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The Crunch Is Nearer Now – The Property Imperative Weekly 26 May 2018
We discuss the latest finance and property news with a distinctively Australian focus
Tag: Property Imperative Weekly
More Data On The Downside – The Property Imperative Weekly 19th May 2018
Welcome to our latest summary of finance and property news to the 19th May 2018.
Watch the video or read the transcript.
Today we start with bank culture and the next round of the Royal Commission.New ASIC chairman James Shipton was at the Australian Council of Superannuation Investors conference in Sydney and was asked how seriously he was taking the threat to the financial system given the failures aired at the royal commission. He said the threat is great. As a former member of the finance profession – as a person who is proud to be a financier – I find it jarring and disappointing that this is where we find ourselves,” he said. As a proud Australian who is returning from nearly 25 years overseas, it is very confronting that we find ourselves in this situation. The misconduct discussed at the royal commission “must not stand, [it] must be addressed”
Mr Shipton also highlighted the “proliferation” of conflicts of interest in parts of the financial industry. “It is clear to me that a number of institutions have not taken the management of conflicts of interest to heart,” he said. “This is verging on a systemic issue. Indeed, it is the source of much of the misconduct ASIC has been responding to and which is being highlighted by the royal commission hearings.” Mr Shipton expressed his “surprise” that many Australian firms have “turned a blind eye” to conflicts of interest as their businesses have grown. “Too often, unacceptable conflicts were justified by firms on the basis that ‘everyone else is doing it’, even though it’s the right thing to do to end them .“A business culture that is blind to conflicts of interest is a business culture that does not have the best interests of its customer in mind. Moreover, it is one that is not observing the spirit as well as the letter of the law,” he said.
These are relevant comments in the light of the next round of the Royal Commission which starts on 21st May. This round of public hearings will consider the conduct of financial services entities and their dealings with small and medium enterprises, in particular in providing credit to businesses. The hearings will also explore the current legal and regulatory regimes, as well as self-regulation under the Code of Banking Practice. They will use the same case study approach.
They will be considering Responsible lending to small businesses, with ANZ, Bank of Queensland, CBA, Westpac and Suncorp on the stand. They will then consider the Approach of banks to enforcement, management and monitoring of loans to businesses with CBA / Bankwest and NAB. Third will be Product and account administration with CBA and Westpac; then the Extension of unfair contract terms legislation to small business contracts with ASIC and finally The Code of Banking Practice with ABA and ASIC. This should be worth watching, as we are expecting more cases of misconduct and poor behaviour. Our Small and Medium Business surveys highlight the problem many have with getting credit and being treated unfairly. There is a link below if you want to grab a free copy.
So now to the statistics. The ABS data this week painted a rather unsettling picture. The latest unemployment data to April 2018 showed that employment growth is slowing. The trend unemployment rate rose from 5.53 per cent to 5.54 per cent in April 2018 after the March figure was revised down, while the seasonally adjusted unemployment rate increased 0.1 percentage points to 5.6 per cent. The trend participation rate increased to a further record high of 65.7 per cent in April 2018 and in line with the increasing participation rate, employment increased by around 14,000 with part-time employment increasing by 8,000 persons and full-time employment by 6,000 persons in April 2018. But as we discussed in our separate post “Jobs Aren’t What They Use To Be” underutilisation – or those in work who want more work, continues to running at very high rates, and this helps to explain the low wages growth, which was also reported by the ABS this week. This showed a showed a further fall compared with last time with the seasonally adjusted Wage Price Index up 0.5 per cent in March quarter and 2.1 per cent through the year. Seasonally adjusted, private sector wages rose 1.9 per cent and public sector wages grew 2.3 per cent through the year to March quarter.
We discussed this in our post “Some Disturbing Trends”. In fact, you can mount an argument the federal budget is already shot as a result. The gap is large, and growing. And for comparison, the Average Compensation of Employees from the national accounts which is to December 2017 is tracking even lower circa 1.3%. And the latest inflation figure is sitting at 1.9%.
An article in The Conversation this week by Stephen Kirchner, from the University of Sydney, argued that the RBA is making an explicit trade-off between inflation and financial stability concerns which is weighing on Australians’ wages. In the past, the RBA focused more on keeping inflation in check, the usual role of the central bank. But now the bank is playing more into concerns about financial stability risks in explaining why it is persistently undershooting the middle of its inflation target. In the wake of the global financial crisis, the federal Treasurer and Reserve Bank governor signed an updated agreement on what the bank should focus on in setting interest rates. This included a new section on financial stability. That statement made clear that financial stability was to be pursued without compromising the RBA’s traditional focus on inflation. But the latest agreement, adopted when Philip Lowe became governor of the bank in 2016, means the bank can pursue the financial stability objective even at the expense of the inflation target, at least in the short-term. He concluded that when the RBA governor and the federal treasurer renegotiate their agreement on monetary policy after the next election, the treasurer should insist on reinstating the wording of the 2010 statement that explicitly prioritised the inflation target over financial stability risks. If the RBA continues to sacrifice its inflation target on the altar of financial stability risks, inflation expectations and wages growth will continue to languish and the economy underperform its potential.
International funding costs continue to rise with the US 10 Year Treasury rising this week, as yields were boosted after a report on U.S. retail sales for April indicated that consumer spending is on track to rebound after a soft patch in the first quarter. Yields have climbing higher since the Fed said on at its May meeting that inflation is moving closer to its 2% target. The Fed raised rates in March and projected two more rate hikes this year, although many investors see three hikes as possible.There is a strong correlation between the 10-year bond yield and the quantitate tightening which is occurring – making the point again that the rate rises are directly correlated with the change in policy.
Libor, the interbank benchmark continued to rise, as we discussed in our post “The Problem with LIBOR”. And this translates to higher mortgage rates in the US, with US headlines speaking of “the highest mortgage rates in seven years.
To be clear, we watch the US markets, and especially the capital market rates. because these movements impact the cost of bank funding and the Australian banks, especially the larger ones need access to these funds to cover perhaps 30% of their mortgage books. As a result, there is pressure on mortgage rates locally, with the BBSW reflecting some of this already.
Canada is another market worth watching, because it shares a number of the same characteristics as our own. The authorities tightened mortgage underwriting standards earlier in the year, and the results are now some significant slowing of purchase volumes, and home prices.
Significantly, the lenders are discounting new loans to try to maintain mortgage underwriting volumes in the fading market, which is similar to the dynamics here, with some Australian lenders now offering discounts to property investors for the first time in a year or so.
We hold our view that credit growth will continue to slow, as underwriting standards get tightened further. Investor lending has fallen by 16.1 per cent over the year to March, while owner-occupied lending is off by 2.2 per cent, according to the Australian Bureau of Statistics. The latest housing finance statistics show that lending to owner-occupiers fell by 1.9 per cent in March, the highest rate of decline in over two years; investor lending fell by 9 per cent over the month.
However, these figures are yet to reflect the latest round of credit tightening by the major banks, who face increased scrutiny amid damning evidence of irresponsible lending during the first round of the royal commission.
Both the major banks and the RBA expect credit growth to slow. We are now entering a “credit crunch”, which will reduce total mortgage volumes by around 10 per cent over the next year. The chances are that people will not be moving as swiftly as they had previously and not only is there lower demand now, particularly for property investors, but tighter lending criteria means that brokers will have to work a lot harder to get the information from clients and go through more hoops to get an application processed. Overall volumes will be down.
The Auction clearance rates continue lower, according to CoreLogic. Last week, a total of 2,279 auctions were held across combined capital cities, returning a final clearance rate of 58.2 per cent, the lowest clearance rate seen since late 2015. This time last year, the clearance rate was much stronger with 72.8 per cent of the 2,409 auctions returning a successful result.
Melbourne’s final clearance rate dropped to 59.8 per cent this week across 1,099 auctions making it the lowest clearance rate the city has seen since Easter 2014 (58.1 per cent).
Sydney’s final auction clearance rate fell to 57.5 per cent across 787 auctions last week, down from 63.1 per cent across 797 auctions over the previous week. Over the same week last year, 960 homes went to auction and a clearance rate of 74.5 per cent was recorded.
Across the smaller auction markets, Canberra, Perth and Tasmania saw clearance rates improve while clearance rates across Adelaide and Brisbane fell slightly. Of the non-capital city auction markets, Geelong returned the highest final clearance rate once again, with a success rate of 83.0 per cent across 50 auctions.
This week they expect to see a lower volume of auctions – 1,931, down from 2,279 last week. Melbourne is the busiest city for auctions again this week, with 948 auctions being tracked so far, down from 1,099 last week. Sydney has 637 auctions scheduled this week, down from 787 last week.
Adelaide and Perth are expecting to see a slight increase in auction volumes this week, with Adelaide tracking 102 auctions, up from 97 last week, while Perth currently has 43 auctions scheduled, up from 40 last week.
In terms of home price movements, prices are continuing to fall in all states last week, according to the CoreLogic Indices, other than Adelaide which was just a tad higher. Perth fell the most, down 0.11% followed by Sydney down 0.10%. The year to data movements, and the rolling 12-month view shows that Sydney is leading the way down. As we have said before, we think Melbourne is 6-9 months behind Sydney. But remember that the latest spate of lending tightening has yet to work though, so we expect prices to continue to fall. Of course prices are still well above those from the previous peak, with Sydney still up 60% and Melbourne up 44%. However, Perth is down 11%, and the overall average is 37% higher.
Finally, The Australian Financial Security Authority released the personal insolvency activity statistics for the March quarter 2018. In state and territory terms, personal insolvencies reached a record quarterly high in Western Australia (1,020) and the highest level since the September quarter 2014 in New South Wales (2,372). Total personal insolvencies in the March quarter 2018 increased slightly by 0.1% compared to the March quarter 2017. We discussed this data in more detail in our video “Some Disturbing Trends”
Given all the data we discussed today, we expect the insolvencies will continue to rise in the months ahead, as the impact of flat incomes, rising costs, and big debt continue to press home.
Fixing The Banking System – The Property Imperative Weekly 5th May 2018
Welcome to our latest digest of finance and property news to 5th May 2018.
Read the transcript, or watch the video.
We continue to be bombarded with news of more issues in the banking sector. CBA admitted that they have “lost” customer data contained on two tapes relating to almost 20 million accounts. The event happened in 2016, and they decided not to inform customers, as the data “most likely” had been destroyed. This is likely the largest data breach for a bank in Australia and goes again to the question of trust. So much customer data in a single tape drive, and passed to a third party for destruction. But there was no record of the tape arriving, and the data has not been recovered. Angus Sullivan Head of Retail at CBA said, an investigation suggests the tape were destroyed, and they chose not to inform customers at the time, despite discussing with the regulators.
We think they had a duty of care to disclose this to customers at this time, but they chose not to, because they did not put customers first. Such rich transaction data would be very valuable to criminals. I have a CBA account, and I feel uncomfortable. Why should I trust them with my data?
And of course CBA featured in the report which was published this week following a review into their culture. We discussed this in detail in a separate video “CBA’s World of Pain and The Regulators’ Wet Lettuce response”. The report says CBA’s continued financial success dulled the institution’s senses to signals that might have otherwise alerted the Board and senior executives to a deterioration in CBA’s risk profile. APRA has applied a $1 billion add-in to CBA’s minimum capital requirement.
Over the past six months, the Panel examined the underlying reasons behind a series of incidents at CBA that have significantly damaged its reputation and public standing. It found there was a complex interplay of organisational and cultural factors at work, but that a common theme from the Panel’s analysis and review was that CBA’s continued financial success dulled the institution’s senses to signals that might have otherwise alerted the Board and senior executives to a deterioration in CBA’s risk profile. This dulling was particularly apparent in CBA’s management of non-financial risks, i.e. its operational, compliance and conduct risks. These risks were neither clearly understood nor owned, the frameworks for managing them were cumbersome and incomplete, and senior leadership was slow to recognise, and address, emerging threats to CBA’s reputation. The consequences of this slowness were not grasped. So CBA agreed to put a plan in place to address the issues raised, and circulated the report to their top 500 executives, and other banks and corporates should also read the report in detail. The core message is simple, a fixation on superior financial performance at all costs, can destroy the business and customer confidence. Oh, and APRA’s $1bn capital add-in is little more than a light slap to the face.
We got results this week from Macquarie Bank who managed to lift their profitability yet again, mainly thanks to significant growth in their Capital Markets Business, plus ANZ and NAB who both revealed pressures on margin and higher mortgage loan delinquencies. They are literally banking on home loans and warned that if funding costs continue to rise they will need to lift rates. NAB’s profit was down 16% on the prior comparable period. We discussed their mortgage delinquency trends as part of our video on Mortgage Stress “More On Mortgage Stress and Defaults”. Both banks are seeking to reduce their exposure to the wealth management sector, and focus more on selling more mortgages. Interesting timing, given the Royal Commission, and tighter lending standards.
And Genworth, the Lenders Mortgage Insurer, who underwrites loans about 80% (or 70%) in some cases also reported higher losses again. The delinquency rate increased slightly from 0.48% in 1Q17 to 0.49% in 1Q18, driven mainly by Western Australia and New South Wales (NSW). Delinquencies in mining areas are showing signs of improving. In non-mining regions there are indications of a softening in cure rates, in particular in NSW and Western Australia.
Our own latest research showed that across Australia, more than 963,000 households are estimated to be now in mortgage stress (last month 956,000). This equates to 30.1% of owner occupied borrowing households. In addition, more than 21,600 of these are in severe stress, up 500 from last month. We estimate that more than 55,600 households risk 30-day default in the next 12 months. We expect bank portfolio losses to be around 2.8 basis points, though losses in WA are higher at 5 basis points. We continue to see the impact of flat wages growth, rising living costs and higher real mortgage rates.
But there was one item in the NAB results which peaked my interest. They included this slide on the gross income distribution of households in their mortgage portfolio. Gross income is defined as total pre-tax unshaded income for the application. This can include business income, income of multiple applicants and other income sources, such as family trust income. And it relates to draw-downs from Oct 17 – Mar 18. ~35% of transactions have income over 200K for owner occupied loans, and ~47% for investment loans. Now, I recognise that NAB has a skewed demographic in their customers, but, the proportion of high income households looked odd to me. So I pulled the household income data from our surveys, including only mortgaged households. We also ask for income on a similar basis, gross from all sources. And we plotted the results. The blue bars are the household gross income across the country for mortgaged households. The next two are a replication of the NAB data sets above. Either they are very, very good at targetting high income customers, or incomes in their system are being overstated. We discussed this in a separate video “Mortgage Distribution By Income Bands”.
AMP published a 28 page response to the issues raised by the Royal Commission. They made the point that the fees for no service issue is old news. In addition, they down played the preparation of a Clayton Utz report into the issue and the firms misleading representations to ASIC. They did unreservedly apologise for their financial advice failings relating to service delivery to customers and spoke about extensive action aims to ensure these issues “never happen again.” But I am not sure they have really understood the implications for their business of the findings, despite the Chairman Catherine Brenner, following the CEO out of the door. And I am not sure they have clarity around their strategy.
But they also announced that David Murray, a well-respected financial services insider to take over the Chairman’s role. He of course was the CEO at CBA during its massive expansion into Wealth Management, and significant vertical integration – the very issues which are at the heart of the Royal Commission Inquiry. And He led the Financial Systems Inquiry, which forced capital ratios higher, but which was also very light on customer centricity. So he will be a safe pair of hands, but we wonder if he can truly transform AMP to a customer focussed business. They have a massive amount to do to deal with potential fines, repair the damaged brand and chart a path ahead. But there are in my mind some critical questions about the role and shape of the board, and how they truly inject a customer first focus. This question should be occupying the minds of all CEO’s and Boards in the sector, not just AMP.
And I have a suggestion. I think the financial services companies should have a customer board – a group of customers of the bank, who would be engaged and involved in the operations and strategic direction of the business. A strong customer Board would be able to ensure the voice of the customer is heard and the priority of customer centricity placed firmly on the agenda. And remember, there is strong evidence that companies who truly put their customers first can create superior and sustainable value for shareholders too.
Of course there are structural options too. I think is likely that the financial services sector will see a bevy of break-ups and sell-offs. NAB, for example will be selling off their MLC wealth management business, marking the end of their mass-market wealth experiment. They will retain their upper end JBWere business as part of their Private Bank, for the most affluent customers. Other players are also divesting wealth businesses, partly because they never really generated the value expected, (and frittered away shareholder funds in the process) and because of the higher risks thanks to the FOFA “Best Interests” requirement. So it raises the question of whether financial advice will be available to the masses, even via robots, and indeed whether they really need it anyway. For most people generally the approach would be pretty simple (but your mileage may vary, so this is not Financial Advice). Pay down the mortgage as fast as you can. Make sure you have adequate insurance. Don’t use consumer credit and save via an appropriate industry fund. Hardly need to pay fees to an adviser for that guidance I would have thought. Financial Advice has been over-hyped, which is why the fees grabbed by the sector are so high. Mostly it’s an unnecessary expense, in my view.
Another option to fix the Banking System would be to bring in a Glass-Steagall type regime. Glass-Steagall emerged in the USA in 1993, after a banking crisis, where banks lent loans for a long period, but funded them from short term, money market instruments. Things went pear shaped when short and long term rates got out of kilter. So The Glass-Steagall Act was brought in to separate the “speculative” aspects of banking from the core business of taking deposits and making loans. Down the track in 1999, the Act was revoked, and many say this was one of the elements which created the last crisis in the USA in 2007.
Now the Citizens Electoral Council of Australia CEC (an Australian Political Party) has drafted an Australian version of the Glass-Steagall act, and Bob Katter has announced that he will try to bring the legislation as a Private Member’s Bill called The Banking System Reform (Separation of Banks) Bill 2018. And Bob Katter has form here, in taking the lead in Parliament on Glass-Steagall, as he did on the need for a Royal Commission into the banks in 2017.
The 21st Century Glass-Steagall Act has been updated to prohibit commercial banks from speculating in the specific financial products that caused the 2008 global financial crisis, which didn’t exist in 1933, such as financial derivatives. These updates are reflected in the Australian bill. Aside from specific practices, the overriding lesson of the 2008 crash is that commercial banks should not mix with other financial activities such as speculative investment banking, hedge funds and private equity funds, insurance, stock broking, financial advice and funds management. The banks have gone far beyond traditional banking, into other financial services and speculating in derivatives and mortgage-backed securities. Consequently, they have built up a housing bubble, which is heading towards a crash and an Australian financial crisis.
The bill also addresses the question of the role and function of APRA, the financial regulator, which we believe has a myopic fixation on financial stability at all costs, never might the impact on customers, as the recent Productivity Commission review called out.
Two points. First there is merit in the Glass Steagall reforms, and I recommend getting behind the initiative, despite the fact that it will not fix the current problem of the massive debt households have. Banks were able to create loans thanks to funding being available from the capital markets, and so bid prices up. Turn that off, and their ability to lend will be curtailed ahead, which is a good thing, but the existing debts will remain. Second, some are concerned about the CEC, and its motives. The CEC, is an Australian federally registered political party which was established in 1988. From 1992 onward the CEC joined with Lyndon H. LaRouche and you can read about his policies and philosophy here. But my point is, if you need a horse, and a horse appears, ride the horse and worry less about which stable it came from. I applaud the CEC for driving the Glass Stegall agenda.
But to deal with the debt burden we have, there are some other things to consider. For example, at the moment the standard mortgage contract gives banks full recourse — if you default the bank can not only sell the property, but also get a court judgment to go after your other assets and even send you bankrupt. In the USA some states have non-recourse loans, and recent research showed that borrowers in these non-recourse states are 32 per cent more likely to default than borrowers in recourse states. This is because if the outcome of missing your mortgage payments is losing pretty much everything you own and being declared bankrupt, you will do just about anything possible to keep paying your home loan. And banks will be more likely to make riskier loans when they have full recourse. So I wonder if we should consider changes to the recourse settings in Australia, which appear to me to favour the banks over customers, and encourage more sporty lending.
Then finally, there is the idea of changing the fundamental basis of bank funding, using the Chicago Plan. You can watch our video “Popping The Housing Affordability Myth” where we discuss this in more detail and “It’s Time for An Alternative Finance Narrative” where we go into more details. Essentially, the idea is to limit bank lending to deposits they hold, and it offers a workout strategy to deal with the high debt in the system and remove the boom and bust cycles. This is not a mainstream idea at the moment, but I think the ideas are worthy of further exploration. This is something I plan to do in a later video and look at how a transition would work.
But my broader point is that we need some fresh thinking to break out of our current dysfunctional banking models. Today, they may support GDP results as they inflate home prices more, but we are at the point where households a “full of debt”. So we see higher risks in the system as the latest RBA Statement On Monetary Policy, which we discussed in our video “The RBA Sees Cake – Tomorrow”. They called out risks relating to the amount of debt in the household sector, and the prospect of higher funding costs, a credit crunch, and lower consumption should home prices fall. And the latest data shows that prices are falling in the major centres now, and auction results continue lower. I believe that the RBA’s business as usual approach will lead us further up the debt blind alley. Which is why we need more radical reform in the banking system and the regulators if we are to chart a path ahead.
Its All About Momentum – The Property Imperative Weekly 16 Dec 2017
This week, it’s all about momentum – home prices are sliding, auctions clearance rates are slipping, mortgage standards are tightening and brokers are proposing to lift their business practices – welcome to the Property Imperative Weekly, to 16 December 2017.
Watch the video, or read the transcript. In this week’s edition we start with home prices.
The REIA Real Estate Market Facts report said median house price for Australia’s combined capital cities fell 0.8 per cent during the September quarter. Only Melbourne, Brisbane and Hobart recorded higher property prices and Darwin prices fell the most sharply, dropping 13.8 per cent.
The ABS Residential Property Price Index (RPPI) for Sydney fell 1.4 per cent in the September quarter following positive growth over the last five quarters. Hobart now leads the annual growth rates (13.8%), from a lower base, followed by Melbourne (13.2%) and Sydney (9.4%). Darwin dropped 6.3% and Perth 2.4%. For the weighted average of the eight capital cities, the RPPI fell 0.2 per cent and this was the first fall since the March quarter 2016. The total value of Australia’s 10.0 million residential dwellings increased $14.8 billion to $6.8 trillion. The mean price of dwellings in Australia fell by $1,200 over the quarter to $681,100.
So, further evidence of a fall in home prices in Sydney, as lending restrictions begin to bite, and property investors lose confidence in never-ending growth. So now the question becomes – is this a temporary fall, or does it mark the start of something more sustained? Frankly, I can give you reasons for further falls, but it is hard to argue for improvement anytime soon. Melbourne momentum is also weakening, but is about 6 months behind Sydney. Yet, so far prices in the eastern states are still up on last year!
CoreLogic said continual softening conditions are evident across the two largest markets of Melbourne and Sydney. This week across the combined capital cities, auction volumes remained high with 3,353 homes taken to auction and achieving a preliminary clearance rate of 63.1 per cent The final clearance rate last week recorded the lowest not only this year, but the lowest reading since late 2015/ early 2016 (59.5 per cent).
The employment data from the ABS showed a 5.4% result again in November. But there are considerable differences across the states, and age groups. Female part-time work grew, while younger persons continued to struggle to find work. Full-time employment grew by a further 15,000 in November, while part-time employment increased by 7,000, underpinning a total increase in employment of 22,000 persons. Over the past year, trend employment increased by 3.1 per cent, which is above the average year-on-year growth over the past 20 years (1.9 per cent). Trend underemployment rate decreased by 0.2 pts to 8.4% over the quarter and the underutilisation rate decreased by 0.3 pts to 13.8%; both still quite high.
The HIA said there have been a fall in the number of new homes sold in 2017. New home sales were 6 per cent lower in the year to November 2017 than in the same period last year. Building approvals are also down over this time frame by 2.1 per cent for the year. The HIA expects that the market will continue to cool as subdued wage pressures, lower economic growth and constraints on investors result in the new building activity transitioning back to more sustainable levels by the end of 2018.
The HIA also reported that home renovation spending is down, again thanks to low wage growth and fewer home sales by 3.1 per cent. A further decline of a similar magnitude is projected for 2018.
Moody’s gave an interesting summary of the Australian economy. They recognise the problem with household finances, and low income growth. They expect the housing market to ease and mortgage arrears to rise in 2018. They also suggest, mirroring the Reserve Bank NZ, that macroprudential policy might be loosened a little next year.
I have to say, given credit for housing is still running at three times income growth, and at very high debt levels, we are not convinced! I find it weird that there is a fixation among many on home price movements, yet the concentration and level of household debt (and the implications for the economy should rates rise), plays second fiddle. Also, the NZ measures were significantly tighter, and the recent loosening only slight (and in the face of significant political measures introduced to tame the housing market). So we think lending controls should be tighter still in 2018.
The latest ABS lending finance data for October, showed business investment was still sluggish, with too much lending for property investment, and too much additional debt pressure on households. If we look at the fixed business lending, and split it into lending for property investment and other business lending, the horrible truth is that even with all the investment lending tightening, relatively the proportion for this purpose grew, while fixed business lending as a proportion of all lending fell. I will repeat. Lending growth for housing which is running at three times income and cpi is simply not sustainable. Households will continue to drift deeper into debt, at these ultra-low interest rates. This all makes the RBA’s job of normalising rates even harder.
HSBC, among others, is suggesting a further fall in home price momentum next year, writing that slowdowns in the Sydney and Melbourne housing markets will continue to weigh on national house price growth for the next few quarters. They expect only a slow pace of cash rate tightening and some relaxation of current tight prudential settings as the housing market cools.
Despite this, most analysts appear to believe the next RBA cash rate move will be higher and ANZ pointed out with employment so strong, there is little expectation of rate cuts in response to easing home prices. In addition, the FED’s move to raise the US cash rate this week to a heady 1.5% despite inflation still running below target, will tend to propagate through to other markets later. More rate rises are expected in 2018. The Bank of England held theirs steady, after last month’s hike.
The UK Property Investment Market could be a leading indicator of what is ahead for our market. But in the UK just 15% of all mortgages are for investment purposes (Buy-to-let), compared with ~35% in Australia. Yet, in a down turn, the Bank of England says investment property owners are four times more likely to default than owner occupied owners when prices slide and they are more likely to hold interest only loans. Sounds familiar? According to a report in The Economist, “one in every 30 adults—and one in four MPs—is a landlord; rent from buy-to-let properties is estimated at up to £65bn a year. But yields on rental properties are falling and government policy has made life tougher for landlords. The age of the amateur landlord may be over”.
In company news, Genworth, the Lender Mortgage Insurer announced that it had changed the way it accounts for premium revenue. ASIC had raised concerns about how this maps to the pattern of historical claims. Genworth said that losses from the mining sector where many of the losses occur, do so at a late duration, and improvements in underwriting quality in response to regulatory actions, along with continued lower interest rates, extended the average time to first delinquency. As a result, Net Earned Premium (NEP) is negatively impact by approximately $40 million, and so 2017 NEP is expected to be approximately 17 – 19 per cent lower than 2016, instead of the previous guidance of a 10 to 15 per cent reduction.
CBA was in the news this week, with AUSTRAC alleging further contraventions of Australia’s anti-money laundering and counter-terrorism financing legislation. The new allegations, among other things, increase the total number of alleged contraventions by 100 to approximately 53,800. CBA contests a number of allegations but admit others. eChoice, in voluntary administration, has been bought by CBA via its subsidiary Finconnect Australia, saying the sale will allow eChoice’s employees, suppliers, brokers, lenders and leadership team to continue to operate and deliver for customers. Finally, CBA announced that, from next year, it will no longer accept accreditations from new mortgage brokers with less than two years of experience or from those that only hold a Cert IV in Finance & Mortgage Broking, in a move intended to “lift standards and ensure the bank is working with high-quality brokers who are meeting customers’ home lending needs.”
The Combined Industry Forum, in response to ASIC’s Review of Mortgage Broker Remuneration has come out with a set of proposals. The CIF defines a good customer outcome as when “the customer has obtained a loan which is appropriate (in terms of size and structure), is affordable, applied for in a compliant manner and meets the customer’s set of objectives at the time of seeking the loan.” Additionally, lenders will report back to aggregators on ‘key risk indicators’ of individual brokers. These include the percentage of the portfolio in interest only, 60+ day arrears, switching in the first 12 months of settlements, an elevated level of customer complaints or poor post-settlement survey results. Now this mirrors the legal requirement not to make “unsuitable” loans, but falls short of consumer advocates, such as CHOICE, who wanted brokers to be legally required to act in the best interests of consumers, in common with financial planners. But both the CBA and CIF moves indicate a need to tighten current mortgage broking practices, as ASIC highlighted, which can only be good for borrowers. By the end of 2020, brokers will also be given a “unique identifier number”.
ASIC says Westpac will provide 13,000 owner-occupiers who have interest-only home loans with an interest refund, an interest rate discount, or both. The refunds amount to $11 million for 9,400 of those customers. The remediation follows an error in Westpac’s systems which meant that these interest-only home loans were not automatically switched to principal and interest repayments at the end of the contracted interest-only period.
We featured a piece we asked Finder.com.au to write on What To Do When The Interest-only Period On Your Home Loan Ends. There is a sleeping problem in the Australian Mortgage Industry, stemming from households who have interest-only mortgages, who will have a reset coming (typically after a 5-year or 10-year set period). This is important because now the banks have tightened their lending criteria, and some may find they cannot roll the loan on, on the same terms. Interest only loans do not repay capital during their life, so what happens next?
The House of Representatives Standing Committee on Economics released their third report on their Review of the Four Major Banks. They highlight issues relating to IO Mortgage Pricing, Tap and Go Debt Payments, Comprehensive Credit and AUSTRAC Thresholds. The report recommended that the ACCC, as a part of its inquiry into residential mortgage products, should assess the repricing of interest‐only mortgages that occurred in June 2017, and whether customers had been misled. While the banks’ media releases at the time indicated that the rate increases were primarily, or exclusively, due to APRA’s regulatory requirements, the banks stated under scrutiny that other factors contributed to the decision. In particular, banks acknowledged that the increased interest rates would improve their profitability.
So, in summary plenty of evidence home prices are slipping, and lending standards are under the microscope. We think home prices will slide further, and wages growth will remain sluggish for some time to come, so more pressure on households ahead. You can hear more about our predictions for 2018 in our upcoming end of year review, to be published soon, following the mid-year Treasury forecast.
Meantime, do check back next week for our latest update, subscribe to receive research alerts, and many thanks for watching.
How Far Are Home Prices Going Down? – The Property Imperative Weekly 25 Nov 2017
Home prices are more to do with sentiment that fundamental economics, and this week we saw new data, so are home prices on their way down?
Welcome to the Property Imperative weekly to the 25 November 2017. Watch the video, or read the transcript.
We start this week’s digest of finance and property news noting that Auction clearance rates continue to drift lower, especially in Sydney and home prices are easing back as the supply/demand equation changes.
CommSec said the average floor size of an Australian home (houses and apartments) has fallen to a 20-year low, with the typical new home now 189.8 square metres, down 2.7 per cent over the past year and the smallest since 1997. Though Australians continue to build some of the biggest houses in the world, an increasing proportion of Australians – especially in Sydney, Melbourne and Brisbane – also want smaller homes like apartments, semi-detached homes and town houses. Generation Y, Millennials, couples and small families want to live closer to work, cafes, restaurants, shopping and airports and are giving up living space for better proximity to the desirable amenities. CBA also make the point that since 2014 the number of people per dwelling has been falling. Lower interest rates and the increased supply of cheaper apartments (compared with houses) have prompted older couples to down-size. More Generation Y have been looking to move out of home and take ownership of accommodation more appropriate to their needs.
Also on the supply/demand property equation was an important study from the ANU. The Government view is high home prices is ultimately driven by lack of supply, relative to demand, including from migration. So the solution is to build more (flick pass to the States!). It has nothing to do with excessive debt, nor does the fact the average number of people per home is falling signify anything. And tax policy is not the problem. But the working paper “Regional housing supply and demand in Australia” from the ANU Center for Social Research and Methods, blows a mighty hole in that mantra. They suggest that demand factors (availability of loans, tax concessions etc.) have a significant impact, while demand and supply equilibrium varies significantly across different regions, with some hot spots, and some where vacant property exists (yet prices remain high, because of these demand factors). Significantly, much of the surplus is in areas where high-rise development has been strong. We think this may signal further downward pressure on prices in areas like Central Sydney, Melbourne and Brisbane as well as Townsville and Cairns. On the other hand, there is a shortage of property in Adelaide, and some outer suburban areas.
Wayne Byers, APRA Chairman spoke at the Australian Securitisation Forum 2017. Household debt is high, and continues to rise he said. He identified three mortgage related risks. First, the trend in non-performing housing loans is upward, despite a relatively benign environment for lenders. In fact the overall rate of non-performing housing loans is drifting up towards post-crisis highs, without any sign of crisis and when rates are ultra low.
Second, while the upward trend in low Net Income Surplus (NIS) lending appears to have moderated over the past few quarters, a reasonable proportion of new borrowers have limited surplus funds each month to cover unanticipated expenses, or put aside as savings.
Third, there is only a slight moderation in the proportion of borrowers being granted loans that represent more than six times their income. As a rule of thumb, an LTI of six times will require a borrower to commit 50 per cent of their net income to repayments if interest rates returned to their long term average of a little more than 7 per cent. High LTI lending in Australia is well north of what has been permitted in other jurisdictions grappling with high house prices and low interest rates, such as the UK and Ireland.
So, APRA finally acknowledge there are risks in the system and is finally looking at LTI. Better late than never…! LVR is not enough. He also called on the finance industry to “devote more effort to the collection of realistic living expense estimates from borrowers” and give “greater thought” to the appropriate use and construct of benchmarks”.
So how big is the problem? Well, the long data series from the Bank for International Settlements comparing household debt to GDP shows that Australia sits at the top of the international list after Switzerland at 122%. Australian households are wallowing in debt (no wonder mortgage stress is so high), even relative to Canada (where home prices have now started to fall), Hong Kong (where prices are in absolute terms higher), and New Zealand (where the Reserve Bank there has been much more proactive in tacking the ballooning debt). Ireland is still trying to deal with the collapse which followed the GFC in 2007 and they have registered a significant plunge in debt.
Another BIS series, trends in home prices, updated this week, shows Australia is near the top in terms of growth, relative to other western countries, including UK, USA, Canada and New Zealand. There is an important lesson in this data. If prices do crash it can take significant time to recover. Home prices in Ireland, which peaked in 2007, 10 years later are still well below the peak – a salutatory warning. USA prices have now just passed their pre-GFC peak and the UK achieved this in 2014! The fallout from home price falls cast a long shadow. The fall in prices took on average 5 years from their peak to the subsequent trough. A warning that if Australian prices slide, they could do so for many years.
The IMF issued a warning this week, based on their latest Australian visit. They warn that growth will be modest, more effort is required to contain housing risks – including macroprudential, and a structural reform agenda is required to lift productivity and growth. They say near-term risks to growth have become more balanced, but large external shocks, including their interaction with the domestic housing market, are an important downside risk. The housing market is expected to cool, but imbalances—lower housing affordability and household debt vulnerabilities—are unlikely to be corrected soon. Declines in household debt-to-income ratios would need to be driven by strong nominal income growth and amortization. They are however, stuck on the supply-side policy mantra as the most effective approach to achieving housing affordability in the longer term.
The RBA had a good trot this week, with Head of Financial Stability Jonathan Kearns, saying the Bank has responsibility to promote the stability of the financial system as a whole so carefully monitors property markets because poor commercial property lending and the large stock of residential property debt means risks to financial stability and household resilience. The high valuation of commercial property increases the potential for a sharp correction and so the risks from commercial property lending. The high level of household mortgage borrowing also brings risks, both for lenders and households. He also discussed the impact of purchases and financing by foreigner investors and banks. Nationally, purchases by foreign buyers are equivalent to around 10-15 per cent of new construction, or about 5 per cent of total housing sales. He said, these purchases by foreign buyers do not, on the whole, reduce the supply of dwellings available to local residents and in fact may actually contribute to expansion of the housing stock – though such purchases by foreign buyers, particularly for investment purposes, are a more recent phenomenon and so their impact on the housing cycle is less clear.
Marion Kohler, Head of Domestic Markets Department, RBA, explored more from their mortgage Securitisation Dataset. There were two insights. First the LVR distribution is highest at 80% (which is skewed because of the securitisation rules), but her claim “on average, securitised loans appear to be no riskier than the broader population of mortgages, was unproven. Second there was some interesting commentary on mortgage rates, with interest-only loans now significantly higher. There is now a greater proportion of principal-and-interest loans with an interest rate below 4 per cent, due to the lower rates applied to owner-occupier loans, and there has reportedly been increased competition for these types of loans. She did not discuss the critical Loan to Income ratios, which should be available in the data!
Finally, RBA Governor Philip Lowe spoke at the Australian Business Economists Annual Dinner. Essentially, the conundrum of low inflation and wage growth, despite better employment means the cash rate will stay lower for longer, though the next move is likely up. High household debt is less about risks to the banking system and more about medium term financial stability, especially as rates rise. Household spending will remain muted. GDP is forecast to be higher because the fall in mining investment has ended, even if other business investment is still low. He also highlighted the bank keeps overestimating future consumption growth. Finally, he said that it is important to be clear that the RBA does not have a target for housing prices. But a return to more sustainable growth in housing prices does reduce the medium-term risks.
A report by Bloomberg says the party is finally winding down for Australia’s housing market. How severe the hangover is will determine the economy’s fate for years to come. After five years of surging prices, the market value of the nation’s homes has ballooned to A$7.3 trillion — or more than four times gross domestic product. Not even the U.S. and U.K. markets achieved such heights at their peaks a decade ago before prices spiralled lower and dragged their economies with them. The report cited UBS economists’ declaration that “Australia’s world-record housing boom is officially over, and the cooling may be happening a bit more quickly than even we expected.”
The risk is that it leaves the Australian economy extremely exposed, and a minor shock could become far more significant,” said Daniel Blake, an economist at Morgan Stanley in Sydney. While the RBA is satisfied that lenders have adequate buffers to cope with any downturn, banks may find it harder to value their collateral in a falling market as investors look to consolidate their portfolios of multiple homes.
Now reflect on this, more than half of all dividends in Australia come from the banks. Data from the latest Janus Henderson Global Dividend Index reveals that Australia’s banks pay $6 out of every $11 of the country’s dividends each year but dividends are growing slowly given already high payout ratios. Leading is Commonwealth Bank which raised its per share payout 3.7 per cent on the back of steady profit growth, but National Australia, Westpac and ANZ all held their dividends flat. CBA and Westpac were identified in the report as the world’s fourth and sixth biggest dividend payers respectively, with Chinese and Taiwanese technology and manufacturing companies taking the top three place. Much of the dividends in Australia comes from mortgage lending.
Standing back, home prices have been rising thanks to high local and foreign demand, and from investors who believe in yet higher prices ahead. But now the evidence is mounting that sentiment is changing, demand is easing (and as lending standards get tightened) and low wage growth in rising and living costs bite. Our household surveys picked this up a few weeks back, and now there is also more awareness of the risks from higher rates ahead.
So we think prices are set to slide further, with Sydney leading the way. Brisbane will follow, but there may be a little more momentum in Melbourne. All the economic data points in the same direction, and our modelling suggests a fall of 20% or more is possible, over the medium term. If we are lucky, the easing will be gentle, but could last for perhaps 5 years, but there is also a risk of a bigger fall sooner. This would create a negative feedback loop which would reduce growth and hit the banks hard. No wonder then many with vested interests in property still want to talk the market up, but the fundamentals don’t lie. It’s not now a question of if, but when, and how far home prices will fall.
That’s the Property Imperative weekly to 25 November 2017. If you found this useful, do leave a comment below, subscribe to receive future updates and check back again next week. Thanks for taking the time to watch. See you next time.
The Property Imperative Weekly Launched
Today we launch the first of our regular Property Imperative Weekly Update Blogs and Vlogs; the next stage in the development of the Digital Finance Analytics site and in response to requests for a summary service.
We have been publishing regular reports on the residential property and mortgage industry in Australia for many years, in our Property Imperative series. Volume 8 is still available.
With so much happening in the property and mortgage sector, we will discuss the events of the past week in an easy to watch summary. We also will deploy the video blog on our YouTube channel and provide a transcript here, with links to the key articles.
This is the first. Watch it here.
We start with the latest data from the Reserve Bank and APRA for March showed that investment mortgage lending grew more strongly than owner occupied loans, and also that the non-banks are getting more active in this less regulated segment of the market. Pepper for example reported strong loan growth.
Smaller regional banks are getting squeezed, and mortgage lending overall is accelerating despite regulatory pressure. As the total mortgage book grew at more than 6% in the past year, when household incomes are static, the record household debt is still growing. More definitive action from the regulators is required.
APRA Chairman Wayne Byers discussed the residential and commercial property sectors this week at CEDA, and indicated the 10% speed limit on investment loan growth was maintained to protect the pipeline of dwellings under construction. This seems a bit circular to me!
In the past week, the upward momentum in mortgage rates continued with both Westpac and ANZ lifting fixed rate and interest only loan rates, by up to 30 basis points, though some owner occupied loans fell a little. These moves follow recent hikes from CBA and NAB, and continues the cycle higher in response to regulatory pressure, funding costs, competitive dynamics and the desire to repair net interest margins. The regulators have given the banks a perfect alibi!
For investors, these out of cycle rises are now getting close to 1%, though owner occupied borrowers, on principal and interest loans have not been hit as hard. However, even small rises are hitting households in a low income growth environment.
Mortgage stress was in the news this week, with a good piece on the ABC’s 7:30 programme, looking at stress in Western Australia, and citing the example of a property investor who is now in trouble. Our research into stress was also covered in the media, with a focus on Melbourne. Our latest analysis, for April shows a further rise in households in mortgage stress. More of that later.
Meantime, Finder.com published analysis which suggested more than half of mortgage holders were close to a tipping point if mortgage repayments rose by just $100. This would equate to a rate of just 5.28%, not far from current rates at all.
Mortgage Brokers were in the news again thanks to evidence given to the Senate Standing Committee on Economics looking at a consumer protection in the banking and finance industry. Evidence suggested commission aligned to achieving specific volume targets and the use of lender lists may mean the interest of consumers are compromised. We discussed this on the DFA blog last year. In addition, ASIC highlighted deficiencies in the information flows between brokers and banks, and suggested that more robust systems and processes are needed, especially around commission data and broker performance.
Also, the risk of loans originated via brokers was discussed again, with the argument being mounted that financial incentives make broker loans intrinsically riskier.
Meantime whilst the government switched the narrative to good and bad debt, housing affordability remained in the news, with the HIA arguing again that supply side issues are the key, despite the fact that the average number of people living in each dwelling across Australia has hardly changed in years.
We think supply is not the big issue. Yes, there should be more focus on building more affordable social housing, but the main focus needs to be the reduction in investor tax incentives. The financialisation of property is the real underlying issue, but this is hard to address, and explains why the government is now wanting us to look elsewhere.
In broader economic news, inflation rose a tad, thanks to a strong rise in Victoria, and as a result there is less reason to expect an RBA cash rate cut. That said, the official CPI understates the real experience of many households, not least because housing costs are so significant now. We maintain our view that the next RBA rise will be up, not down, unless we get a significant external shock. Of course a cash rate rise will likely flow on to mortgage holders, putting them under more under pressure.
Finally, in preliminary news from CoreLogic they suggest that Sydney home prices may have stalled in April. Whilst some reports say this is the top, there are a range of technical issues which suggests it is too early to make this call. We need to see more data, and the Auction clearances may be an indicator of what is to come.
Nevertheless, we hold the view that we have probably reached the peak, and as mortgage lending tightens, and investors become more sanguine, prices in the major centres are likely to slide, mirroring the falls in WA, now, in some places down more than 20%. It then becomes a question of whether is turns into a rout, or whether prices drift sideways for some long time.
And that’s the Property Imperative week to the 29th April!