Tag: The Property Imperative

Welcome to the Property Imperative weekly to 7^th July 2018, our digest of the latest finance and property news with a distinctively Australian flavour.

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Watch the video, listen to the podcast, or read the transcript.

My interview with John Adams on the $1 trillion of foreign debt Australia is saddled with, was well received this week, with considerable interest not only from audiences in Australia, but also in the US.  It’s worth noting that global debt, of all type stands at a record US$237 trillion and by the way the nonfinancial debt as a share of GDP in the US is also at a record 46%.  We are drowning in debt. The discussion around how companies are borrowing more to boost shareholder returns in the short term and the risks ahead, resonated with many who watched our discussion. Our next one will focus on the apparently simple question of what is money and will touch on value destruction. So watch out for that.

We also covered household finance and mortgage stress this week, on a range of mainstream media outlets, including the ABC and Seven Sunrise; as more banks, including Macquarie, Bendigo and AMP Bank all lifted their mortgage rates in the week between 8 and 17 basis points depending on the bank loan type because of ongoing funding pressures. My headline of 1 million households in stress by September if the majors followed suite received significant attention, despite some analysts choosing to say there is no issue at all because rates are so low, or confusing stress with default, clearly the education must continue… To which I reply, look at the data, one third of owner occupied households have no wriggle room to accommodate rising rates. Even small increases – 10 basis points on an average $750,000 Sydney mortgage is another $60 each and every month. Given rising costs and flat incomes this is significant.  It is also worth noting that CBA this week dropped the base rate on its NetBank Saver account by 30 basis points after Westpac last week also cut the return on its eSaver product by the same amount. Three of the major banks – CBA, Westpac and ANZ – are now offering annual rates of only 0.5 per cent on their online savings accounts. So depositors are also getting hit hard and this could in fact make banking funding costs in the capital markets go even higher as savers look for alternatives and withdraw funds from bank deposit accounts.

APRA reported the outcomes of their bank stress tests were fine, but our own analysis of the data using the same high risk scenario came out with a more worrisome result. You can watch our video “When Is A Test, Not A Test” for more.   According to the Australian, CLSA analyst Brian Johnson said it was “a bit late for the regulator to acknowledge housing as a potential systemic risk” after it “watched from the sidelines” as household debt exploded and house prices reached “bubble-ish” territory. He also said Mr Byre’s speech was indicative of an “accommodative” stance that would let the banks continue to lend largely unrestrained. More evidence of the ongoing debt balloon.

The outgoing secretary of the Australian Treasury John Fraser warned in a speech at an economist’s forum published by Treasury, against lifting interest rates saying “considerable care” needed to be taken to unwind the extreme fiscal and monetary policy interventions of the past decade.  “As we all know, these interventions have left fiscal and monetary policymakers with difficult legacies: structural balance deficits and high net debt levels and official interest rates at historically very low levels,” “Judgment is required, together with a healthy scepticism about what economic models alone might be telling us,” he said. My own view is we see more and more evidence of the politicisation of the Treasury, as reflected in their unrealistically optimistic forecasts.

The latest edition of NAB’s quarterly property industry survey contained data which showed that demand for property from foreign buyers has fallen to levels not seen since 2010.  This is true of both new and existing properties, and is the result on tighter credit controls and higher transaction fees. Another reason why we think property prices will continue to fall. And data from NSW shows again the significant drop in the number of foreign buyers transacting at the moment.

CoreLogic’s home price indices continues to record weekly falls, with no state rising and Melbourne falling 0.2% on the prior week, followed by Sydney and Perth both down another 0.1%.  Auction clearance rates have remained relatively consistent over the past 2 months; remaining within the low to mid 50 per cent range.  Volumes have been trending lower over each of the last 4 weeks, and also tracking lower relative to volumes from the same period last year. CoreLogic says Melbourne’s final auction clearance rate fell to 56.1 per cent across 631 auctions last week, down from the 57.2 per cent across a higher 791 auctions over the previous week. Over the same week last year, 818 homes went to auction and a clearance rate of 72.9 per cent was recorded. Sydney’s final clearance rate has been fairly stable over the last 3 weeks, with last week’s final clearance rate coming in at 50.1 per cent across 552 auctions, compared to 49.7 per cent across 634 auctions the week prior. This time last year, 656 homes went under the hammer, returning a clearance rate of 68.6 per cent. There is noise in the data here because of the high number of unreported auctions, so in fact the true situation is considerably worse. We discussed this at length in our video “Auction Results Under the Microscope”.

The AFR reported that at the end of May, the average days on market in Sydney for houses has risen to 63 days up from about 45 days at the peak of the market last year. Days on market have been hovering around the 60s since March. For units, that number is now 64 days, rising from last year’s peak of 54 days. It takes an average of 48 days to sell a house privately, rather than through auction, in Melbourne. That number has remained fairly stable in 2017 and 2018 so far. For units, the average days on market in Melbourne has improved to 75 days down from nearly 100 days last year.

There was significant discussion from the analysts this week, with Morgan Stanley’s forward-looking housing model – MSHAUS – at a new historical low at -1.0 in the June quarter. Their model includes consideration of construction, credit availability and other factors including the Royal Commission.  They conclude “National and Sydney dwelling prices are down ~2.3% and 4.8% from their peak, respectively, and auction clearance rates are tracking around 50%.  As a result, consensus has turned negative on the market, but the debate now pivots on the extent of any decline. At this stage, we remain of the view that a price adjustment will be closer to 10%, while noting that deeper falls would bring a monetary or prudential policy adjustment into the debate. “Credit has tightened further, sentiment is slipping, and additional stock is hitting the market,” said Morgan Stanley strategists Daniel Blake and Chris Nicol.

Deloitte released its Australian Mortgage Report 2018, which forecasts that Australia’s housing correction will continue on the back of falling mortgage volumes. Australia’s leading lenders and mortgage brokers predict the nation’s housing settlement volumes will either remain flat or more likely decrease by up to 5% from the highs of previous years. “It is already appearing as if 2018 will be the second consecutive year since 2012 that settlement volumes (that is, the level of new mortgages issued in the market) either flattens off or reduces.  Deloitte Access Economics’ Director Michael Thomas said: “Regulators aiming to restrain increasing property debt amid concerns of an overheating market, have targeted investor lending. Tighter lending standards and restrictions on the volume of ‘interest-only’ loans to total new residential mortgages, have pushed up rates for investors. Market activity has begun cooling, with house price growth slowing in the latter half of 2017 and continuing into 2018.”.

The ANZ-Property Council Survey for the September 2018 quarter shows that sentiment in Australia’s property sector worsened from last quarter’s record peak. The fall occurred across most states and territories, with only Queensland and South Australia recording mild increases. The latter has continued its impressive run and is now the country’s most optimistic region. The fall in sentiment is entirely due to the residential segment. In a sharp reversal from the stabilisation of previous quarters, the outlook for capital values in residential property has deteriorated markedly. Staffing levels, construction activity and the forward work schedule are all expected to ease in the residential space. Importantly, survey respondents expect the availability of debt finance to worsen. We believe this has been the main driver of the current weakness in the housing market. Any further tightening of credit will put more pressure on the industry.

This is all about credit tightening.

Chief executive of Aussie Home Loans, James Symond said that after banks have tightened credit standards “dramatically” in the last year, more customers Aussie was dealing with were falling outside the lending policies of banks, which have ramped up their scrutiny of customers’ living expenses. …”I’m hoping everyone is looking at it very, very carefully, because I’m seeing a credit marketplace tightening a lot, a real lot. And if we saw it tighten any more, I think that you mightn’t get the desired outcomes you want,” he said in an interview with Fairfax Media.

But CBA announced further expense checks on mortgage applicants, with to two rounds of detailed quizzing about their weekly spending on everything from school fees to gym memberships, children and pets. The formal categories cover: children; pets; clothing and personal care; communication; education; food and groceries; housing and property expenses; insurance; medical, health and fitness; recreation, travel and entertainment; and transport and auto. I doubt most households would have a clue, bearing in mind that according to our surveys half maintain no formal household budgets, so many will take a guess, and carry the liability of so doing. Further evidence of credit tightening, and importantly risk transference to the borrower, because once you sign the expenses declaration, the bank is insulated from “not unsuitable” liability.

HashChing, also said this week that lending regulations have gone overboard, and the tightening restrictions have, at times, become the reason for the unnecessary disapproval of loan applications.

Yet the credit data from the ABS this week showed that there was still some credit growth, despite investors falling off a cliff, especially in Sydney and Melbourne. The ABS data shows that total lending stock grew again in May. This is original data split between owner occupied and investment loans. Total housing loan stock rose 0.5% in the month to $1.66 trillion. Within that owner occupied lending rose 0.5% to $1.1 trillion and and investment lending rose just 0.1% to $563 billion. Investment loans fell to be 33.8% of all loans. Overall growth is circa 6% annualised. As for whether growth at 3 times income is “healthy” to quote Wayne Byers; well that’s another story.   Remember debt has to be repaid, eventually. Growth has been strongest in owner occupied lending, but investment lending was also higher. If anything, further tightening is in order…

On the markets bank stocks did quite well this week, with the ASX 100 up to 5,155, despite the latest round in the trade wars. CBA up to 74.85 and Westpac ended at $29.60 but above the recent lows and a little lower on Friday. Clearly concerns about their mortgage books are not translating to share prices at the moment.

And the Aussie Dollar was a little stronger, although the drift down from the start of the year has continued, and many think it will go further.

On the US markets, Wall Street ended the week higher, with all the major indices closing in the green. The Dow ended at 25,019, still below the February highs. Tech stocks were winners for the week. The tech-heavy Nasdaq finished up more than 1%. Among the big winners in tech land was Amazon. The stock got a boost on a price target raise by Canaccord to $2,000 from $1,800 Thursday and again when S.G. Cowen raised its price target on the stock to $2,100 from $2,000 Friday. Alphabet’s Google, Apple and Facebook all closed up for the week. But Netflix, ended in the red, hurt by a Friday selloff ahead of their results. There are likely a few jitters about what numbers Netflix would have to report to spur more buying with the stock up around 100% year to date. The top 20 internet leaders highlight the concentration in a small number of the stocks, with Amazon and Alphabet right at the top.

Inflation data was paramount during the week, especially after last Friday’s employment report gave mixed signals of strong continued job creation but weaker-than-expected wage growth. The numbers grabbing the headlines were the levels in wholesale and retail inflation not seen for a while. The producer price index (PPI) was up 3.4% in June year over year, the highest level in 6-1/2 years. The June consumer price index (CPI) posted a year-over-year rise of 2.9%, the largest rise in six years. But the stock market tends to focus more on the month-on-month numbers and those figures were mixed. CPI was in line with expectations month over month, while core CPI, which excludes volatile food and energy prices, was up less than expected. PPI and core PPI came in just a little hotter than expectations. So, while prices are definitely rising, the US economy is so far avoiding the spikes that would fuel fears over interest rates rising quickly.

More significant for those zoned in on the Fed’s rate-hike path than the inflation data was likely the shift of Chicago Fed President Charles Evans comments in a wide-ranging interview with The Wall Street Journal that the economy could handle a move to neutral rates. That was interpreted to mean he’d support two rate-hikes this year. There is currently a more-than-80% of a rate hike in September and a more-than-55% chance of one in December.  This would of course flow on to higher capital market funding costs. The 3 month US Bond rate was higher again on Friday,

The bank earnings were supposed be the highlight of the week. But the mixed results from Citigroup, JPMorgan Chase and Wells Fargo failed to spur anything but a muted reaction from the market Friday. Instead, Delta Air Lines likely offered the most insight for investors. Shares climbed Thursday after the airline beat second-quarter profit expectations thanks to fare increases. But it also highlighted a jump in fuel costs of nearly 40% in the quarter, a $2 billion increase. That’s trouble for the airline sector as whole, which is already struggling in 2018. The Dow Transports are off about 0.6% year to date. But there could be more weakness ahead if fuel costs remain high and companies like FedEx and UPS are hit by trade battles.

Until earnings arrived in earnest on Friday, the summer, low-volume market has been especially susceptible to the vagaries of trade tensions. The week started off with more saber rattling between the U.S. and its trade partners. The U.S. released a list on Tuesday of $200 billion more in Chinese goods that it would assess for tariffs of 10%. China again promised retaliation. That same day, ahead of his trip to Europe, President Donald Trump tweeted that the U.S. loses $151 billion on trade with the EU and that the single bloc charges the U.S. big tariffs and enacts trade barriers. But worries were reduced on Thursday when Treasury Secretary said there was a possibility that the U.S. and China could restart trade talks. And the president, while hammering allies of NATO spending, has not made any remarks about specific trade action against Europe. The rosier outlook on trade was reflected in the performance of Boeing, which is particularly sensitive to trade battles given the amount of its overseas business. Boeing was one of the best Dow performers for the week.

Oil prices fell for the week, but energy stock bulls will be heartened by crude oil’s ability to stay above $70 mark on Friday. Crude oil futures for August delivery settled at $71.01 per barrel, up 1% on the day. Oil did dip below $70 in morning trading, rose steadily through the rest of the day, then sold off late. For the week, mixed signals on supplies scaled back investor expectations for a global supply shortage as Libya resumed exports, U.S. supplies fell more than expected, while bets on a significant loss of Iranian crude were trimmed.

Gold prices resumed their decline and remained on track for their lowest settlement in nearly two weeks as easing trade-war concerns offset the dollar’s retreat against its rivals from a two-week high. The U.S. dollar index, which measures the greenback’s strength against a trade-weighted basket of six major currencies, rose by 0.01% to 94.58, but remained well below its intraday of high of 95.00.

Dollar-denominated commodities such as gold are sensitive to moves in the dollar. A rise in the dollar makes gold more expensive for holders of foreign currency, reducing demand for the precious metal.

So amid all the market noise the fragile US bank results and the prospect of higher interest rates ahead shine through as factors which could flow through into our own markets, which remain bullish, despite the warning signs of more downside risk from the finance and property sectors locally. As I said to the AFR on Friday, I have never seen so much interest in offshore investors seeking ways to short our market, given the next moves are likely to be lower as we move into spring. Expect further falls ahead.

Before I sign off, mark your diary. On the 17^th July at 8 PM Sydney time I will be running our next live streaming session, where you can discuss in real time the issues in play. Judging by the previous session, it will be a lively event. This time we will be focussing on Financial Resilience. I have scheduled the event on our YouTube channel.  Or send me questions beforehand via the comments section below.

Welcome to the Property Imperative weekly to 16^th June 2018, our digest of the latest finance and property news with a distinctively Australian flavour.

Watch the video, listen to the podcast, or read the transcript.

We start with the international markets, because familiar market foes returned this week as the U.S. and China vowed to move ahead with trade tariffs. China ignored U.S. President Donald Trump’s threat of further tariffs in the event of retaliation, vowing to immediately impose penalties of the “same scale” on American goods, raising the prospect of a tit-for-tat trade war between the world’s two largest economies.

The Fed rate hike on Wednesday was accompanied by a more hawkish outlook on rate hikes. The U.S. central bank hinted at the prospect of two additional rate hikes this year, taking the expected total rate hikes for 2018 to four from three previously. The odds of a fourth rate hike at the Fed’s December meeting has soared to 51.1% from 33.8% the previous week. While the prospect of a faster pace of US monetary policy tightening also weighed on sentiment, that didn’t stop US stocks from notching a third-straight weekly win as a rally in tech and media stocks underpinned investor demand.  The VIX volatility index, which signals the relative uncertainty in the market, was down again, from its peak a few weeks ago.

The U.S. District Court ruled in favour of the AT&T and Time Warner merger earlier this week, sparking a wave of action in media stocks and a day after the ruling, Comcast launched a $65 billion bid for Twenty-First Century Fox assets that Walt Disney had already struck a deal to buy, setting the stage for perhaps an intense bidding war. The S&P 500 posted a weekly win despite closing 0.25% lower Friday at 2,781.50 reacting to the escalating trade wars.

Crude oil prices settled sharply lower on Friday on concerns that OPEC would lift limits on production restrictions, paving the way for an uptick in global output, threatening the pace of rebalancing in oil markets. Investor fears that OPEC and its allies would hike output at its June 22 meeting came to the fore this week amid remarks from both Russia’s and Saudi Arabia’s Energy Ministers. Both agreed to gradually increase production. Crude futures settled 2.74% lower on Friday as data showed U.S. oil rigs continued to climb.

The US dollar closed at year-to-date highs against its rivals despite a modest setback on Friday, as a sharp tumble in the euro earlier this week encouraged traders to pile into the greenback. The euro suffered its worst daily loss in two years on Thursday after the European Central Bank said that it would leave interest rates unchanged until the summer of 2019, although they will taper down QE through this year. That came a day after the Federal Reserve had signalled a faster pace of rate hikes for this year and the next, further encouraging investor appetite for the greenback. The dollar fell 0.16% to 94.79 against a basket of major currencies on Friday. The Aussie Dollar slipped against the US Dollar, which signals a risk of importing inflation into Australia and risks to the local economy.

Gold prices fell to 2018 lows on Friday as traders appeared to unwind their holdings of gold despite the growing prospect of a trade war between the U.S. and China.  That, however, failed to lift demand for safe-haven gold amid expectations the dollar will continue its upside momentum.

And crypto currencies slid this week, wiping more than $60 billion from the market, as bitcoin fell to a near four-month low before staging a timid rebound. Bitcoin started the week on the back foot after South Korean crypto exchange Coinrail confirmed in a tweet that cyber thieves had made off with over $30 million worth of lesser-known cryptocurrencies following a successful cyberattack. That proved to be touch paper for further selloffs as the popular crypto fell close to a four-month low of $6,125.7, rattling traders’ appetite to hold cryptos as billions of dollars were pulled from the market.

The total crypto market cap fell to about $282 billion, from about $342 billion a week ago. Over the past seven days, Bitcoin fell 18.67%, Ethereum fell 14.04%, while Ripple XRP fell 19.29%. More evidence, if you needed it that crypto is not a stable currency alternative.

But risks lurk in the dark corners, according to Fitch Ratings. Global trade tensions have risen significantly this year, but at this stage they say the scale of tariffs imposed remains too small to materially affect the global growth outlook. A major escalation that entailed blanket across-the-board geographical tariffs on all trade flows between several major countries would be much more damaging.

In addition, populist political forces continue to create policy risk and increase the threat of rising tensions within the eurozone that could adversely affect the outlook for investment, a key driver of growth last year. Fitch made only a modest downward revision to their eurozone investment forecast for this year (to 3.3% from 3.9% in March), but a further escalation in uncertainty represents an important downside risk.

And a much sharper-than-anticipated pick-up in US inflation remains a key risk to the global outlook they said. The decline in US unemployment – to 3.8% in May – is becoming more important to watch, and they forecast the rate to hit a 66-year low of 3.4% in 2019. A wide array of indicators of US labour market tightness suggest it is now only a matter of time before sharper upward pressures on US wage growth start to be seen. They said that “An inflation shock in the US could bring forward adjustments in US and global bond yields and sharply increase volatility, harming risk appetite. In particular, it could lead to a rapid decompression of the term premium, which remains negative for US 10-year bond yields. In combination with a likely aggressive Fed response, this would be disruptive for global growth.

Indeed, the synchronised global economic growth that began in 2018 appears to be running its course, according to NAB.  ‘Synchronised global growth’ was a favoured expression by economists and research houses at the end of last year, with each of the 45 major economies tracking upward growth.

But according to the latest economic summary by NAB this global growth rate may have reached its peak. Growth in the major economies was 2.2 per cent year-on-year in the first quarter of 2018, a small drop from the 2.4 per cent growth in the last quarter of 2017. “Although this slowdown was modest, it points to a divergence in conditions across countries, which over recent years have displayed relatively synchronised growth.” In addition, many short- and long-term interest rates have started to increase, or will do so over the forecast period”.

Turning to the local scene, Moody’s confirmed Australia’s rating of Aaa, which puts us in an exclusive club alongside United States, Switzerland, Sweden, Norway, Denmark, Netherlands and New Zealand. They just reviewed the rating (some other agencies still have a negative watch on Australia, as they are more concerned about the outlook, given our exposure to foreign trade and debt) but Moody’s concluded that thanks to good GDP numbers, relatively low (on an international basis) Government debt – at only 42% of GDP, though up from 26.5% five years ago and our strong institutions (RBA and APRA), the rating is confirmed. The bonus income from higher resources prices also helped. They did highlight some concerns about the Government needing to control spending in order to bring the budget back into balance as forecast, against a fraught political background and also the risks from high levels of household debt in a flat wage environment.  They suggest that household income growth will be lower than government forecasts, but they are still looking for GDP growth around 2.75%. They also suggest that Government spending will remain under pressure given the expected 6% rise in social welfare programmes including health and NDIS. In terms of risks, they see two, first is rising household debt, which they say exposes the economy and government finances. Second is Australia’s reliance on overseas funding, which may be impacted by changes in international investor sentiment. Rate rises abroad might lift the cost of government and bank borrowing, adding extra pressure on the economy. But their judgement is these risks are not sufficient to dent the prized Aaa rating. So that’s OK then, except that…

S&P Global Ratings RMBS Performance Watch to 31st March 2018 said that the prime 30-day SPIN was 1.37% in Q1 2018, up from 1.07% the previous quarter. They say that loans more than 90 days in arrears were at a historically high level at the end of Q1, indicating that mortgage stress has increased for some borrowers. Western Australia meanwhile again recorded the nation’s highest arrears, at 2.71%. Arrears rose during Q1 in most parts of the country. And they warned of the consequences of higher interest rates ahead. You can grab our separate post “What the Rating Agencies Are Saying” for more details.

Our latest Household Financial Security Index showed a further fall dropping to 90.2, down from 91.7 last month. This is below the neutral setting of 100. Property-related sentiment is hitting hard, especially in New South Wales and Victoria where price falls are most evident. Younger households the budget pressure on them remains severe, especially those paying rent, or mortgages. Those entering the retirement phase, 60+ continue to wrestle with outstanding mortgages (many hold these loans into retirement now) and also lower returns from deposits. You can get the full results in our post “Household Financial Security Tanks In May, As Property Falls Hit Home”.

It’s worth putting this alongside the RBA comments this week on wages growth, which suggests that any lift from the current anaemic levels will be slow.  And real debt burdens will stay higher for longer in this scenario. Many people who borrowed expected their incomes to grow at something like the old rate rather than the current rate. With their expectations not being realised, the real value of the debt stays higher than they expected and this is likely to affect their spending decisions. And beyond these purely economic effects, the slow wages growth is diminishing our sense of shared prosperity. If this remains the case, it can make needed economic reforms more difficult.

Oh, and the employment data out this week superficially looked OK, with an increase in the total number of jobs, and a fall in the seasonally adjusted rate of employment from 5.6% last month to 5.4% in May.  But in fact we think this is another soft result, thanks to a slide in the number of hours worked, anaemic and falling jobs growth, a further shift to part time employment, and a rise in underemployment. The monthly trend unemployment rate remained steady at 5.5 per cent, well above the 5% level at which wage rises may kick in according to the bank. See more at our post “Unemployment Signals More Trouble Ahead”.  The trend participation rate decreased by less than 0.1 per cent to 65.5 per cent in May 2018.

The auction results last week were down again but hardly worth a mention, given the long weekend in many states. But the trend of slowing property continues to bite harder. CoreLogic once again have been looking at where prices are falling.  They say that across the combined capital cities, dwelling values have fallen 1.1% over the past 12 months. Looking at the 1st decile, values have increased by 1.3% over the past year while across the 10th decile values have fallen by -5.7%. Of note is that when values fall, declines across the most affordable properties have been significantly smaller than the declines across the most expensive properties. The opposite is generally the case during the growth phase, where the most expensive properties have generally outperformed the broader market.

Sydney has seen the largest declines of all capital cities over the past year with values -4.2% lower. Across the 1st decile, values are 1.0% higher while the 10th decile has recorded value falls of 7.3%. Over the past year, Melbourne dwelling values have increased by 2.2% with the 1st decile recording an increase of 10.3% while the 10th decile has seen value fall -3.5%.

This makes it clear that you need to get granular across the property market, something which we discussed in our interview with Buyers Agent Chris Curtis, last week. The full interview “Property Dispatches from The Front Line” is still available and I recommend it. This post hit top spot on both our blog and YouTube sites.   It seems that first time buyers are helping to support the market, though the latest figures show that total number of first time buyer loans in May fell by 8%.

Indeed, overall lending growth is slowing as the ABS data this week showed. They confirm the macro trends we already reported. Lending volume flows are solidly down, and the trends suggest more in the months ahead. We are entering a new phase in the credit cycle, and this will put further pressure on home prices. You can get more from our post “Yet More Evidence Of The Property Slowdown”

Finally, as the AFR pointed out, the banks are under intense margin pressure now as they are being squeezed by higher borrowing costs as the US Federal Reserve accelerates its interest rate hikes and drains liquidity from global financial markets while the Hayne royal commission makes it difficult for them to raise home loan rates. They said that analysts estimated that the spreads paid by Australian banks have climbed by close to 40 basis points since the beginning of the year, which has swollen the wholesale borrowing costs of the country’s banks by some $4.4 billion a year. They quoted AMP’s head of investment strategy, Shane Oliver, who said the blowout in the BBSW could reflect Australian borrowers rushing to lock in funding before the end of the financial year, for fear that the borrowing situation could worsen.  Dr Oliver said the banks were likely to be absorbing the higher funding costs in their margins. But, he warned, the “risk is that they will start to increase some mortgage rates”.

But we think something else is going on, because the spreads in Australia are a lot bigger now than other markets, and we suspect it’s a lack of confidence in our local banks, thanks to the revelations from the Royal Commission. A quick look at the recent share prices of for example Westpac, the largest investment loan lender, and CBA the largest owner occupied loan lender tells the story. The markets are nervous.  The pincer movements of higher funding, less confidence and a slowing and more risky housing market are all adding to the banks’ woes.  They are stuck because any lift in mortgage rates will drive prices lower and lift defaults from overleveraged households.  Actually this is the reason why we think the RBA may be forced to cut the cash rate ahead. A nasty cocktail.

Welcome to the Property Imperative Weekly to 28th April 2018.

In this weeks digest of finance and property news we review the implications from the Royal Commission, the latest on the Westpac loans issue, APAC mortgage lending and rising near-prime non-bank lending.

In this week’s summary of the latest finance and property news we start with the Royal Commission into Financial Services Misconduct. The latest hearings wrapped up on Friday, with a litany of company breaches and illegal behaviour being called out. During the close, it was suggested AMP might face criminal prosecution for misleading the corporate regulator. But large institutions, adviser groups, individual advisers, industry associations and regulators all failed to meet our expectations.

I’ve been amazed by the coverage these issues are getting in the media, and also the surprise being expressed, as many industry insiders have been aware of significant issues for years. But then companies, with the deep pockets and aggressive stances have largely contained them. I think the live streaming of the sessions has had a significant impact, and it shows the power and reach of digital. But now, exposed is the lopsided focus on shareholder returns at all costs, even if customers are disadvantaged and laws are broken. In a way this mirrors the behaviour we saw in the previous rounds on lending practice.

It’s also worth noting that Kelly O’Dwer, who tried to defend the un-defendable on ABC Insiders last Sunday arguing that the Government did not drag their feet with regards to the calling of the Commission, did an about face saying on Friday “”With the benefit of hindsight we should have called it earlier, and I am sorry we didn’t, and I regret not saying this when asked earlier this week”. But Ms O’Dwyer maintains the Government was not sitting on its hands in the months leading up to the commission, and has again argued it used the time to strengthen regulations in the sector and beef up penalties for misconduct.

But we need to understand that corporates across many sectors actually exhibit the same type of behaviour, whether it is Telstra, who was fined by the ACCC this week for charging customers for online services, without their consent, Ford for failing to fix faulty vehicles, electricity providers allowing customers to sit on high priced non discounted tariffs, or Pay Day loan providers now offering instant loans via ATM type machines. I could go on.

We need to stand back, and think about the corporate values which all these examples signify –profit at all cost, and a willingness to sail close to the wind, without a moral compass, or worse just break the law. Whilst we can expect tighter laws, and higher fines ahead, I think we need a new philosophy of the company, which puts the interests of customers first, rather than last. Now that is a major challenge, but also an opportunity; and I am waiting for real leaders to take a stand. They are now all on notice.

Turning to the latest home prices and auctions, Corelogic reported that last week, the final auction clearance rate increased to 62.2 per cent after the prior week’s lowest level seen over the year-to-date, of 61.7 per cent. They say that volumes are around the 1,800- 1,900 level, much lower than last year. And of course there are still questions about the accuracy of the data, in the light of the higher number of property’s withdrawn prior to auction, as we discussed in our recent post “Auction Results Under the Microscope”

They say that Melbourne and Sydney returned an equal 63.6 per cent auction clearance rate last week, both higher than the prior week. Looking at volume of auctions, Melbourne recorded a slightly higher volume week-on-week with 914 held, increasing on the 873 the previous week, while Sydney saw a fall in activity with 588 auctions held, down on the 795 auction held the week prior. The performance across the smaller auction markets were mixed last week, with clearances rates improving in Brisbane and Tasmania, while Adelaide, Canberra and Perth all saw a fall in the final clearance rate over the week.  Of the non-capital city regions, Geelong recorded the highest clearance rate with 85.3 per cent of auctions clearing last week.

This week, the number of auctions scheduled to take place across the combined capital cities is expected to rise, with 2,342 currently being tracked by CoreLogic, increasing from the 1,799 auctions held last week. Both Melbourne and Sydney is expected to see an increase in activity this week, with 1,218 homes scheduled for auction across Melbourne, while Sydney is set to host 737 auctions, increasing on the 914 and 588 auctions held last week respectively.

I posted on the latest UBS report recently, “On Mortgage Underwriting Standards and Risks”. They continued their forensic dissection of the mortgage industry with the release of their analysis of data from Westpac, which the lender provided to the Royal Commission. This was representative data from the bank of 420 WBC mortgages analysed by PwC as part of APRA’s recent review. APRA Chairman Wayne Byres found WBC to be a “significant outlier”, with PwC finding 8 of the 10 mortgage ‘control objectives’ were “ineffective”.

UBS says for the first time information on borrower’s Total Debt-to-Income ratios (not Loan-to-Income) has been made available. They found WBC’s median Debt-to-Income at 5.4x, with 35% of the sample having Debt-to-Income ratios of >7x. Further 46% of the mortgage applications had an assessed Net Income Surplus of <$250 per week.

This data raises questions regarding the quality of WBC’s $400bn mortgage book (70% of its loans). While WBC has undertaken significant work to improve its mortgage underwriting standards over the last 12 months, we expect it and the other majors to further sharpen underwriting standards given the Royal Commission’s concerns with Responsible Lending. This could potentially lead to a sharp reduction in credit availability.

So I was amused by a piece in the AFR from Christopher Joye, who argued that there was nothing to see here. PwC found that 38 of the 420 loans failed APRA’s loan assessment standards and should not, on this test, have been originated. He argued that on Thursday Westpac disclosed that PwC used a limited data file on each borrower, and once Westpac applied its full data file 37 of the 38 loans were, in fact, appropriately approved. And the one loan that should not have passed its credit scoring system is “currently ahead on its repayments”. Also, Westpac highlighted that 90 of the 420 loans have already been fully repaid, which combined with its other evidence suggests that the bank’s loan portfolio remains of a high quality. Westpac’s chief financial officer Peter King hammered this point home, noting that “our mortgage delinquencies and losses remain low both relative to historical and industry standards”. That’s important because Westpac has aggressively raised its interest-only loan rates, which should have propagated higher defaults. And he says …Contrary to Tony Abbott’s suggestion the regulators should be sacked in response to the royal Commission, APRA has generally been doing an excellent job. The housing boom kicked- off in 2013 and APRA has been hounding banks on loan serviceability standards since late 2014, when it introduced a raft of rules and established a prudential mortgage lending guide.

Trouble is, we know that in a low interest rates environment most loans will survive, it’s when rates rise that things start to go wrong. And the issues around HEM and APRA (and remember ASIC has commenced proceedings against Westpac) suggests they have questions to answer.  So I did not find Joye convincing.  I do not think the regulator has done a great job!

As I said the other day, the results from the UBS work raises two questions. First how much tighter will credit availability now be ahead? We continue to expect an absolute fall in loan volumes, and this will translate to lower home prices.

Second, is this endemic to the industry, or is Westpac really an outlier? From our data we see similar patterns elsewhere, so that is why we continue to believe we have systemic issues.

1. Income is being overstated and expenses understated.
2. Customers have multiple loans across institutions and these are not always being detected, so their total debt burden is higher than the bank sees.

Combined these are significant and enduring risks. Chickens will come home to roost! Especially if rates rise. In fact, UBS has now put a sell recommendation on Westpac.

Now back to APRA, the banking regulator announced plans to remove the investor loan growth benchmark and replace it with more permanent measures to strengthen lending standards. This could be seen as an easing strategy to allow banks to lend more freely, but I do not think it is. In fact, it underscores the tighter lending standard now being imposed.

In summary, for the 10 per cent benchmark to no longer apply, Boards will be expected to confirm that: i) lending has been below the investor loan growth benchmark for at least the past 6 months; ii) lending policies meet APRA’s guidance on serviceability; and iii) lending practices will be strengthened where necessary.

As part of these measures, APRA also expects ADIs to develop internal portfolio limits on the proportion of new lending at very high debt-to-income levels, and policy limits on maximum debt-to-income levels for individual borrowers. This they say provides a simple backstop to complement the more complex and detailed serviceability calculation for individual borrowers, and takes into account the total borrowings of an applicant, rather than just the specific loan being applied for.

Remember the Bank of England imposed limits on high loan to income loans a couple of years ago to cool the market, so in a sense APRA is belatedly following suit, having argued previously that everything in the mortgage garden was rosy. What a change of tune!

Combined these underscore that credit growth will continue to slow, and there will be intense focus on credit underwriting.  If you want arguments as to why home prices will continue to drift lower and perhaps fall faster, you need look no further.

And high home prices and debt is not just an Australian thing. Fitch Ratings issued an interesting note saying that banks in Asia-Pacific (APAC) will face heightened property risks over the medium term, given their relatively high exposure to the sector and the susceptibility of heavily indebted household sectors to a rise in interest rates or unemployment.

Residential property risks are highest for Australian and New Zealand banks, and may remain elevated in the short term as low interest rates and high house prices continue to drive mortgage growth, albeit it a slower rate. Residential property loans accounted for 43% of Australian bank assets in December 2017, up from 39% five years earlier, while in New Zealand the share rose to 46% from 43%. Australian and New Zealand households also have some of the region’s highest debt burdens.

Hong Kong banks’ property risks are increasing, with the territory being one of the few markets where property lending has accelerated over the past year, while intense competition continued to pressure margins. Mortgages account for a relatively low proportion of system assets, but a sharp housing market downturn could hurt sentiment and expose vulnerabilities, as rising prices have boosted private-sector wealth, banks’ reserves and collateral valuations. Banks’ rising exposure to mainland Chinese property is driving real-estate lending growth.

Korea’s high household debt would make its economy less resilient to shocks, including a housing market downturn. Household debt ratios are unlikely to decline over the medium term. However, household assets are also relatively high and banks’ property exposure is healthy overall, with low delinquencies and moderate LTV ratios. The same is also broadly true for Singapore, where we expect a more buoyant property market to support bank lending in 2018.

APAC regulators have actively tightened macro-prudential measures in an effort to strengthen banking-sector resilience to potential property risks. These measures have helped cool property markets in Singapore and Taiwan, while the tight stance has generally bolstered loss-absorption buffers and supported lending standards. Nevertheless, continued rapid lending and a further rise in risk appetite could increase the prospects of negative ratings action in the medium term, particularly in the absence of commensurate reinforcement to buffers.

Household leverage has started to decline in the emerging markets where it is highest – Malaysia and Thailand. We expect some fallout from over-supply in Malaysia, but risks to banks should be manageable as their exposure to the more vulnerable segments has remained small. Strong commercial real-estate lending growth by Thai banks in 2017 reflected an improving operating environment and followed sluggish growth in previous years, although there are still risks associated with consumer lending. Real-estate lending growth has also remained high in the Philippines.

Chinese banks shifted toward retail banking and mortgage lending in 2017, amid pressures in the corporate and financial sectors. However, increases in household leverage have been from a low base and have not reached the levels of most developed economies, suggesting that any near-term risks from China’s household debt burden remain moderate. Bigger risks would emerge if household lending was left unchecked over the medium term.

They conclude that rapid mortgage lending growth, incrementally higher risk-taking and relaxed mortgage pricing amid competitive pressures are likely to have created vulnerabilities that could be tested by a change in economic conditions. Rising interest rates are a potential trigger, despite saying that monetary tightening will be much slower in APAC than in the US.

Worth remembering this as the US 10-year bond has moved above 3%. Here is the latest chart. This is further evidence of the continued rise in rates in the USA, as the FED executes its plan to reverse QE and take rates higher. This follows through to higher mortgage rates in the US, as shown by this chart.

This will indeed have consequences as the capital markets rates will follow, putting more pressure on local banks, who still fund significant portions of their books from overseas. This will continue to put pressure on the BBSW, and is likely to translate into higher mortgage rates ahead.

Next, CBA subsidiary Bank West has announced that it is implementing changes to its broker commission payment model, including changes to trail and the adoption of CIF recommendations, effective from 1 July. The bank is the first lender to make major moves to change broker remuneration following the ASIC remuneration review, Combined Industry Forum package reforms and the ongoing commissions. Bankwest has said that it is bringing in the changes to “align itself with evolving industry practice and regulator expectations”. The changes, which will be effective on settlements from 1 July 2018, include:  The reintroduction of Year 1 trail commission. The reduction of trail commissions in Year 3 to 0.15 per cent and from Year 5 and onwards to 0.20 per cent. The adoption of the Combined Industry Forum (CIF) recommendations on paying commissions on utilised funds and net of offset. There will be no changes to the upfront commission rate.

Commenting on the industry recommendations, Bankwest said: “Bankwest has been a very long-standing supporter of the broker industry, going back to the very start some four decades ago, and we remain committed to brokers as a channel of choice for customers. We support the current upfront and trail model as well as the improvements to the model outlined in the ASIC review and the Combined Industry Forum (CIF) recommendations. We understand the lack of Year 1 trail has been outstanding for some time and we are pleased to reintroduce this to bring us back in line with the market.  Our contract stipulates that trail commissions represent payment for continuous customer maintenance and services, and we believe trail remains warranted for brokers to ensure ongoing support is provided to customers they refer to Bankwest.”

Our own view is the broker commissions are likely to be replaced by a fixed service fee, following the Royal Commission revelations.  We also think mortgage brokers and financial advisers should be regulated under a common set of best interest rules. You can watch our separate post “We Need Common Rules for Mortgage Brokers and Financial Advisers”.

Finally, this week, Non-bank lender, Bluestone Mortgages, has announced its entry into the near prime mortgage space.  The move includes rate cuts of up to 2.25 basis points across its entire product suite, at a time when “PAYG and credit impaired customers are affected by the tightening criteria of traditional lenders”.  It comes off the back of extra funding through the acquisition of Cerberus Capital Management. The Crystal Blue portfolio is being seen as particularly ambitious, comprising of full and alt doc products geared to support established self-employed borrowers and PAYG borrowers with a clear credit history. Bluestone Mortgages said, “The recent acquisition of the Bluestone’s Asia-Pacific operations by Cerberus Capital Management has enabled a number of immediate opportunities to be realised, most notably the assessment of our full range of products and to ensure they fully address market demands. This comes at an opportune time as a growing volume of self-employed, PAYG and credit impaired customers are affected by the tightening criteria of traditional lenders. Unlike big banks, we don’t have credit scorecards, which means we’re able to assess every borrower based on their merits and individual circumstances. We’re not one-size-fits-all by any means, which is increasingly appreciated.

So this is all playing out as expected. As the majors throttle back on new mortgage lending under tighter controls, the non-bank sector continues to pick up the slack. This is a concern as the regulatory environment for these lenders is weaker, with both ASIC and APRA now involved, ASIC from a responsible lending perspective and APRA from new supervision on the non-bank sector, despite their failure in the core banking sector. So we expect to see significant non-prime non-bank lending growth, ahead, which will stoke the current massively high household debts even higher.