Tag: UBS

Home Prices and Lending To Fall? Perhaps Hard!

The good people at UBS has published further analysis of the mortgage market, arguing that the Royal Commission outcomes are likely to drive a further material tightening in mortgage underwriting. As a result they think households “borrowing power” could drop by ~35%, mainly thanks to changes to analysis of expenses, as the HEM benchmark, so much critised in the Inquiry, is revised.

Their starting point assumes a family of four has living expenses equal to the HEM ‘Basic’ benchmark of $32,400 p.a. (ie less than the Old Age Pension). This is broadly consistent with the Major banks’ lending practices through 2017.

As a result, the borrowing limits provided by the banks’ home loan calculators fell by ~35% (Loan-to-Income ratio fell from ~5-6x to ~3-4x).

This leads to a reduction in housing credit and a further potential fall in home prices.

This plays out similarly to our own scenarios, which we discussed a couple of weeks back, exploring the outcomes from a mild correction, to a crash. A 20% reduction in borrowing power has already hit, by the way, and this before the Royal Commission revelations.

This will have a significant impact on the banks, but a broader hit to the economy also.

 

Real Estate Bubbles: These 8 Global Cities Are At Risk

From Zero Hedge.

If you had $1 billion to spend on safe real estate assets, where would you look to buy?

For many funds, financial institutions, and wealthy individuals, the perception is that the world’s financial centers are the places to be. After all, world-class cities like New York, London, and Hong Kong will never go out of style, and their extremely robust and high-density city centers limit the supply of quality assets to buy.

But, as Visual Capitalist’s Jeff Desjardins asks, what happens when too many people pile into a “safe” asset?

According to UBS, certain cities have seen prices rise at rates that are potentially not sustainable – and eight of these financial centers are at risk of having real estate bubbles that could eventually deflate.

Global Real Estate Bubble Index

Every year, UBS publishes the Global Real Estate Bubble Index, and the most recent edition shows several key markets in bubble territory.

The bank highlights Toronto as the biggest potential bubble risk, noting that real prices have doubled over 13 years, while real rents and real income have only increased 5% and 10% respectively.

However, the largest city in Canada was certainly not the only global financial center with real estate appreciating at rapid rates in the last year.

In Munich, Toronto, Amsterdam, Sydney and Hong Kong, prices rose more than 10% in the last year alone.

Annual increases at a 10% clip would lead to the doubling of prices every seven years, something the bank says is unsustainable.

In the last year, there were three key markets where prices did not rise: London, Milan, and Singapore.

London is particularly notable, since it holds more millionaires than any other city in the world and is rated as the #1 financial center globally.

More Suggestions Of Poor Mortgage Underwriting Standards

As reported in the AFR, UBS has continued their analysis of the Australian mortgage market, with a focus on disclosed incomes of applicants.

UBS said its work suggested 42 per cent of all households with income of more than $500,000, and 27 per cent of all households with income between $200,000 and $500,000, had taken out a mortgage in 2017, which Mr Mott said “did not appear logical and [is] highly improbable”. Borrowers could be “materially overstating their household income to secure a mortgage”, or the population could be consistently understating income across the census, ATO tax returns and ABS surveys, he suggested.

The extension of the terms of reference for the financial services royal commission to include mortgage brokers and intermediaries provides “a clear indication” it will focus on mortgage mis-selling, Mr Mott added.

“We believe that it is imperative that the Australian banks continue to focus on improving underwriting standards,” he said.

We have to agree with their analysis, as our surveys lead us to the same conclusion.  Here is a plot of income bands and number of mortgaged households. On this data, around 15% of households would reside in the $200-500k zone, compared with the 27% from bank data.

We have been calling for tighter underwriting standards for some time. As UBS concludes:

We believe that responsible lending and mortgage mis-selling are material risks for the banks.

More Warnings On The Sleeping Risks From Interest Only Loans

The SMH reported today on research from UBS suggesting that around one third of interest only mortgage holders are not aware of the fact that the loan will revert, normally at the end of 5 or sometimes 10 years to principal and interest only borrowing. A roll to a further IO period is not guaranteed.

We discussed a couple of years back, as well in this in October, Citi covered it a few months back, and last week we got Finder.com.au to discuss what borrowers might do; so there should be no surprise to readers of this blog.  This chart shows the estimated value of IO loans which will now fall due outside current lending criteria, based on our research.

This is an extract from the SMH article:

A third of customers with interest-only mortgages may not properly understand the type of loan they have taken out, which could put many in “substantial” stress when the time comes to pay their debt, UBS analysts warn.

Amid a regulatory crackdown on interest-only loans, a new report by analysts led by Jonathan Mott highlights the potential for repayment difficulties with this type of mortgage

Their finding is based on a recent survey conducted by the investment bank, which found only 23.9 per cent of 907 respondents had an interest-only loan, compared with economy-wide figures that show 35.3 per cent of loans are interest-only.

Mr Mott said he initially suspected the survey sample had an error, but now believed a “more plausible” reason was that interest-only customers did not properly understand their loan.

“We are concerned that it is likely that approximately one third of borrowers who have taken out an interest-only mortgage have little understanding of the product or that their repayments will jump by between 30 and 60 per cent at the end of the interest-only period (depending on the residual term),” he said.

You can read more about the risks from IO loans in our recent Property Imperative Report, free on request.

 

 

FBAA calls out UBS conclusion as ‘assumptions’

From The Adviser.

The Finance Brokers Association of Australia has excoriated UBS for releasing reports “based on assumptions and not data”.

Source: UBS

Earlier this week, banking analysts at UBS released a banking sector update that suggested a third of borrowers with interest-only (IO) loans “do not know or understand that they have taken out an IO mortgage”.

According to the results, 23.9 per cent (by value) of respondents stated that they were on an IO mortgage.

UBS analysts were reportedly surprised by this finding, as it was much below APRA’s figure that stated 35.3 per cent of loan approvals in the year to June were for IO loans.

However, the analysts suggested that instead of its figures/APRA’s figures being at fault, the disparity was down to the ignorance of borrowers.

The report concluded: “While we initially suspected that this was a sample error… We believe a more plausible explanation is that around one-third of IO customers do not know or understand that they have taken out an IO mortgage.”

While the analysts acknowledged that this could appear “farfetched”, they went on to say that the conclusion “needs to be considered in the context of the lack of financial literacy in Australia”.

It’s this conclusion that many, including the executive director of the FBAA, have taken exception to.

Speaking to The Adviser, FBAA executive director Peter White said that the conclusion was “the biggest load of nonsense on the planet”.

He said: “There is no analytical data to support what they’re saying. Their comments are that this is what they believe is the response; they are assuming that people don’t know that they have an interest-only loan. So, the conclusion is based on assumptions, not data.

“When you look at the process that a borrower goes through, it’s impossible for them not to know that they are on interest-only. From the conversation they have with their broker or lender, leading into the paperwork, the quote, credit guide, the loan documentation, communications from the broker or lender, the loan contract, the key fact sheets for their home loan — all of that spells out what kind of loan they have and what kind of repayments they will be making. “

He continued: “There are so many documents that people get over and above just the conversation that is had, that it is impossible for somebody not to know that they have an interest-only facility.”

Mr White did acknowledge that while borrowers may not know the “nuances” of their loan structures, he also did not expect borrowers on principal & interest loans to know all the nuances of their loan either.

“But the reality is that they know they are paying off part interest and part principal and how that works. And the reality is that those with interest-only know they are paying off the interest.”

Ties to ASIC remuneration review

The head of the FBAA went on to decry the trend of data not being taken in context or taken to some considerable degree.

He highlighted that some of the findings and proposals of the ASIC review into broker remuneration was another case where the data “didn’t go to the end of the lending journey”.

Adding that he believed ASIC “did a good job” and that its data research was “extensive”, Mr White suggested that some of the conclusions were “based on assumptions of what the data meant.”

He gave the example of the finding that brokers write higher loan-to-value ratio loans, and were responsible for loans with larger loan sizes.

“They assume that’s perceived to be a bad outcome driven by commission (but, of course, we know that this isn’t commission chasing). But, more importantly, they didn’t ask the borrower whether they thought it was a bad outcome.

“So, while [their conclusion] is one possible result of the data, it’s not the only one.

“Likewise, with the UBS report, they said that they believe that this result came from people not understanding that they are on interest-only. But there is no evidence. That’s absolutely ludicrous. To me, it puts a big question mark over the competencies of the people named as conducting this research.”

Mr White concluded: “UBS are not lenders in this space, so they’re making commentary outside of their knowledge and skill set and coming up with the wrong answers. They aren’t doing themselves any favours.

“Consumers are not idiots. They do understand what they are doing. They are well informed.”

 

Are IO Households Aware They Have IO Loans?

DFA analysis shows that over the next few years a considerable number of interest only loans (IO) which come up for review, will fail current underwriting standards.  So households will be forced to switch to more expensive P&I loans, assuming they find a lender, or even sell. The same drama played out in the UK a couple of years ago when they brought in tighter restrictions on IO loans.  The value of loans is significant. And may be understated, according to new research.

A few observations. ASIC in 2015, released a report that found lenders providing interest-only mortgages needed to lift their standards to meet important consumer protection laws. They identified a number of issues relating to bank underwriting practices. We would also make the point that despite the low losses on interest-only loans to date in Australia, in a downturn they are more vulnerable to credit loss.

In April this year we addressed the problem of IO loans.

Lenders need to throttle back new interest only loans. But this raises an important question. What happens when existing IO loans are refinanced?

Less than half of current borrowers have complete plans as to how to repay the principle amount.

Interest-only loans may seem like a convenient way to reduce monthly repayments, (and keep the interest charges as high as possible as a tax hedge), but at some time the chickens have to come home to roost, and the capital amount will need to be repaid.

Many loans are set on an interest-only basis for a set 5 year term, at which point the lender is required to reassess the loan and to determine whether it should be rolled on the same basis. Indeed the recent APRA guidelines contained some explicit guidance:

For interest-only loans, APRA expects ADIs to assess the ability of the borrower to meet future repayments on a principal and interest basis for the specific term over which the principal and interest repayments apply, excluding the interest-only period

We concluded:

This is important because the number of interest-only loans is rising again. Here is APRA data showing that about one quarter of all loans on the books of the banks are interest-only, and that recently, after a fall, the number of new interest-only loans is on the rise – around 35% – from a peak of 40% in mid 2015. There is a strong correlation between interest-only and investment mortgages, so they tend to grow together. Worth reading the recent ASIC commentary on broker originated interest-only loans.

But if households are not aware they have IO loans in the first place, then this raises the systemic risks to a whole new level. The findings from the follow-up study by UBS, after their “Liar-Loans” report (using their online survey of 907 Australians who recently took out a mortgage – they claim a sampling error of just +/-3.18% at a 95% confidence level) are significant.

They say their survey showed that only 23.9% of respondents (by value) took out an interest only loan in the last twelve months. This compares to APRA statistics which showed that 35.3% of loan approvals in the year to June were interest only.

They believe the most likely explanation for the lack of respondents
indicating they have IO mortgages is that many customers may be
unaware that they have taken out an interest only mortgage. In fact, around 1/3 of interest only borrowers do not know that they have this style of mortgage.

Source: UBS

They also says 71% of respondents who took out an interest only mortgage during the last 12 months indicated they are already under moderate to high levels of financial stress.

Source: UBS

Finally, they found that Interest Only borrowers via the broker channel are more likely to be under high financial stress from recent rate rises.

 

 

 

Are first home buyers locked out of housing?

According to UBS, first time buyers are pretty much locked out of the property market. ‘Typical’ first home buyers are facing ~11 years to save; and ~40 years in Sydney!

Housing affordability is extreme as house price-income surged to a record 6.5x

UBS already ‘called the top’ of housing, with a key reason being that affordability is stretched, as the house price-income ratio surged to a record high of 6.5x, up sharply from 4.5x in 2012 (& >doubling from 3x in 1996). While interest rates have fallen to a record low, the mortgage repayment share of income still lifted to a near decade high, & the key issue for first home buyers (FHBs) is the ‘deposit gap’ even before buying.

‘Typical’ first home buyers facing ~11 years to save; and ~40 years in Sydney

UBS have now created a new and dynamic interactive model to estimate how long it would take a FHB to save a deposit to buy a home (click here for the model). The findings are confronting. We estimate a ‘base case’ scenario for a ‘typical’ FHB would take ~11 years to save for a home based on assumptions including: 1) a 10% deposit is required; 2) individual income is AWOTE of ~$80k per year; 3) saving rate is 5% of gross income (i.e. $4k per year); 4) home price today is $400k (~average FHB price); 5) home prices grow in line with household income ahead at 3% per year. However, given recent macroprudential tightening including for high-LVR loans, if we instead assume a 20% deposit is now required, then the time to save more than doubles (due to compounding) to ~24 years. Alternatively, saving a 10% deposit to buy at the average Sydney house price of $1.2mn would take an incredible ~40 years to save.

If house price vs income growth repeats, FHBs likely never can save enough Importantly, the key driver of time to save is house price growth vs income.

In the last 5 years, house price growth averaged 7%, but income only 4%. If this were to be repeated ahead, a FHB would likely never be able to save a 10% deposit – unless they were given (at least part of) the deposit (i.e. from the ‘bank of mum and dad’). Note that due to the frequent changes of Government policy on housing incentives/taxes (& other costs), our model purposely excludes these factors. However, they can be input to the model directly by the user by adjusting the required deposit or purchase price. For instance, the recent FHB super saver scheme potentially reduces the required time by up to several years (contributions are capped at $15k/year and $30k in total).