, well, how do we respond to that. What is the right reaction to that? Is it to just throw more regulation there which basically constipates the banking and financial industry which means that people can’t start businesses and people can’t get jobs, people can’t get home loans. Or do we want to move to a smarter way of how this is all done and I think in the era of financial technology in particular there are some real opportunities there. We are going to continue to listen and carefully respect the royal commission, not prejudge the findings, but be very careful about any responses that are made because this can determine how strong an economy we live in over the next ten years and whether people get jobs and start businesses.
But in essence, expect some unnatural acts from the Government to try to keep the bubble going a little longer. All bets are off the other side of the election.
And the third risk, and the one which takes us closest to GFC 2.0 is what is happening in Italy. I am not going to go back over the history, but after months of wrangling, Italy’s political crisis has a hit an impasse, with new elections now increasingly likely. The country faces an institutional crisis without precedent in the history of the Italian republic. Its implications extend well beyond Italy, to the European Union as a whole.
Since an election on March 4, there have been endless vain attempts to form a government – with the likely outcome changing every 24 hours. By mid-May, the Five Star Movement (M5S) and the League, both populist parties, had come together to draft a programme for government featuring tax cuts and spending plans. But it sent shivers down the spines of those contemplating Italy’s public debt – running at over 130% of GDP – and threatened the stability of the eurozone.
The appointment of Carlo Cottarelli, a former official from the International Monetary Fund, as prime minister on May 28 was merely a stop-gap measure until fresh elections in the autumn. His government will almost certainly fail to win the necessary vote of confidence required of all incoming governments upon taking office. This means that it will be unable to undertake any legislative initiatives that go beyond day-to-day administration.
ITALY’S president, Sergio Mattarella had originally planned to put a former IMF economist, Carlo Cottarelli, at the head of a government of technocrats, tasked with steering the country back to the polls after the summer. But Mr Mattarella was reportedly considering changing tack after meeting Mr Cottarelli on May 29th amid growing evidence of support in parliament for an earlier vote. Not a single big party has declared its readiness to back Mr Cottarelli’s proposed administration in a necessary vote of confidence.
So the president is expected to decide on May 30th whether to call a snap election as early as July in an effort to resolve a rapidly deepening political and economic crisis that has sent tremors through global financial markets. There was also concern that the populist parties could win a bigger parliamentary majority in the new election, creating a bigger risk for the future of the eurozone.
In a sign of investors’ concern, the yield gap between Italian and German benchmark government bonds soared from 190 basis points on May 28th to more than 300. The governor of the Bank of Italy, Ignazio Visco, warned his compatriots not to “forget that we are only ever a few steps away from the very serious risk of losing the irreplaceable asset of trust.”
The yield on two-year debt has risen from below zero to close to 2% and Italy’s 10-year bond yields, which is a measure of the country’s sovereign borrowing costs, breached 3 per cent on Tuesday, the highest in four years. At the start of the month they were just 1.8 per cent. Italy’s sovereign debt pile of €2.3 trillion is the largest in the eurozone
The Italian stock market was also down 3 per cent on Tuesday, and has lost around 13 per cent of its value this month.
But these movements need to be put in some context. The Italian stock market is still only back to its levels of last July, after experiencing a strong bull run since later 2016.
In 2011 and 2012 Italian bond breached 7 per cent and threatened a fiscal crisis for the government in Rome. Yields are still some distance from those extreme distress levels.
George Soros was quoted in the FT:
The EU is in an existential crisis. Everything that could go wrong has gone wrong,” he said. To escape the crisis, “it needs to reinvent itself.” Mr Soros said tackling the European migration crisis “may be the best place to start,” but stressed the importance of not forcing European countries to accept set quotas of refugees. He said the Dublin regulation — which decides which nation is responsible for processing a refugee’s asylum status, largely based on which country the individual first enters — had put an “unfair burden” on Italy and other Mediterranean countries, “with disastrous political implications.” While austerity policies appeared initially to have been working, said Mr Soros, the “addiction to austerity” had harmed the euro and was now worsening the European crisis. US president Donald Trump’s exit from the nuclear arms deal with Iran and the uncertainty over tariffs that threaten transatlantic trade will harm European economies, particularly Germany’s, he said, while a strong dollar was prompting “flight” from emerging market economies. “We may be heading for another major financial crisis,” he said. Meanwhile, years of austerity policies had led working people to feel “excluded and ignored,” sentiment that had been exploited by populist and nationalistic politicians, said Mr Soros. He called for greater emphasis on grassroots organisations to meaningfully engage with citizens.
To play devil’s advocate, if Italy were to leave the Eurozone, the Lira would drop, hard. Most probably Italy would default on debt, and this would hit the Eurozone banks hard, especially those in German and French banks will be hit hard and they are saddled with about half the outstanding debt. Just like in the GFC a decade back, global counter-party bank risk will rise, and this time sovereign are involved, so it may go higher. The US Dollar will run hot, and there will be a flight to quality, tightening the capital markets, lifting rates and causing global stocks and commodities to crash, possibly a recession will follow.
In Australia, the dollar would slide significantly, fuelling stock market falls and a further drop in home prices, leading to higher levels of default, and recession, despite the Reserve Bank cutting rates and even trying QE.
Now the financial situation in Italy at the moment, a far cry from the height of the eurozone crisis in 2012, when it really did look possible that weaker member states would be imminently forced to default and the single currency would collapse. Then, that situation was finally defused when the head of the European Central Bank, Mario Draghi, announced he would do “whatever it takes” to stop this break up happening, unveiling an emergency programme of backstop bond buying by the central bank. This reassured private investor that they would, at least, get their money back and bond yields in countries like Italy and Spain fell back to earth, ending the risk of a destructive debt spiral.
But the latest deadlock in Rome is nevertheless the biggest crisis in the eurozone since Greece last threatened to leave in 2015. And Italy is a much larger economy than Greece. If the third largest country in the bloc exited the euro, it is doubtful the single currency would survive.
Falling bank shares dragged down Europe’s main share markets. At the close the UK’s FTSE 100 fell almost 1.3%, while Germany’s Dax was down 1.5% and France’s Cac 1.3% lower. “It’s a market that is totally in panic”, said a fund manager at Anthilia Capital Partners, who noted “a total lack of confidence in the outlook for Italian public finances”. And the chief economic adviser at Allianz in the US said: “If the political situation in Italy worsens, the longer-term spill overs would be felt in the US via a stronger dollar and lower European growth.”
So whether you look locally or globally its risk on at the moment, and we are it seems to me teetering on the edge of our Scenario 4. This will not be pretty and it will not be quick. I see that slow moving train wreck still grinding down the tracks, with no way out.
Second, the volume and share of loans via brokers, having reach a peak last year look to be falling, reflecting first lower absolute volumes of new loans, and second a preference by the banks to use their own channels. We will be watching the mix by channel in the months ahead, our thesis is mortgage brokers are going to have to work a lot harder down the track!
OK, I lied, there is a fourth slide. Despite all the tightening, the total balances grew again in March to $1.6 trillion, despite investment loans falling to 33.8% of the portfolio. So lets be clear, household debt is still rising, with investment loans rising 0.4% in the quarter and owner occupied loans rising by 2%. Or over the past year, 2.6% and 8% respectively. Still too hot in the current climate, in my view. So more tightening is needed, and I suspect a harder Debt to Income hurdle of 6% is where it will bite.
