RBA’s Chris Aylmer spoke at the Australian Securitisation Conference entitled “Towards a more Transparent Securitisation Market“. He highlighted the significantly lower volume of mortgage backed securitisation written since the GFC, thanks to changed funding dynamics and lenders. In addition, using RBA’s securitisation dataset which contains information from around 50 sponsors and 270 trusts on around 1,100 securities and covers around 2 million loans; he highlighted portfolio LVR and default data. Finally, he discussed the need to improve data quality further for the future.
Recent Developments
The Australian securitisation market experienced a gradual recovery following the global financial crisis, spurred initially by support from the Australian Office of Financial Management (AOFM) and demand from authorised deposit-taking institutions (ADIs, namely banks, building societies and credit unions) (Graph 1). However, issuance remains well below pre-crisis levels.
Graph 1
Residential mortgage-backed securities (RMBS) continue to form the largest part of the market, although there has been a notable reduction in issuance this year. Commercial mortgage-backed securities (CMBS) comprise only a tiny fraction of issuance, while other asset-backed securities (ABS) issuance is also quite small.
The stock of marketed securitisations outstanding is a little above $100 billion, compared with a peak of about $250 billion in 2007 (Graph 2).
Graph 2
The decline in RMBS issuance this year has been driven by a significant reduction in issuance by banks (Graph 3). This reflects, among other things, less favourable conditions than in the senior unsecured wholesale debt market where banks have been able to issue in size and for longer maturities. The treatment of encumbered assets in the net-stable funding ratio also favours the issuance of senior unsecured debt over RMBS.
Graph 3
Consistent with the reduced presence of banks in the asset-backed market, the share of conforming RMBS issuance has declined. In fact, over the past year non-conforming RMBS, which are mainly issued by non-bank mortgage originators, have accounted for about a quarter of total RMBS issuance, compared to a post-crisis average of around 5 per cent. Non-conforming RMBS have also become larger, with some recent issues being between $700 and $800 million – larger than any other non-conforming deal since 2007.
As noted previously, pricing on RMBS issuance has become somewhat less favourable relative to other sources of funding (Graph 4). Average primary market spreads on banks’ conforming AAA rated RMBS rose markedly in early 2016, from around 100 basis points to around 150 basis points. While these spreads have recently come down a little, they remain higher than is usually the case relative to spreads on the major banks’ unsecured Australian dollar-denominated bonds.
Graph 4
Before the crisis, typically around 40-60 per cent of ABS issuance was offshore. Since then, offshore issuance has been much smaller, and averaged around 4 per cent over the period 2012 to 2016. Some of this foreign demand may have been sated by covered bonds, the majority of which have been issued offshore. There is currently about $100 billion of covered bonds outstanding.
The investor base for Australian ABS has continued to evolve (Graph 5). Holdings of marketed ABS by ADIs have decreased a little over the past year or so, though they still remain high by historical standards, while there has been a pick-up in demand from real money investors.
Graph 5
The Securitisation Dataset
Our understanding of developments in the securitisation market has been enhanced by the individual deal data that we are now receiving, and in particular the de-identified loan-level data. For RMBS, these data include: 62 fields related specifically to the loan, such as loan balances, interest rates and arrears measures; 18 fields related to the borrower, such as borrower income and employment type; and 13 fields that detail the collateral underpinning the mortgage, including the postcode and property valuation. Useful new information includes data on offset balances and borrower income at origination. In addition, issuers are required to provide a working cash-flow waterfall model of the security which provides useful information about structural aspects of ABS.
The dataset contains information from around 50 sponsors and 270 trusts on around 1,100 securities (Table 1). It covers around 2 million loans, the majority of which are residential mortgages, or around one-third of mortgages outstanding.
Table 1: Asset-backed Securities in the New Securitisation Dataset Number
Sponsors(a)
Trusts
Securities
Loans
Total
RBA eligible
‘000(b)
Marketed RMBS
30
195
860
367
366
Of which:
– ADI
21
145
514
256
311
– Non-ADI
9
50
346
111
55
Non-marketed RMBS(c)
40
49
107
—
1,400
CMBS
2
3
23
5
1
Other ABS
7
26
127
24
407
Total
54
273
1,117
—
2,174
(a) Sponsors organise a securitisation transaction to sell or transfer receivables (such as loans) that they originated or acquired; the categories do not add to total because some sponsors are involved in multiple categories
(b) The categories do not add to total due to rounding
(c) Self-securitisations; these require a related-party exemption to be eligible for repo with the RBA
Source: RBA
As noted previously, the primary purpose for the RBA collecting these data is to allow it to manage its actual and contingent exposure to these securities. The RBA has accepted certain asset-backed securities as part of its regular market operations since 2007, and there are now nearly 400 eligible, marketed asset-backed securities that the RBA accepts under repurchase agreements (repo). While the RBA only accepts the AAA rated tranches in repo transactions and insists that these securities not have structural features or triggers that are particularly complex or unusual, they still have a wide range of features that make understanding the structure of the securities important. The assets underpinning them also range from household and commercial mortgages, through to auto loans and credit card receivables.
While we require these data to be collected for our own risk management purposes, the RBA also sees merit in the information on marketed securities being made available more broadly, in the interests of enhanced market transparency. Therefore, as part of our eligibility requirements for accepting certain marketed securitisations as collateral, we require issuers to make a significant share of the data they provide to us available more broadly to investors and other permitted data users.
The RBA also needs to understand non-marketed securitisations (known as self-securitisations) because these are potentially a significant share of the collateral used in our standing facilities. The Committed Liquidity Facility (CLF) is a large contingent liability for the RBA. It is used by ADIs to meet their liquidity requirements under the liquidity coverage ratio. The CLF enables participating ADIs to access a pre-specified amount of liquidity from the Reserve Bank by entering into repurchase agreements of eligible securities outside of our normal market operations. The current size of the CLF is $245 billion.
The self-securitisations are also used to cover payment settlements that occur outside business hours under the RBA’s ‘open repo’ arrangements. These arrangements, which permit banks to convert these securities to exchange settlement balances at the RBA, will become increasingly important as we move to the new payments platform (NPP) in late 2017. From this time more payment settlements will be occurring outside business hours, including over the weekend.
So what can we see in the data?
Debt securities
On the liabilities side, we have a wealth of information about the structure of each ABS. The main liabilities of a securitisation are the issued notes, which may be structured quite differently across deals. For example, RMBS marketed by the ADIs tend to have very simple structures, commonly one large senior note with relatively little subordination (Graph 6). In contrast, the RMBS structures issued by non-ADI mortgage lenders typically require a larger amount of subordination in order for the senior tranches to obtain a AAA rating, as the loan pools typically have a larger share of non-conforming loans. Another common feature of non-ADI deals is the large number of subordinated tranches.
Graph 6
The structure of different securitisations may change over time. This reflects the operation of each trust’s cash-flow waterfalls, which determine the linkages between the assets, the trust support features and the liabilities. The waterfalls specify the precise rules for the ordering of cash allocations in each period of the trust’s lifetime. As noted previously, the ordering and linkages within the cash-flow waterfalls permit a better understanding of the risk characteristics of individual deals.
These models of the cash flows allow us to monitor the performance of a deal and observe how it performs under a range of scenarios, including stress scenarios. For example, one risk associated with RMBS is prepayment risk, as mortgagees have the option to pay back their loans ahead of schedule. We can now observe how note balances and credit support evolve under different prepayment rates (Graph 7). In this case, a higher prepayment rate results in the principal outstanding on the senior notes being paid down faster; it also leads to higher credit enhancement sooner.
Graph 7
How each securitisation addresses mismatches between assets and liabilities and, in particular, the role of various support facilities such as those that provide the trust with liquidity, or mitigate its interest rate risk, is explicit in the data. Each deal will have several facilities, which may be provided by a number of different parties and potentially by a counterparty presenting the security as collateral to the RBA. This is particularly important for the RBA because of its relevance to how we mitigate ‘wrong way’ risk – that is, the risk that our exposure to a counterparty increases as the credit quality of that counterparty declines. To deal with this, additional repo haircuts are applied if the counterparty is ‘related’ to the asset-backed security presented to the RBA.
Loan-level information
The source of the cash flows needed to support the trust’s liabilities is the underlying asset pool. The new securitisation dataset provides important information on the quality of the underlying assets, by providing a detailed description of the associated collateral, borrowers and loan contracts. The loan-level data contain static information determined at origination (such as the type of collateral and its geographical location) and data that changes over time (such as the loan balances, loan-to-valuation ratio and arrears rates).
Features of the underlying assets can vary considerably across securitisations (Graph 8). The loans underpinning both the major bank and non-ADI securitisations shown here are geographically diversified across states, with the non-ADI deal a little underweight in NSW and overweight in Victoria relative to those states’ shares of the Australian population. At the same time, the non-ADI deal is more heavily concentrated in postcodes that are more distant from the centre of the capital cities than the major bank securitisation (Graph 9).
Graph 8
Graph 9
The interest rates paid by borrowers can also differ markedly across deals in the market, reflecting the considerable variation in characteristics of borrowers and lenders (Graph 10). Consistent with a loan pool comprising a higher share of non-conforming loans and self-employed borrowers, almost all loans backing the non-ADI deal shown here pay higher interest rates than those in the major bank deal (although again there is considerable variation across individual ADI and non-ADI deals).
Graph 10
It is also possible to monitor the quality of a security’s underlying assets over time (Graph 11). For example, at origination, a large share of the loans in these two deals had loan-to-valuation ratios (LVRs) close to 80 per cent, although the non-ADI deal had fewer loans with LVRs above this threshold. But now that the loans have aged, more recent data show that the LVRs are less concentrated as some of the loans have been paid down over time (although the data may not capture changes in valuations). The smaller shift in the distribution of the non-ADI deal could reflect a higher share of interest-only loans and/or a difference in the loan seasoning between the two portfolios, for example.
Graph 11
We are also able to analyse the distribution of arrears rates for securitised residential mortgages across Australia. Graph 12 shows that mortgage arrears are highest in Western Australia and Queensland, and in non-metropolitan regions, particularly those near mining operations.
Graph 12
The next steps for the RBA will be to develop an internal collateral pool model using, for example, credit risk models that take into account characteristics such as geographic concentrations, delinquencies and loan-to-value ratios.
Areas for Further Development
So what have we observed about the quality of the data, and where to from here?
The first point that I would make is that the data quality is generally good, though there is still scope to improve the accuracy, consistency and completeness of the data.
There is little consistency in reporting around credit scores and debt serviceability metrics. The RBA does not currently require this information to be made available to users of the data, but did flag last year that it would review this requirement once the information was collected. The RBA’s assessment is that because issuers are using very different measures and these metrics are currently being reported for only around half or three quarters of loans depending on the measure, publication would do little to enhance transparency at this stage. This will remain a ‘work-in-progress’ for the time being.
To improve data quality further, the RBA has continued to roll out more validation rules. To date, these rules have targeted the most critical fields for eligibility and the calculation of haircuts, ensuring that the information is complete and within plausible ranges. The rules also check for the completeness and internal consistency of the data. These checks will become increasingly sophisticated, focusing in particular on ensuring that the data evolve in a consistent manner over time.
The feedback that we have received from investors and other market participants is that, to date, the process for gaining access to the data is cumbersome, particularly the need to sign access deeds. With this in mind the ASF has recently released a new standard framework for loan-level data disclosure. The framework is a recommended minimum standard for industry participants when providing and receiving loan-level data for RMBS. The primary purpose of the framework is to mitigate certain risks, but particularly those relating to privacy where sponsors have to manage the risk around the possible re-identification of data.
There is more interest in the new data from buyers of lower-rated tranches, but this has not yet opened up a new investor base as investors have tended to rely on existing means of access to the relevant information. Better access arrangements would promote greater interest in the data from a wider investor base. It would also assist in the monitoring of deals so that investors can satisfy themselves that they are receiving the correct cash flows.
As I mentioned earlier, one of the RBA’s requirements for ABS to be considered repo eligible is that a large proportion of the new dataset (including summary stratification tables) be made available to the public. We will shortly be surveying information providers to see how this requirement is being met. Of particular interest is how users are accessing the securitisation data, how many requests have been received, the type of data request and take-up by investors and other permitted users.
The RBA is also planning to align the deadline for reporting to the RBA with the date that investor reports are due. This would remove the current mismatch and allow the RBA and other permitted users to price and assess the credit risk of these securities more accurately, and in a more timely manner.
In the interest of transparency, the RBA is now publishing information on our website about the progress of applications for securities to be considered eligible for the RBA’s market operations. This information includes details of securities that have been made ineligible because the ongoing reporting requirements have not been met.
In the past two days we have seen a couple of important changes of direction from the RBA relating to housing and household debt.
First, in the minutes of the meeting held on Melbourne Cup day, they acknowledge that assessing conditions in the housing market had become more complicated. “While overall conditions had eased relative to 2015, some indicators had strengthened over the previous few months. In particular, housing price growth had picked up noticeably in Sydney and Melbourne. However, housing turnover and growth in housing credit both remained lower than a year earlier, consistent with the supervisory measures that had been taken to tighten lending standards and the more cautious attitude to lending in certain segments. In addition, a considerable supply of apartments is scheduled to come on stream over the next few years, particularly in the eastern capital cities, and growth in rents in the September quarter was the slowest for some decades”.
Last night the Governor his address said that some households are being more cautious, and not using their houses like ATMs as much as in the early 2000’s. He says “this more prudent behaviour is a positive development but given the high and rising levels of debt, though, we need to watch things carefully. It is important that we avoid a build-up of financial imbalances in household balance sheets. We can never know with certainty exactly what level of debt is sustainable. It depends on income growth, lending standards and asset prices. But it surely must be the case that the higher is the debt, the greater is the risk. Given this, as I said recently when explaining our monetary policy decisions, it is unlikely to be in the public interest, given current projections for the economy, to encourage a noticeable rise in household indebtedness, even if doing so might encourage slightly faster consumption growth in the short term”.
Household debt is high on any measure as we have frequently discussed and this was intentional RBA policy to offset the fading momentum from the mining sector. Household income is growing but slowly, so are under pressure from large mortgage commitments. But now with commodity prices a little higher, it is time to ratchet back growth in household debt. As we discussed before the next move in interest rates on mortgages is likely to be up.
But the key question is how to get businesses to investment in growth. As the RBA noted recently, many companies still have very high internal rates of return for investment hurdle assessments, and we noted growth in business lending is slow relative to home lending.
The risk weightings for business lending, under Basel III are significantly higher than for mortgage lending, so the banks can spread their capital further and leverage more by lending to households for home purchase.
So, the issue for the RBA and other policy makers is how to tilt the playing field to encourage business activity and lending. Lower cash rates will make no difference, but perhaps thought should be given to other incentives to encourage business investment.
Philip Lowe RBA Governor spoke about the Australian economy tonight. He included (finally) some comments about household debt. He said it surely must be the case that the higher the debt, the greater is the risk. It is unlikely to be in the public interest, given current projections for the economy, to encourage a noticeable rise in household indebtedness, even if doing so might encourage slightly faster consumption growth in the short term. This is an important policy shift in my book! It may lead to tighter lending controls, and a slowing in home lending growth.
To provide some context I would like to begin with two observations.
The first is that Australia’s economic success over recent decades reflects both the underlying fundamentals and our ability to ride out various shocks. The fundamentals that have helped us are well known. They include our openness to trade and investment, our generally favourable demographics, our diverse and talented people, our abundance of natural resources, our ability to undertake structural reform to boost productivity and our links with the fast-growing Asian region. But also important to our prosperity is the fact that over the past quarter of a century, our economy has not been seriously derailed by economic shocks. After all, nothing undermines prosperity like a severe recession in which large numbers of people lose their jobs and see their wealth decline.
It is not as if there has been a shortage of shocks that could have derailed us. There was the Asian crisis, the bust of the US tech boom and the global financial crisis. We also experienced a once in a century surge in our terms of trade and the subsequent decline.
The point is that we have been able to ride out these and other shocks without too much difficulty. In part this is because of the flexibility of our exchange rate, monetary policy and the labour market. We have also avoided the build-up of large financial imbalances. But this resilience is also because when the shocks hit we have had buffers to absorb them. Because of these buffers, we had options that not all other countries have had.
The second observation is that today many business people tell us they feel the heavy weight of uncertainty. The long list of factors we hear includes: uncertainty about the transition in the Chinese economy; the future direction of technology; the political environment, both abroad and at home; the impact of high debt levels on future consumer demand; and uncertainty about where the extraordinary global monetary expansion will ultimately end. Understandably, when people feel uncertain, they sometimes feel that it’s best to delay making decisions, especially if those decisions are difficult to reverse. We want to seek out more information before proceeding. We want to wait.
So, to draw these two observations together: Australians have managed pretty well over the past quarter of a century, but we feel a bit uncertain about the future.
In my view, despite the uncertainties, we should still be looking forward to the future with some optimism. Here in Australia, with our long track record of good economic growth and our demonstrated ability to adjust to a changing world, we have a set of advantages that not all countries have. Our collective challenge is to capitalise on those advantages. Ensuring a strong focus on lifting productivity is surely the key here.
As we work out how to do this, though, we obviously can’t ignore the uncertainties. But neither can we let those uncertainties force us to retreat, to withdraw from the world. If we do this, then we, and our children, will be poorer as a result. Rather, we need to deal with, and prepare for, those uncertainties. This brings me back to the title of my remarks, ‘Buffers and Options’. Part of our preparation is to ensure that we have adequate buffers in place to deal with future shocks wherever they come from. These buffers provide us with options when challenges arise.
I would like to talk about buffers in three broad areas: the financial system, the fiscal arena and household finances.
Financial System
One area where it is particularly important to have adequate buffers is in the financial sector. The financial sector can either act as a cushion for adverse shocks or it can act as an amplifier. Which one it turns out to be depends upon how well the system is prepared to deal with bad events. If the system has skimped on liquidity and is carrying too little capital, then it is likely to amplify shocks. Conversely, if the financial system has adequate buffers, it is better able to support the economy in difficult times.
The aftermath of the global financial crisis is a good example of what can happen. This chart (Graph 1) shows how bank lending has grown – or in the case of Europe, contracted – since the financial crisis in 2008. Many banks in Europe and the United States simply did not have large enough buffers for the events that unfolded. Even today, capital levels remain an issue for some European banks. Insufficient capital means that some banks are constrained in their ability to provide finance and helps explain why banks have not taken advantage of the European Central Bank’s offer to lend them money at an interest rate below zero. The European economy has suffered as a result. In the United States, the picture is more positive, partly because there were more successful efforts early on to rebuild the buffers in the system.
Graph 1
In Australia, it has been a different story. The banking system did have the capacity to support the economy during the global crisis, although it is important to point out that it did this with the assistance of the Australian Government through various guarantee schemes following the freezing of global capital markets.
Around the world, the experience of recent years has rightly caused banks and their regulators to think again about how large the buffers should be. And the answer has been that they should be larger than they were before. This has been true in Australia too, despite the starting point here being better than in many other countries.
Since the beginning of 2015, the major banks have raised around $28 billion from new equity and retained earnings, significantly increasing their capital relative to their assets (Graph 2). Banks are also holding a larger share of their assets in liquid form and have changed the composition of their funding towards more stable sources (Graph 3). During 2016, liquid assets have accounted for around 20 per cent of the major Australian banks’ total assets, up from an average of around 15 per cent in the years preceding the financial crisis. Banks have also increased their use of deposits and long-term debt and reduced their use of short-term debt.
Graph 2
Graph 3
These are positive developments and they provide us with an extra degree of insurance against future shocks.
Of course, this insurance does not come for free. Higher capital, more liquidity and more expensive, stable funding all have a price. We need to keep an eye out to make sure that this price is not too high and that we don’t constrain the ability of the financial system to do its job. My view is that this has not been the case in Australia and that the changes have increased the resilience of our system.
There is, though, a legitimate discussion to be held as to who pays the price. We see this issue frequently debated in our media. One possibility is that the cost falls on the bank shareholders in the form of lower returns on equity. Another is that it falls on borrowers in the form of higher interest rates on bank loans relative to the cash rate.
Ultimately, the balance is for the market to sort out, but it would seem unlikely that the cost will fall entirely on one side or the other. Over time, shareholders and borrowers will both benefit from these larger buffers to the extent that they contribute to economic stability. The shareholders should experience less volatile returns and borrowers should be more likely to be supported during difficult times. The larger buffers provide a form of insurance to all.
Fiscal Arena
A second area where buffers are important is on the fiscal front.
Again, the events of the past decade provide a useful illustration.
In Europe, we saw examples of what can happen when public finances are not in order when difficult times strike. In some countries, when troubles arrived, governments felt that they had little choice other than to impose austerity measures to restore the fiscal accounts, despite the fact that these measures added to the immediate downturn in the economy.
Australia, again, provides a counter example. When the shockwaves of the global financial crisis hit us, the Australian Government did have the capacity to support the economy through a fiscal expansion. This support was one of a number of factors that helped us get through this period. The ability to provide the stimulus was enhanced by the sound fiscal position that had been built up over previous years (Graph 4). While the exact nature of the stimulus remains a matter of debate, regardless of where you stand on that debate the fiscal buffers that we had did provide us with options that not all other countries had.
Graph 4
Since the financial crisis in 2008, the budget has been in deficit and debt levels have moved higher. Under current projections, net debt is expected to peak in 2017/18 at 19.2 per cent of GDP and a balanced budget is not expected until 2020/21. This would still leave the fiscal accounts in better order than those in many other countries. Importantly, this means that fiscal policy still retains capacity to support the economy in difficult times. But this capacity is less than it once was. We have a smaller buffer than we once did and a smaller buffer means fewer options.
So from a risk-management perspective, there is merit in rebuilding our buffers on the fiscal front. This is a task that can be undertaken over time and it requires difficult choices to be made. As Secretary to the Treasury John Fraser reminded us in a recent speech, the task is made more difficult by slow growth in nominal income.[1] But it is important that we ensure our public finances are on a sustainable track. This requires a better balance to be established, over time, between recurrent spending and revenue. It is worth pointing out that this does not preclude government spending on infrastructure, where this is backed by a strong business case. Such spending can provide support for the economy and can help generate the productive assets that a prosperous economy needs. Done well, infrastructure spending is not inconsistent with establishing a better balance between recurrent spending and revenue.
Household Finances
The third set of buffers that I would like to talk about are those in household balance sheets.
These buffers too are important as they influence how households respond to difficult economic times. Ideally, in such times, people are able to draw on their savings a bit, and perhaps even access credit, so that they don’t have to cut their consumption sharply. Of course they can do this only if their balance sheets are in reasonable shape.
Again, overseas experience is relevant here. In the United States when the recession hit in 2008 some households found that they had simply borrowed too much. What followed was a period of defaults by some, less new borrowing and faster repayment of some debt. The result was a more severe downturn and a more protracted recovery than otherwise would have occurred.
Given this and other experiences, we need to pay close attention to household balance sheets here in Australia too. Debt levels, relative to income, are high in Australia and are much higher than they once were (Graph 5). Currently, household debt is equivalent to 185 per cent of annual household disposable income, a record high and up from around 70 per cent in the early 1990s. If we net off the household sector’s holdings of cash and deposits the pattern looks somewhat different. It is important, though, to recognise that the households with the debt typically are not the same ones with the large deposits.
Graph 5
The reasons for the large increase in household debt have been well documented. The lower nominal interest rates that followed lower inflation in the 1990s allowed people to borrow more, as did the liberalisation of the financial system. As a nation, we took advantage of these new opportunities to borrow. As a result, we ended up with both higher levels of debt and higher housing prices.
Given the low level of interest rates and ongoing employment growth, most households are managing the higher levels of debt, but many feel that they are closer to their borrowing capacity than they once were and have adjusted their behaviour accordingly. Since the financial crisis, there has been a noticeable increase in the household saving rate. We are not using our houses like ATMs in the way that we were in the decade to the mid 2000s. Gone are the days when higher housing prices were a sign that we should go to the bank and borrow more to spend.
One illustration of this change in behaviour is the large increase in balances held in mortgage offset accounts and redraw facilities. In aggregate, households now have balances in these accounts equivalent to 17 per cent of total outstanding housing loans, which is a buffer worth 2½ years of scheduled repayments at current interest rates (Graph 6). From the survey data we look at, we can see that over recent years more households in all income brackets have got ahead on their mortgages (Graph 7).
Graph 6
Graph 7
This more prudent behaviour is a positive development. Given the high and rising levels of debt, though, we need to watch things carefully. It is important that we avoid a build-up of financial imbalances in household balance sheets. We can never know with certainty exactly what level of debt is sustainable. It depends on income growth, lending standards and asset prices. But it surely must be the case that the higher is the debt, the greater is the risk. Given this, as I said recently when explaining our monetary policy decisions, it is unlikely to be in the public interest, given current projections for the economy, to encourage a noticeable rise in household indebtedness, even if doing so might encourage slightly faster consumption growth in the short term.
Conclusion
So in each of the three areas I have talked about this evening – the financial sector, the fiscal arena and household balance sheets – the story is broadly similar. Stronger buffers give us more options. And more options promote stability and prosperity. If we skimp on the buffers then we expose ourselves to more risk.
It is true that building these buffers does not come for free. In the financial sector, it might mean lower returns on equity or higher lending margins. In the fiscal arena, it means difficult trade-offs about recurrent spending and taxation. And in the household sector, it means consumption growth is slower for a time than it might otherwise be. But this is the nature of insurance. You pay a premium for protection against future uncertainties and to provide resilience. Of course, we need to make sure that this premium is not too high. But it is surely better to pay the insurance premium when the sun is shining than when the storm clouds are building or, worse still, to seek insurance when it is too late.
I am very conscious that this evening I have spoken a lot about providing resilience against future shocks. Before finishing, I want to point out that I am doing so not because we are predicting difficult times ahead. The Reserve Bank’s central scenario for the Australian economy remains a relatively positive one.
Instead, my focus tonight probably reflects the inherent cautiousness of a central banker. Just as the past 25 years have seen numerous shocks to the global economy, chances are, so too will the next 25 years. In the past, we have been served well by the economy’s flexibility and the buffers that we had. Being realistic, we will probably need these buffers again some time in the years ahead.
At the moment, though, our economy is adjusting better than many predicted to the unwinding of the mining investment boom. Over the next year, we are expecting the economy to grow at around its potential rate, before picking up a bit in the following year. We also expect some further modest progress in lowering unemployment, although spare capacity remains.
The low interest rates are helping to support the economy. And the decline in the exchange rate over recent years has assisted a number of industries. Survey measures of business conditions and consumer confidence generally remain above average. The prices for our commodity exports have also lifted since the start of 2016. As a result, for the first time in some years, Australia’s terms of trade have moved higher. This will help to boost incomes and fiscal revenues.
Inflation remains low, but the latest reading did not suggest that it was moving lower still. There remain reasonable prospects that inflation will return to around average levels over the next couple of years.
Finally, to repeat an earlier point, despite the uncertainty in the world, we should be looking forward to the future with some optimism. Australians can continue to enjoy a level of prosperity enjoyed by relatively few people around the world. We have a strong set of fundamentals and a demonstrated ability to adjust to a changing world. We should also take some comfort that our system retains buffers against future shocks. Strengthening these buffers makes sense in the uncertain world in which we live.
Members noted that assessing conditions in the housing market had become more complicated. While overall conditions had eased relative to 2015, some indicators had strengthened over the previous few months. In particular, housing price growth had picked up noticeably in Sydney and Melbourne. However, housing turnover and growth in housing credit both remained lower than a year earlier, consistent with the supervisory measures that had been taken to tighten lending standards and the more cautious attitude to lending in certain segments. In addition, a considerable supply of apartments is scheduled to come on stream over the next few years, particularly in the eastern capital cities, and growth in rents in the September quarter was the slowest for some decades.
Of note is their bank funding costs comment:
There had been little change to bank deposit rates in October, with the exception of some reversals of previous increases in term deposit rates by the major banks. The cost of banks’ funding sourced from wholesale debt markets had declined by almost 20 basis points since the August cash rate reduction and was expected to decline further as the cost of new issuance remained below the cost of outstanding debt. There had been little change to housing or business lending rates in October.
This may change now, given recent ructions on the international scene, post Trump.
We need measures of residential property price inflation. They need to identify bubbles, the factors that drive them, instruments that contain them, and analyse their relation to recessions. Such measures are also needed for the System of National Accounts and may be needed as part of the measurement of owner-occupied housing in a consumer price index. So, timely, comparable, proper measurement is a prerequisite for all of this, driven by concomitant data.
Critical to price index measurement is the need to compare, in successive periods, transaction prices of like-with-like representative goods and services. Price index measurement for consumer, producer, and export and import price indexes (CPI, PPI and XMPIs) largely rely on the matched-models method. The detailed specification of one or more representative brand is selected as a high-volume seller in an outlet, for example a single 330 ml. can of regular Coca Cola, and its price recorded. The outlet is then revisited in subsequent months and the price of the self-same item recorded and a geometric average of its price and those of similar such specifications in other outlets form the building blocks of a price index such as the CPI. There may be problems of temporarily missing prices, quality change, say size of can or sold as a bundled part of an offer if bought in bulk, but essentially the price of like is compared with like every month. RPPIs are much harder to measure.
First, there are no transaction prices every month/quarter on the same property. RPPIs have to be compiled from infrequent transactions on heterogeneous properties. A higher (lower) proportion of more expensive houses sold in one quarter should not manifest itself as a measured price increase (decrease). There is a need in measurement to control for changes in the quality of houses sold, a non-trivial task.
The main methods of quality adjustment are (i) hedonic regressions; (ii) use of repeat sales data only; (iii) mix-adjustment by weighting detailed relatively homogeneous strata; and (iv) the sales price appraisal ratio (SPAR). The method selected depends on the database used. There needs to be details of salient price-determining characteristics for hedonic regressions, a relatively large sample of transactions for repeat sales, and good quality appraisal information for SPAR. In the US, for example, price comparisons of repeat sales are mainly used, akin to the like-with-like comparisons of the matched models method, Shiller (1991). There may be bias from not taking full account of depreciation and refurbishment between sales and selectivity bias in only using repeat sales and excluding new home purchases and homes purchased only once. However, the use of repeat sales does not require data on quality characteristics and controls for some immeasurable characteristics that are difficult to effectively include in hedonic regressions, such as a desirable or otherwise view from the property.
The problem of source data
Second, the data sources are generally secondary sources that are not tailor-made by the national statistical offices (NSIs), but collected by third parties, including the land registry/notaries, lenders, realtors (estate agents), and builders. The adequacy of these sources to a large extent depends on a country’s institutional and financial arrangements for purchasing a house and varies between countries in terms of timeliness, coverage (type, vintage, and geographical), price (asking, completion, transaction), method of quality-mix adjustment (repeat sales, hedonic regression, SPAR, square meter) and reliability; pros and cons will vary within and between countries. In the short-medium run users may be dependent on series that have grown up to publicize institutions, such as lenders and realtors, as well as to inform users. Metadata from private organizations may be far from satisfactory.
We stress that our concern here is with measuring RPPIs for FSIs and macroeconomic analysis where the transaction price, that includes structures and land, is of interest. However, for the purpose of national accounts and analysis based thereon, such as productivity, there is a need to both separate the price changes of land from structures and undertake adjustments to price changes due to any quality change on the structures, including depreciation. This is far more complex since separate data on land and structures is not available when a transaction of a property takes place. Diewert, de Haan, and Hendriks (2011) and Diewert and Shimizu (2013a) tackle this difficult problem.
Figure 1 shows alternative data sources in its center and coverage, methods for adjusting for quality mix, nature of the price, and reliability in the four quadrants. Land registry data, for example, may have an excellent coverage of transaction prices, but have relatively few quality characteristics for an effective use of hedonic regressions, not be timely, and have a poor reputation. Lender data may have a biased coverage to certain regions, types of loans, exclude cash sales, have “completion” (of loan) price that may differ from transaction price, but have data on characteristics for hedonic quality adjustment. Realtor data may have good coverage, aside from new houses, data on characteristics for hedonic quality adjustment, but use asking prices rather than transaction prices.
The importance of distinguishing between asking and transaction prices will vary between countries as the length of time between asking and transaction varies with the institutional arrangements for buying and selling a house and the economic cycle of a country.
Whether measurement matters
A natural question is whether the differences in source data and methodologies used matters to the overall outcome of the index. Silver (2015) undertook an extensive formal analysis based on the RPPIs and, as explanatory variables, the associated methodological and source data for 157 RPPIs from 2005:Q1 to 2010:Q1 from 24 countries. The resulting panel data had fixed-time and fixed-country effects; the estimated coefficients on the explanatory measurement variables were first held fixed and then relaxed to be time varying. Subsequently, the explanatory variables were interacted with the country dummies.
The rest of the paper examines, consolidates, and provides improved practical methods for the timely estimation of hedonic RPPIs, though, as noted earlier, the proposed methods apply equally to CPPIs. Hedonic regressions are the main mechanism recommended for and used by countries for a crucial aspect of RPPI estimation—preventing changes in the quality-mix of properties transacted translating to price changes.
RPPIs and CPPIs are hard to measure. Houses, never mind commercial properties, are infrequently traded and heterogeneous. Average house prices may increase over time, but this may in part be due to a change in the quality-mix of the houses transacted; for example, more 4-bedroom houses in a better (more expensive) post-code transacted in the current period compared with the previous or some distant reference period would bias upwards a measure of change in average prices. A purpose and crucial challenge of RPPIs and CPPIs is to prevent changes in the quality-mix of properties transacted translating to measured price changes. The need is to measure constant-quality property price changes and while there are alternative approaches, the concern of this paper is with the hedonic approach as a recommended widely used methodology for this.
Note: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.
The latest RBA Statement of Monetary Policy, released today includes a range of comments on housing, and mortgage lending. Clearly the RBA wants to continue to show there is nothing to see here. High absolute household debt and rising defaults hardly gets a mention! They also choose to use the APM home price data rather than CoreLogic’s indices (which would show higher growth). They say the average outstanding housing interest rate has fallen by around 35 basis points this year.
However, they do warn that if growth in housing demand does not continue to keep pace with the scheduled large increases in supply, it would place downward pressure on housing prices and rents and increase the risk of off-the-plan apartment purchases failing to settle.
They also warn that if the broader housing market was to weaken substantially, consumption growth may be lower than currently expected in response to wealth and income effects. Consumer price inflation would also be affected as housing costs comprise a significant share of household expenditure.
As expected, private dwelling investment was strong over the year to the June quarter. The value of residential building approvals has reached record levels as a share of GDP and the amount of work in the pipeline has edged higher. Accordingly, dwelling investment is likely to contribute to growth for some time yet. However, the large amount of work in the pipeline raises concerns that some locations could become oversupplied, particularly in inner-city areas where a lot of highdensity housing is planned. This could lead to settlement failures by off-the-plan purchasers and a general reduction in rents and prices.
Conditions in the established housing market have eased relative to a year ago, although some indicators suggest that conditions may have strengthened over recent months. In particular, housing price growth has picked up noticeably in Sydney and Melbourne, where auction clearance rates have also increased to high levels.
However, the number of auctions and housing market turnover more generally are lower than they were last year and properties are, on average, taking longer to sell. While housing credit growth has also declined over the past year, loan approvals data suggest that lending to investors has increased a little over recent months. Housing market conditions remain weak in Perth, where prices of both apartments and detached dwellings have declined further over the past year.
Housing credit growth has eased to an annualised pace of around 6 per cent. Growth in net housing debt is about 1 percentage point below growth in housing credit due to ongoing strong growth in deposits in mortgage offset accounts.
While the slowing in housing credit growth and loan approvals has been reasonably broad based, there remains some divergence in the pace of growth across states (Graph 4.11). The slowing in loan approvals has been particularly pronounced in Western Australia; while loan approvals in NSW have also eased over the past year, they continue at a pace noticeably above the national average.
Growth in credit advanced to investors has increased a little in recent months, consistent with a pick-up in investor housing loan approvals. In contrast, growth in credit advanced to owner-occupiers has eased a little recently. The current level of approvals is consistent with housing credit growth continuing at around its current pace.
The slowing in housing loan approvals over the past year is consistent with the decline in turnover in the housing market. It also reflects slower growth in average dwelling prices and a decrease in the average loan-to-valuation ratio. The latter follows the introduction of measures by the Australian Prudential Regulation Authority (APRA) to strengthen lending standards. Another factor that may be contributing to the easing in housing credit growth over the past year is an increase in the share of off-the-plan purchases, which are yet to flow through to the demand for credit. These transactions do not involve a mortgage at the time the dwelling is purchased off the plan, but add to the stock of housing credit when a mortgage is provided to the purchaser upon completion of the dwelling.
Around half of the August cash rate reduction was passed through to most advertised housing lending rates. The average outstanding housing interest rate has fallen by around 35 basis points this year and is likely to decline a little further as maturing loans are replaced with loans on lower The lowest available variable interest rates are more than 50 basis points below the average outstanding interest rate and, reflecting the lower rates on offer, the level of refinancing activity remains relatively high. One bank has recently introduced a loan product with the interest rate margin fixed at 249 basis points above the cash rate.
Recent strength in dwelling investment, particularly the construction of higher-density dwellings, has played a role in supporting the rebalancing of economic activity away from the resources sector.
Low interest rates and increases in housing prices have encouraged a substantial increase in the supply of apartments and the pipeline of residential work yet to be done has increased to historically high levels. While this pipeline should support growth in dwelling investment over the next year or so, the outlook for dwelling investment beyond this period is uncertain.
There is concern about the risk of an oversupply of apartments in specific geographical areas, such as inner-city areas of Melbourne and Brisbane. Outside Western Australia, the supply of housing has to date largely been absorbed by population growth. However, if growth in housing demand does not continue to keep pace with the scheduled large increases in supply, it would place downward pressure on housing prices and rents and increase the risk of off-the-plan apartment purchases failing to settle. If the broader housing market was to weaken substantially, consumption growth may be lower than currently expected in response to wealth and income effects. Consumer price inflation would also be affected as housing costs comprise a significant share of household expenditure.
The RBA has release an FOI response relating to documents created since 1 July 2015 containing information on Australian metropolitan apartment vacancy rates.
They say that a first look at the data indicates that the large additions to supply may be weighing on the apartment markets in inner-city Brisbane and Melbourne. It also highlights the strength of current conditions in the Sydney apartment market, whereas Perth and areas heavily exposed to the mining industry are experiencing some weakness in housing markets
The substantial volume of apartment construction currently taking place across Australia has been concentrated in Sydney, Melbourne and Brisbane. The large amount of expected apartment completions over the coming years has led to concerns around potential oversupply, particularly in the inner-city areas of Brisbane and Melbourne. By number, these 3 city’s CBDs are forecast to have the largest amount of apartment completions over the coming two years As a share of the existing stock, the new forecast supply in Brisbane CBD will increase the dwelling stock in that area by 25 per cent. Adjacent areas to the Brisbane CBD, such as Brisbane Inner – North, and Holland Park – Yeronga are also forecast to have substantial increases in supply.
In Melbourne, the total number of new units is estimated at over 16 000 over the next two years, well above the forecast increase in other areas and as in Brisbane, neighbouring areas such as Port Phillip are also expected to have large numbers of new units.
Liaison suggests developers will increasingly offer rental guarantees as apartment supply increases (as a way of securing investor sales) and will be quick to adjust rents in response to vacancies. This raises the risk that a ‘flight to quality’ will translate to the broader apartment market over time through softer demand for older low quality, low amenity apartments.
In Sydney, the areas forecast to have large numbers of new units are more geographically dispersed and the proportional increase to the dwelling stock is generally smaller than for Melbourne and Brisbane. The dataset provides information about market conditions at a more granular level. For example, CBD apartment market conditions differ markedly across cities; the weakness in the Perth economy has led to sizeable declines in apartment values and rents as well as elevated vacancy rates, Brisbane and Melbourne’s apartment market conditions are subdued, while Sydney’s remains strong.
For Greater Sydney, expected apartment completions are higher than in the other capital cities. But oversupply is less of a concern, because this expected supply forms a lower share of the dwelling stock and is relatively spread out across the inner and middle suburbs. For those areas within Sydney forecast to experience larger increases in supply relative to the existing dwelling stock, (such as Strathfield – Burwood – Ashfield, Parramatta, Ryde – Hunters Hill and Auburn), there is little sign that oversupply concerns are weighing on these areas, with both value and rental growth remaining relatively strong However, in Melbourne and Brisbane, value growth in areas with the largest amount of expected completions (such as Melbourne City and Brisbane Inner) is relatively weak.
In Darwin, the housing market faces major headwinds as population growth slows. Contacts reported that high-density housing is oversupplied after years of strong building activity, which has led to falls in rents and prices and a rise in vacancy rates. High-rise construction has fallen significantly and building companies have had to adapt by rapidly shedding staff.
Apartment vacancy rates are already the highest of any capital city and residential rents have fallen considerably “white collar” workers – such as in engineering and design – do rent apartments. These highly-paid workers are either leaving now or have already left, which could partially explain the high vacancy rates already in Darwin. The decrease in accommodation costs resulted in Darwin’s CPI growth falling to around 0 per cent in year-ended terms in June 2016.
In the latest edition of the RBA’s Chart Pack, we get an update of household finances to end October 2016. The debt to income ratio rose again, from 186 in June 2016, reinforcing the piles of debt household have. A record. How will this all get repaid given the current low levels of income growth? Whilst low interest rates mean repayments are manageable at the moment, this will change if rates rise.
At its meeting today, the Board decided to leave the cash rate unchanged at 1.50 per cent.
The global economy is continuing to grow, at a lower than average pace. Labour market conditions in the advanced economies have improved over the past year, but growth in global industrial production and trade remains subdued. Economic conditions in China have steadied recently, supported by growth in infrastructure and property construction, although medium-term risks to growth remain. Inflation remains below most central banks’ targets.
Commodity prices have risen over recent months, following the very substantial declines over the past few years. The higher commodity prices have supported a rise in Australia’s terms of trade, although they remain much lower than they have been in recent years.
Financial markets are functioning effectively. Funding costs for high-quality borrowers remain low and, globally, monetary policy remains remarkably accommodative. Government bond yields have risen, but are still low by historical standards.
In Australia, the economy is growing at a moderate rate. The large decline in mining investment is being offset by growth in other areas, including residential construction, public demand and exports. Household consumption has been growing at a reasonable pace, but appears to have slowed a little recently. Measures of household and business sentiment remain above average.
Labour market indicators continue to be somewhat mixed. The unemployment rate has declined this year, although there is considerable variation in employment growth across the country. Part-time employment has been growing strongly, but employment growth overall has slowed. The forward-looking indicators point to continued expansion in employment in the near term.
Inflation remains quite low. The September quarter inflation data were broadly as expected, with underlying inflation continuing to run at around 1½ per cent. Subdued growth in labour costs and very low cost pressures elsewhere in the world mean that inflation is expected to remain low for some time.
Low interest rates have been supporting domestic demand and the lower exchange rate since 2013 has been helping the traded sector. Financial institutions are in a position to lend for worthwhile purposes. These factors are assisting the economy to make the necessary adjustments, though an appreciating exchange rate could complicate this.
The Bank’s forecasts for output growth and inflation are little changed from those of three months ago. Over the next year, the economy is forecast to grow at close to its potential rate, before gradually strengthening. Inflation is expected to pick up gradually over the next two years.
In the housing market, supervisory measures have strengthened lending standards and some lenders are taking a more cautious attitude to lending in certain segments. Turnover in the housing market and growth in lending for housing have slowed over the past year. The rate of increase in housing prices is also lower than it was a year ago, although prices in some markets have been rising briskly over the past few months. Considerable supply of apartments is scheduled to come on stream over the next couple of years, particularly in the eastern capital cities. Growth in rents is the slowest for some decades.
Taking account of the available information, and having eased monetary policy at its May and August meetings, the Board judged that holding the stance of policy unchanged at this meeting would be consistent with sustainable growth in the economy and achieving the inflation target over time.
The RBA released their credit aggregates for September today. Overall, lending for housing rose 0.5% to reach another record $1.6 trillion, up $8.6 billion. Within that, owner occupied lending rose 0.6%, up $6.1 billion and investment lending rose 0.4% or $2.5 billion. This is a slightly lower growth rate than a year back (7.5%), but is still strong, well above inflation and wage growth. This means household debts will continue to rise.
The monthly growth rate for investment mortgages shows a sharp move up, and from March 2016, as banks started to focus on lending to this sector. Lending for owner occupation growth rates fell a little, having peaked at the end of last year.
The annualised analysis shows a tilt down, but if recent trends continue, this will reverse. This is hardly a good indicator that housing lending is under control. Indeed, we saw another high auction clearance rate at the weekend.
It is worth noting that there was $1bn of mortgages being switched between owner occupied and investment categories. The proportion of loans for investment purposes is still stitting at 35%. In addition, the proportion of lending to business continues to fall, rising just 0.3% this month, or $2.9 bn. Lending for personal finance fell again, down 0.1%.
The RBA said:
Following the introduction of an interest rate differential between housing loans to investors and owner-occupiers in mid-2015, a number of borrowers have changed the purpose of their existing loan; the net value of switching of loan purpose from investor to owner-occupier is estimated to have been $45 billion over the period of July 2015 to September 2016, of which $1.0 billion occurred in September 2016. These changes are reflected in the level of owner-occupier and investor credit outstanding. However, growth rates for these series have been adjusted to remove the effect of loan purpose changes.
Note we have used the seasonally adjusted data in our analysis. You can read our analysis of the companion APRA monthly banking stats here.
