RBA FOI on Negative Gearing and Investment Properties

Under a freedom of information request, the RBA has just released some material which casts light on their perspective on investment property and negative gearing from the Financial System Inquiry.

There are a few interesting points.

  • Whilst tax reform is an issue for Government, the RBA has noted that concessional rates of taxation of capital gains might encourage leverage speculation, especially in combination with negative gearing provisions.
  • Risks have been building in investor housing (no coincidence, this is happening at a time when some other asset classes have seen modest/volatile returns).
  • Negative gearing and capital gains concessions could together encourage “leveraged and speculative investment in housing” – including bidding up house prices, risks to financial stability if prices were to fall, and a rise in interest only loans (which do not repay capital so do not build an equity buffer).
  • If changes were made to these policies, it might increase rents, and if the arrangements were not grandfathered, could lead to the large-scale sale of negatively geared properties.

Note: Labor’s proposals, of course include grandfathering.

 

RBA May Monetary Statement – Inflation Lower For Longer

The RBA has released its latest statement on monetary policy. Essentially, inflation will be lower for longer, and they see home lending still running at around 7% growth whilst competition to lend grows more intense.

The March quarter underlying inflation outcome was around ¼ percentage point lower than expected at the time of the February Statement.

The broad-based nature of the weakness in nontradables inflation and the fact that wage outcomes were lower than expected over 2015 has resulted in a reassessment of the extent of domestic inflationary pressures, leading to downward revisions to the forecasts for inflation and wage growth. Underlying inflation is now expected to remain around 1–2 per cent over 2016 and to pick up to 1½–2½ per cent at the end of the forecast period.

RBA-May-01Given data observed over the past few months, the recovery in wage growth and labour costs underpinning the inflation forecasts has been revised lower.

Within the household sector, they say that household consumption growth increased in the second half of 2015 to around its decade average in year-ended terms, driven by relatively strong growth in New South Wales and Victoria. Factors supporting the pick-up in consumption growth include solid employment growth and low interest rates, as well as the ongoing effects of lower petrol prices and a further increase in household wealth.

With growth in household disposable income remaining below average, the saving ratio has continued to decline.

Retail sales volumes grew at a similar pace in the March quarter as in late 2015, although other timely indicators of household consumption have eased of late. Motor vehicle sales to households have continued to decline in early 2016, though at a slower pace than in late 2015, and households’ perceptions of their own finances have declined of late, although they remain around their longrun average. However, in the past these indicators have had only a modest correlation with quarterly aggregate consumption growth. Liaison suggests that trading conditions in the retail sector have softened in recent months, but remain generally positive.

Conditions in the established housing market have stabilised somewhat over the past two quarters or so. Housing prices increased in the early months of 2016, after easing slightly in the December quarter of 2015. Auction clearance rates are above average in Sydney and Melbourne, although they remain lower than a year ago. The average number of days that a property is on the market is a little higher than the lows of last year, while the eventual discount on vendor asking prices is little changed. Housing turnover rates are below average.

Housing credit growth has eased a little in recent months, after stabilising in the second half of 2015. This follows an earlier period of rising credit growth, driven in large part by investor lending. This moderation has been consistent with the increases in mortgage interest rates implemented by most lenders towards the end of 2015 and the tightening of lending standards.

The pace of housing credit growth has eased in recent months, to around 7 per cent. This follows increases in variable lending rates by most lenders in late 2015 and measures introduced by the Australian Prudential Regulation Authority (APRA) to strengthen lending standards. In particular, loan serviceability criteria have been tightened by lenders, which reduce the amount that some households can borrow. Consistent with these developments, there has been a decline in turnover in the housing market, along with slower growth in the average size of loans. Net housing debt has continued to grow around 11/4 percentage points slower than housing credit due to ongoing rapid growth in deposits in mortgage offset accounts. Recent housing loan approvals data suggest that housing credit will continue to grow at about its current pace.

Prior to the May cash rate reduction, the estimated average outstanding housing interest rate had been little changed since lenders increased interest rates in the second half of 2015. Following the May rate reduction, banks have lowered their standard variable rates by 19–25 basis points.

More broadly, there are signs that competition for both owner-occupier and investor loans is intensifying. New loans are typically benchmarked to standard variable rates, with lenders then offering discounts below these rates. Over recent months, interest rate discounts for new owner-occupier loans have increased and may be offsetting some of the increase in standard variable rates last year.

Discounts for investors on variable-rate housing loans were reduced substantially last year but have increased in recent months. Fixed interest rates for housing loans continue to be priced competitively and, consistent with this, a higher share of mortgages has been taken out with fixed interest rates.

Since the introduction of differential pricing for investor and owner-occupier lending by most major banks in the second half of 2015, growth in investor lending has slowed considerably, while growth in owner-occupier lending has accelerated. As noted previously, a large number of borrowers have contacted their existing lender to change the purpose of their loan, while there has also been a surge in owner-occupier refinancing and a drop in investor refinancing with different lenders.

Conditions in the rental market have continued to soften. Growth in rents has declined and the aggregate rental vacancy rate has increased to around its average since 1990. While the recent increase in the national vacancy rate mainly reflects developments in the Perth rental market, growth in rents has eased in most capital cities.

Dwelling investment has continued to grow strongly, supported by low interest rates and the significant increase in housing prices in recent years. Investment in higher-density housing grew at close to 30 per cent over 2015, accounting for most of dwelling investment growth over that period. More recently, the amount of residential construction work still in the pipeline has continued to rise and points to further strong growth in dwelling investment. The pace of growth is likely to moderate, however, consistent with the decline in building approvals since last year.

 

 

RBA Cuts Cash Rate

At its meeting today, the Board decided to lower the cash rate by 25 basis points to 1.75 per cent, effective 4 May 2016. This follows information showing inflationary pressures are lower than expected.

The global economy is continuing to grow, though at a slightly lower pace than earlier expected, with forecasts having been revised down a little further recently. While several advanced economies have recorded improved conditions over the past year, conditions have become more difficult for a number of emerging market economies. China’s growth rate moderated further in the first part of the year, though recent actions by Chinese policymakers are supporting the near-term outlook.

Commodity prices have firmed noticeably from recent lows, but this follows very substantial declines over the past couple of years. Australia’s terms of trade remain much lower than they had been in recent years.

Sentiment in financial markets has improved, after a period of heightened volatility early in the year. However, uncertainty about the global economic outlook and policy settings among the major jurisdictions continues. Funding costs for high-quality borrowers remain very low and, globally, monetary policy remains remarkably accommodative.

In Australia, the available information suggests that the economy is continuing to rebalance following the mining investment boom. GDP growth picked up over 2015, particularly in the second half of the year, and the labour market improved. Indications are that growth is continuing in 2016, though probably at a more moderate pace. Labour market indicators have been more mixed of late.

Inflation has been quite low for some time and recent data were unexpectedly low. While the quarterly data contain some temporary factors, these results, together with ongoing very subdued growth in labour costs and very low cost pressures elsewhere in the world, point to a lower outlook for inflation than previously forecast.

Monetary policy has been accommodative for quite some time. Low interest rates have been supporting demand and the lower exchange rate overall has helped the traded sector. Credit growth to households continues at a moderate pace, while that to businesses has picked up over the past year or so. These factors are all assisting the economy to make the necessary economic adjustments, though an appreciating exchange rate could complicate this.

In reaching today’s decision, the Board took careful note of developments in the housing market, where indications are that the effects of supervisory measures are strengthening lending standards and that price pressures have tended to abate. At present, the potential risks of lower interest rates in this area are less than they were a year ago.

Taking all these considerations into account, the Board judged that prospects for sustainable growth in the economy, with inflation returning to target over time, would be improved by easing monetary policy at this meeting.

OO Home Lending Drives Mortgages To A Record $1.55 Trillion

The RBA released their credit aggregates to end March today.  Housing lending grew 0.5% in March and reflects an annual rate of 7.2% – well above inflation! Business credit grew by 0.3% or $2.6 billion (annualised 6.5%) and personal credit fell 0.3% or $0.6 billion, and represents an annualised fall of 1%. We are still not seeing real relative growth in the important business investment sector.

RBA-March-2016-AggregatesSo, housing momentum is driving banks lending books. Seasonally adjusted lending for owner occupation grew 0.76%, or $7.5 billion, whilst lending for investment homes grew just 0.08%. Total growth was 0.5% or $7.7 billion to a new record of $1,547.6 billion.  One third of loans are for investment purposes, though there is still some movement and reclassification. The RBA says:

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 $39 billion over the period of July 2015 to March 2016 of which $1.5 billion occurred in March. 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.

Such strong growth in home lending will make the RBA pause for thought before they cut the cash rate again – household debt continues to sky rocket, at a time when incomes are static. Not a good formula for enduring financial stability. Cutting rates will have little impact on personal credit (which is still falling) or business borrowing (driven more by confidence and future prospective growth). This should temper the knee-jerk calls for a cut following the lower than expected inflation number earlier in the week.

We will post separately on the APRA numbers, also released today.

What Persistent Low Growth Might Mean

Interesting comments from Glenn Stevens in his address to Credit Suisse Global Markets Macro Conference New York. He discusses the impact of low growth on savers seeking yield, impacts on the broader economy, and the limits of monetary policy. He also mentions over-leveraged households, something which Australia knows all about!

Interest Rates and Savers

The first is the increasing concern that this world of ultra-low interest rates over a lengthy period is a big problem for savers. Here we are not talking about short-term trends. When everyone wants to save, the return to doing so will fall – that’s economics. In a cyclical sense that has to be expected, just as costs of borrowing rise when demand is strong.

The issue is when long rates are very low for a long time. In such a world, the whole set of assumptions embodied in retirement income plans will be called into question. Increasingly, we hear commentary about the difficulty – or impossibility – of defined-benefit pension plans making good on their promises with long-term rates of return so low. The fact that accounting rules and regulation now strongly incentivise trustees to hold bonds – at the lowest rates of return in human history – so as to minimise mark-to-market valuation changes over the short term only exacerbates the problem.

The problem is surely not confined to defined-benefit plans. Accumulation arrangements are still predicated on some set of assumptions about future income needs and returns. It may take longer but surely many of the owners of these funds are going to feel disappointment. The implicit promises – even if made only to themselves – about their retirement incomes are in danger of not being fulfilled. It is not a very daring prediction to say that these issues will loom ever larger over the years ahead.

Some critics lay these problems at the door of the central banks, whose policy actions have worked to lower long-term yields on financial assets. If it were really true that central bank policies were the only factor at work in very low long-term interest rates, while at the same time they were not helping growth, the critics might have a point.

But are central banks alone responsible for the decline in long-term interest rates? Real interest rates have fallen noticeably since 2007 – nearly a decade ago now. For there to be persistent effects on real interest rates as a result of central bank actions is perhaps not impossible, but seems contrary to everything we were taught when we studied economics. Monetary policy is not supposed to be able to affect real variables – like real interest rates – on a sustained basis. Presumably, changes in risk appetite, subdued growth and expectations that growth will continue to be subdued have also played a role in lowering real rates.

Interest Rates and Growth

This brings into focus the really critical question: what are the prospects for sustained growth in the future? Relatedly, what expectations about rates of return in the future are reasonable? The real economy needs to generate decent returns on the real capital stock that are then matched (risk-adjusted) by the yield on financial assets. The financial assets are, in the end, just paper claims on that flow of real returns – directly in the case of private sector obligations and indirectly for government obligations, which rely on being able to tax growing private incomes. If the real economy can’t perform to provide real returns to capital, there is nothing to back higher yields on financial assets. In that world, nominal and real yields on bonds would remain extremely low, the income being generated by those working with the capital stock would struggle to fund the benefits required by retirees through dividends and returns on bonds and bank deposits. Governments may not receive all the revenue they need to service their obligations. On the other hand, the stronger the prospects for long-term growth and good returns on the real capital stock, the smaller those problems will be and the more we can expect that, sooner or later, the yield on financial assets will be higher, in line with those real outcomes.

Which outcome will it be?

The more pessimistic are moving closer to the position of ‘secular stagnation’: that situation where the desire to save is so overwhelming and the apparent opportunities for profitable investment so weak, that real interest rates cannot equilibrate saving and investment for the system at positive rates of interest and full employment. The result is that the ex ante excess saving leads to a sustained below-full-employment equilibrium. The concept arose originally in the 1930s, but has recently been articulated by Lawrence Summers as a description of the current environment.[2]

I still find this a bit too pessimistic, because I struggle to accept that today, to an extent virtually unprecedented in modern history, ingenuity, technological development, entrepreneurial drive and opportunity for improvement are so weak – so unprecedentedly weak – and people’s desire to defer gratification so strong, that the equilibrium real rate of interest is actually going to be negative over an extended period.

What is undeniable, though, is that monetary policy alone hasn’t been, and isn’t, able to generate sustained growth to the extent people desire. Maybe this is simply the inevitable outcome after a period of excessive optimism and over‑leverage – an essentially cyclical explanation, where the cycle is a low‑frequency, financial one. Or maybe it is something more deep-seated and structural. That can all be debated. Either way, though, policies that encourage growth through means other than just ultra-cheap borrowing costs are surely needed.

It is often said, rightly, that policymakers should try to avoid unnecessary policy uncertainty. For central banks, this has meant trying to be clear about our objectives and our reaction functions – and what we will, or might, do in various states of the world. Maybe we need to be clearer about what we can’t do. Monetary solutions are for monetary problems. If there are other problems in the underlying working of the economy, central banks won’t be able to solve those.

Helicopter Money?

It is this recognition that purely monetary actions can go only so far, coupled with the need for some more growth and more inflation, that lies behind the recent discussion of ‘helicopter money’. In essence, this approach, were it to be attempted, would really be fiscal policy or a combined fiscal-monetary operation. It could involve unrequited transfers (gifts) to individuals’ bank accounts by the central bank – which diminishes the central bank’s net worth and so would require the acquiescence of its owner. Alternatively, it could involve direct funding of government spending by central bank finance – monetary-fiscal coordination.

There would be a host of practical issues to sort out in the ‘helicopter money’ approach. Other commentators have talked about these recently.

The main complication is surely that it would be a lot easier to start doing helicopter money than to stop, if history is any guide. Governments have found that a difficult decision to get right. That is, after all, how we got to the point where direct central bank financing of governments is frowned upon, or actually contrary to statute, in so many countries. It would be a very large step to overturn those taboos, which exist for good reason. The governance requirements in doing so would be, if not intractable, at least very complex. Desperate times call for desperate measures, perhaps. Are we that desperate?

Before we even got close to that point, one would have thought that for many governments today there must still be projects of an infrastructure kind that would, through conventional fiscal operations at current bond rates, offer returns comfortably above their cost of funding. Helicopter money is surely not needed in these cases. Questions may arise, in some jurisdictions at least, in the minds of citizens about the ‘soundness’ of such conventional policies. But if such questions arise about conventional fiscal actions, it seems unlikely that adding central bank financing to the mix would allay them.

It all Comes Back to Growth

But the very fact – extraordinary as it is – that such possibilities are being openly discussed by serious commentators reinforces the point that, while people find global growth outcomes still a bit disappointing, we are reaching the limits of monetary policy in boosting it. Central banks must of course do what they can, consistent with their mandates, and they continue to explore options. It is certainly clever to find ways of pushing the effective lower bound for interest rates down a bit further. It is inventive to find ways of lending more, at more generous terms, to the private sector.

But surely diminishing returns are setting in. My suspicion is that more and more people realise this. Maybe this has something to do with market confidence being easily rattled. There was a hint in the recent episode of the feeling that central banks didn’t have much left they could do, if things got worse.

So in the end we will collectively have to face up to the question of whether trend growth is lower and, if so, what is to be done about that. A few candidates might be advanced as contributing to such an outcome. Demographics is one. What we might label productivity pessimism – or is it realism? – along the lines of Robert Gordon’s views might be another. Others would point to excess debt in many jurisdictions as another.

If trend growth is lower and we can’t or don’t want to do anything about that, then expectations about future incomes, tax bases and so on will have to be reconfigured. People will need some explanation of why we have to accept that outcome. It may be that this reconfiguration is, in fact, what is happening. That would help to explain why ultra-low interest rates are not, apparently, as successful in boosting growth in demand as might have been expected. The future income against which people would borrow looks lower than it did, not to mention that the current income against which some already had borrowed has turned out to be lower than assumed.

Alternatively, even if we accept that demographic headwinds and the legacy of earlier problems make growth harder to achieve, perhaps we can re-double our efforts to address the things that may be unnecessarily restraining growth today and in the future. They might be things like:

  • in some jurisdictions, inadequately capitalised banks
  • over-leveraged firms or households
  • poor incentives for risk-taking of the ‘right’ kind
  • practices that unnecessarily impede productivity, or that slow down the re‑allocation of capital from old industries to new ones.

If we could engender a reasonable sense that future income prospects are brighter, that there is a good return to innovation and ‘real economy’ risk taking, and so on, then people might use low-cost funding for more productive purposes than just bidding up the prices of existing assets. Over time, the return on financial instruments could rise in line with returns in the real economy. Pension funds and insurers would be better able to meet their obligations. Governments would more easily service their debts. Citizens, having had some explanations as to why changes were necessary, would, in time, see some gains in their way of life, or at least some threats to their living standards abate. They would see less resort to very unorthodox policies, because there would be less need for them. And I can’t help thinking they would feel better about that.

RBA Financial Stability Review Released Today; And All Is Well…ish

The RBA released the latest edition of the Financial Stability Review. Whilst they highlight the risks in emerging markets and higher bank funding costs, they argue local banks have limited exposure to these issues, households and business are financially sound and banks have tightened lending standards (as shown by lower LVRs and bigger affordability buffers) so predicted losses remain low, whilst profitability is strong. They are not concerned about high household debt ratios. The RBA also highlights the capital improvements which are in train. So overall they argue the financial sector is well positioned (though with a few issues to work though, for example, exposures to New Zealand Dairy and Property, Resource sector, property development, Insurance sector).  They also say the tighter access to credit for households could pose near-term challenges in some medium- and high-density construction markets given the large volume of building activity that was started several years ago. They also suggest some foreign banks operating here could be under more pressure.

They examined Chinese buyers in the Australian Property Market.

Chinese investment in Australian residential and commercial property has increased significantly in recent years. This interest in property from Chinese households, institutional investors and developers is not unique to Australia; they are also active in the property markets of other countries, such as the United States, the United Kingdom, Canada and New Zealand.

The Australian banking system’s direct exposure to Chinese property investors and developers appears to be small. However, if Chinese demand were to decline significantly, that could weigh on domestic property prices and so lead to losses on the banks’ broader property-related exposures. Non-resident Chinese buyers own only a small portion of the Australian housing stock, but industry contacts suggest that they account for a significant and increasing share of purchases. These purchases are largely concentrated in off-the-plan apartments (especially in Sydney and Melbourne), in part because all foreign buyers, other than temporary residents, are generally restricted to purchasing newly constructed dwellings. Consistent with observations by industry contacts, the limited and partial data available from the Foreign Investment Review Board (FIRB) suggest that approvals for all non-residents applying to purchase residential property have increased substantially of late. The majority of these approvals are for new dwellings in New South Wales and Victoria. China is the largest source of approved investment in (residential and commercial) real estate and its share of total approvals is growing, but it still only accounts for a small fraction of overall market activity.

Nonetheless, if a significant subset of buyers reduce their demand sharply, this can weigh on housing prices, and Chinese buyers are no exception to this given their growing importance in segments of the Australian market. Such a reduction in housing demand could result from a number of sources, including:

  • A sharp economic slowdown in China that lowers Chinese households’ income and wealth. Any accompanying depreciation of the renminbi against the Australian dollar could further reduce their capacity to invest in Australian housing. In the extreme, Chinese investors may need to sell some of their existing holdings of Australian property to cover a deteriorating financial position at home. A macroeconomic downturn in China could also be expected to have knock-on effects on other countries in the region, which could also affect those countries’ residents’ capacity and appetite to invest in Australian property. On the other hand, if economic prospects in China deteriorate this could make investment abroad, including in Australia, more attractive and result in an increase in demand for Australian property.
  • A further tightening of capital controls by the Chinese authorities that restricts the ability of Chinese households to invest abroad.
  • A domestic policy action or other event that lessens Australia’s appeal or accessibility as a migration destination, including for study purposes. Industry contacts suggest that in addition to wealth diversification, many Chinese purchases are dwellings for possible future migration, housing for children studying in Australia or rental accommodation targeted at foreign students. If so, this demand could be expected to be fairly resilient to shorterterm fluctuations in conditions in China or developments in the domestic property market, but more sensitive to changes in migration or education policy.

A substantial reduction in Chinese demand would likely weigh most heavily on the apartment markets of inner-city Melbourne and parts of Sydney, not only because Chinese buyers are particularly prevalent in these segments but also because other factors would reinforce any initial fall in prices. These include the large recent expansion in supply in these areas as well as the practice of buying off the-plan, which increases the risk of price declines should a large volume of apartments return to the market if the original purchases fail to settle.

The Australian banking system has little direct exposure to Chinese investors. Australian owned banks engage in some lending to foreign households to purchase Australian property, but the amounts are small relative to their mortgage books. Australian-owned banks also have tighter lending standards for non-residents than domestic borrowers, such as lower maximum loan-to-valuation ratios, because it is harder to verify these borrowers’ income and other details, and because the banks have less recourse to these borrowers’ other assets should they default on the mortgage.

Australian branches of Chinese-owned banks appear to be more willing to lend to Chinese investors because they are often in a better position to assess these borrowers’  creditworthiness, particularly where they have an existing relationship. Nonetheless, although the direct exposures are small, if a reduction in Chinese demand did weigh on housing prices this could affect banks’ broader mortgage books to some extent.

Where Did The 10% Investor Mortgage Growth Speed Limit Come From?

An interesting FOI disclosure from the RBA tells us something about the discussions which went on within the regulators in 2014 and beyond, as they considered the impact of the rise in investor loans. Eventually of course APRA set a 10% speed limit, and we have see the growth in investment loans slow significantly and underwriting standards tightened.

Back then, they discussed the risks of investment lending rising, especially in Melbourne.

Macroeconomic: Extra speculative demand can amplify the property price cycle and increase the potential for prices to fall later. Such a fall would affect household spending and wealth. This effect is likely to be spread across a broader range of households than the investors that contributed to the heightened activity.

Concentration risk: Lending has been concentrated in Sydney and Melbourne, creating a concentrated exposure in these cities. The risk could come from a state-based economic shock, or if the speculative upswing in demand brings forth an increase in construction on a scale that leads to a future overhang of supply. In Sydney, the risk of oversupply appears limited because of the pick-up in construction follows a period of limited new supply and it has been spread geographically and by dwelling type. While the unemployment rate has picked up a little over the past 18 months, the overall economic environment in NSW is in a fairly good state. In Melbourne, there has been a greater geographic concentration of higher-density construction in inner-city areas. Some developments have a concentration of smaller-sized apartments that may only appeal to some renters, or purchasers in the secondary market. Economic conditions are not as favourable in Victoria and the unemployment rate is 6.8%.

Low interest rate environment: While a pick-up in risk appetite of households is to some extent an expected outcome given the low interest rate environment, their revealed preference is to direct investment into the housing market.  Historically low interest rates (combined with rising housing prices and strong price competition in the mortgage market) means that some households may attempt to take out loans that they would not be able to comfortably service in a higher interest rate environment. APRA’s draft Prudential Practice Guide (PPG) emphasises that ADIs should apply an interest rate add-on to the mortgage rate, in conjunction with an interest rate floor in assessing a borrower’s capacity to service the loan. In order to maintain the risk profile of borrowers when interest rates are declining, the size of the add-on needs to increase (or the floor needs to be sufficiently high).

Lending standards: In aggregate, banks’ lending standards have been holding fairly steady overall; lending in some loan segments has eased a little, while lending in some other segments has tightened up a bit. The main lending standard of concern is the share of interest-only lending, both to owner-occupiers and investors. For investors, 64% of banks’ new lending is interest-only loans and for owner-occupiers the share is 31%. The typical interest-only period is 5 years, but some banks allow the interest-only period to extend to 15 years. During this period, the loan is amortising more slowly than a loan that requires principal and interest (P&I) payments. If housing prices should fall, this increases the risk that the loan balance may exceed the property value (negative equity). There is some risk that the borrower could face difficulty servicing the higher P&I payments when the interest-only period ends, although this is typically mitigated by banks assessing interest-only borrowers on their ability to make P&I payments.

Of course the regulators found underwriting standards were more generous than they thought, at times in 2015 more than half of all new loans were investment loans, and recently banks have reclassified loans, causing the absolute proportion of investment loans to rise. Things were whose than they thought.

Next they discussed how to set the “right” growth rate:

How to calibrate the benchmark growth rate?  Household debt has been broadly stable as a share of income for about a decade. National aggregate ratios are not robust indicators of a sector’s resilience because the distribution of debt and income can change over time. But as a first pass, it is reasonable to expect that the current level of the indebtedness ratio is sustainable in a range of macroeconomic circumstances. Therefore there does not seem to be a case to set the benchmark growth rate significantly below the rate of growth of household income, in order to achieve a material decline in the indebtedness ratio. With growth in nominal household disposable income running at a little above 3 per cent, this sets a lower bound for possible benchmarks at around 3 per cent. Current growth in investor credit, at nearly 10 per cent, suggests an upper bound around 8 per cent to achieve
some comfort about the leverage in this market. Within this range, there are several options for the preferred benchmark rate for investor housing credit growth (including securitised credit).

a) Around 4½ per cent, based on projected household disposable income growth over calendar 2015. This could be justified as being consistent with stabilising the indebtedness ratio. However, it would be procyclical, in that it would be responding to a period of slow income growth by insisting that credit growth also slow. It would also be materially slower than the current rate of owner-occupier credit growth, which so far has not raised systemic concerns.

b) Around 6 per cent, based on a reasonable expectation of trend growth in disposable income, once the effects of the decline in the terms of trade have washed through. It is also broadly consistent with current growth in owner-occupier housing credit, which as noted above has not been seen as adding materially to systemic risk.

c) 7 per cent, consistent with the system profile for residential mortgage lending already agreed as part of the LCR/CLF process. Unless owner-occupier lending actually picks up from its current rate, however, the growth in investor housing credit implied by the CLF projections would be stronger than this. It is therefore not clear that these projections should be the basis for the preferred benchmark.

Staff projections suggest that only a moderate decline in system investor loan approvals would be required to meet a benchmark growth rate for investor housing credit in the 5–7 per cent range for calendar 2015. The exact size of the decline depends partly on assumptions about repayments through churn, refinancing and amortisation in the investor housing book. For a reasonable range of values for this implied repayment rate, and assuming that investor housing credit growth remains at its current rate for the remainder of 2014, the required decline in investor approvals is of the order of 10–20 per cent. This would take the level of investor housing loan approvals back to that seen a year ago. It is worth noting that investor loan approvals would have to increase noticeably from here to sustain the current growth rate of investor housing credit, even though the implied repayment rate is a little below its historical average. Since credit is not available at a state level, the benchmark can only be expressed as a national growth rate. The flow of loan approvals at a state level can be used as a cross-check to ensure that the benchmark incentive has had its greatest effects in the markets that have been strongest recently.

When the 10% cap (note this is higher than those bands discussed above) was announced, some Q&A’s provide some insights into their thinking.

Isn’t 10 per cent a bit soft?  We are not trying to kill the market stone dead. Investor housing credit is currently running at a bit under 10 per cent. Some lenders will have investor credit growth well below this benchmark anyway, so if all lenders do end up at least a little under this benchmark, which we hope they will, then aggregate growth in investor credit will be noticeably below 10 per cent. Setting a benchmark for individual institutions is not the same thing as setting it for an aggregate, and APRA has allowed for that.

Where did the 10 per cent benchmark come from?  This was a collective assessment by the Council agencies. We took the view that we did not want to clamp down on the market excessively. We also took the view that in the long run, household credit can expand sustainably at a rate something like the rate of trend nominal household income growth, maybe a bit more or less in shorter periods. Trend income growth is below 10 per cent, more like 6 per cent or thereabouts. But it was important to make an allowance for the fact that some lenders will undershoot the benchmark, so the aggregate result will likely be slower than that.

But isn’t household income growth likely to be below average in the next few years, because of the end of the mining boom?  Maybe, but we don’t want to be procyclical and clamp down on credit supply more when the economy growing below trend.

This of course confirms the regulators were wanting to use household debt as an economic growth engine (interesting, see the recent post “Why more-finance-is-the-wrong-medicine-for-our-growth-problem” )

We also see a significant slow down in household income growth, yet credit growth, especially housing has been stronger, creating higher risks if interest rates or unemployment was to rise. Raises the question, were the regulators too slow to act, and did they calibrate their interventions correctly? We will see.

 

RBA Holds Cash Rate Once Again

At its meeting today, the Board decided to leave the cash rate unchanged at 2.0 per cent.

Recent information suggests that the global economy is continuing to grow, though at a slightly lower pace than earlier expected. While several advanced economies have recorded improved growth over the past year, conditions have become more difficult for a number of emerging market economies. China’s growth rate has continued to moderate.

Commodity prices have generally increased a little recently, but this follows very substantial declines over the past couple of years. Australia’s terms of trade remain much lower than they had been in recent years.

Sentiment in financial markets has improved recently after a period of heightened volatility. However, uncertainty about the global economic outlook and policy settings among the major jurisdictions continues. Funding costs for high-quality borrowers remain very low and, globally, monetary policy remains remarkably accommodative.

In Australia, the available information suggests that the economy is continuing to rebalance following the mining investment boom. Consistent with developments in the labour market, overall GDP growth picked up over 2015, despite the contraction in mining investment. The pace of lending to businesses has also picked up.

Inflation is quite low. Recent information has confirmed that growth in labour costs remains quite subdued. Given this, and with inflation also restrained elsewhere in the world, inflation in Australia is likely to remain low over the next year or two.

Given these conditions, it is appropriate for monetary policy to be accommodative. Low interest rates are supporting demand, while supervisory measures are working to emphasise prudent lending standards and so to contain risks in the housing market. Credit growth to households continues at a moderate pace, albeit with a changed composition between investors and owner-occupiers. The pace of growth in dwelling prices has moderated in Melbourne and Sydney and has remained mostly subdued in other cities.

The Australian dollar has appreciated somewhat recently. In part, this reflects some increase in commodity prices, but monetary developments elsewhere in the world have also played a role. Under present circumstances, an appreciating exchange rate could complicate the adjustment under way in the economy.

At today’s meeting, the Board judged that there were reasonable prospects for continued growth in the economy, with inflation close to target. The Board therefore decided that the current setting of monetary policy remained appropriate.

Over the period ahead, new information should allow the Board to assess the outlook for inflation and whether the improvement in labour market conditions evident last year is continuing. Continued low inflation would provide scope for easier policy, should that be appropriate to lend support to demand.

Housing Lending Up To New Record $1.54 trillion

The latest data from the RBA showing the monthly credit aggregates shows that home lending continues to grow, in both the owner occupied and investment property arena.  Non banks are more active. Total lending for housing was a seasonally adjusted $1541.2 billion, up $8.6 billion, or 0.56%. This equates to an annual rate of 7.3%, well above inflation, and income growth. Within that, lending for owner occupation rose $7.6 billion, or 0.77%, whilst lending for investment property rose $1.0 billion or 0.19%.

Credit-Aggregates-Feb-2016Investment housing comprised 35.7% of all loans outstanding, a small fall from last month, but still a large number and higher than it should be.

Business lending rose 0.71% or $5.9 billion, to $844 billion, and comprises 33.4% of all lending, still lower than the 34.3% in 2013. So the slew towards lending for housing still remains.  This equates to 6.5% annual growth.

Banks still prefer to lend for housing than to productive businesses.

Personal credit hardly moved, with a small fall of 0.37%, to $145.4 billion.

The normal caveats apply with regards to the home lending data, with $1.9 billion of adjustments made in February. “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 $37.3 billion over the period of July 2015 to February 2016 of which $1.9 billion occurred in February. 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”.

We will discuss the APRA monthly banking data in our next post. But according to APRA, total lending to the banks for housing was $1,432 billion, so the rest – $109.4 billion is the non-bank sector, and this represents a 1.38% rise (up $1.49 billion) compared with last month. So one important observation is the non-bank sector is now growing their mortgage loan books faster than the banks. This is a worrying sign.

Why Are Credit Card Rewards Points Being Devalued?

Recently several banks have quietly reduced the value of points within their rewards programmes. So whats going on?

For example, CBA will decrease the rate at which Diamond and Black card holders can earn a Qantas Point from 2 to 2.5 reward points, a 20% loss of value.

ANZ has reduced its rewards on many of its cards, with its Visa version dropping from 2 Points per $1 spent to 1.25 ANZ Reward Points per dollar spend; their Platinum American Express earn rate is falling from 3 to 2 points per dollar spent and their Platinum Visa earning 1 ANZ Rewards Point per $1 rather than the previous 1.5 points per dollar.

They are not alone. Virgin Money says from April 1 2016, the rate at which cardholders can earn Velocity Frequent Flyer Points will be reduced by up to 33%, from one Point per dollar, to 0.66 Points while the Points cap will remain at $1,500 per month. Velocity High Flyer cardholders will also see a drop from 1.25 Points per dollar, to one Point per dollar with a new points cap of $10,000 per month.  They also removed rewards from BPay payments (whilst offsetting purchases from Virgin).

Citibank, effective 18th March,  lowered Rewards points per A$1 to 1.5 and from uncapped to the first $20,000 spent in each monthly statement period. Credit card BPAY payments no longer earn points and Citibank’s overseas transaction fees rose to 3.4%.

There are two factors in play. First, the interchange fees (that’s the interbank fee for payment processing) has been examined by the RBA, but this is at the discussion stage, and in December 2015, the RBA said

Given the complexity of issues involving interchange fees and companion cards, it is unlikely that the Board will take any formal decision on changes to the interchange standards before its May 2016 meeting … In the case of surcharging, depending on consultation responses, it is possible that the Board may be in a position to make an earlier decision on changes to its standards.

The RBA consultation paper noted that lower interchange fees may follow.

No credit card interchange fee would be able to exceed 0.80 per cent and no debit interchange fee would be able to exceed 15 cents if levied as a fixed amount or 0.20 per cent if levied as a percentage amount.

They also said:

The reduction in interchange fees, especially the cap on the highest credit card rates, is likely to result in some reduction in the generosity of rewards programs on premium cards. It is likely, however, that there would be only limited changes to other elements of the credit card package (e.g. interest rates, interest-free periods). Similarly, the reduction in the high percentage debit/prepaid interchange categories may be likely to result in some reduction in rewards generosity for some of the new debit/prepaid rewards cards. There are unlikely to be other material changes to arrangements for transaction accounts.

We discussed credit card economics in this earlier post and the recent Senate Inquiry into Credit Cards made 11 reform recommendations.

The writing is on the wall, and interchange fees, especially for premium cards, are likely to drop.

Second, with banks experiencing margin pressure, fiddling with card reward programmes is a cheap way of growing margins. The intrinsic complexity of the reward programmes (and the fact that not all card holders cash out their rewards anyway) means that changes are so opaque as to be unnoticed by many.

Remember also that credit card interest rates have not followed the target cash rate down.

The truth is, unless you are a devoted points collector, and spend the time to calculate the value (both earn and burn) of the reward points you may gain, you will simply not react to point devaluations. And the RBA interchange intervention provides perfect cover for reducing the value of points.

Expect more cuts in coming months, hikes in some fees and charges and changes to the terms and conditions for rewards points.