Welcome to The Property Imperative Weekly to 12 May 2018.
In this week’s review of the latest finance and property news we look at the impact of the impending credit crunch. Watch the video or read the transcript.
The evidence is mounting that we are entering a credit crunch, driven by tighter lending restrictions, and the recent revelations from the Royal Commission. And the implications of this are profound, not just in terms of the immediate impact on home prices, but also, and perhaps more significantly, on the broader economy. Housing and finance for housing has formed a significant plank in the trajectory of the economy over recent years and when coupled with construction activity it has supported the transition from the mining boom. But now that could change, and the impact on households and the broader economy is potentially profound, as borrowers deal with massively higher debt levels, and the inability to spend as a result; and new loans harder to get. As a result, home prices will fall, further and harder. Let’s look at the evidence.
First there is a quite a strong relationship between auction volumes and home price growth. This is why we watch the auction results so closely. Now we know there is a lot of noise in the system because of the way auction volumes are reported – for more on that watch our separate video – Auction Results Under The Microscope, but CoreLogic reported that the auction volumes fell last week. There was a total of 2,311 auctions held, which returned a final clearance rate of 62.1 per cent. Over the same week last year, the clearance rate was much stronger with 73.0 per cent of the 1,689 auctions cleared. Melbourne’s final clearance rate has been fairly stable over the last 3 weeks. Last week’s final clearance rate came in at 63.7 per cent across 1,144 auctions, compared to 63.9 per cent across 1,334 auctions the previous week. This time last year, 792 homes went under the hammer, returning a clearance rate of 77.5 per cent. Sydney’s final auction clearance rate increased to 63.1 per cent across 797 auctions last week, after falling to 55.8 per cent across 829 auctions over the previous week, the lowest clearance rate recorded across the city all year. Over the same week last year, 592 homes went to auction and a clearance rate of 73.8 per cent was recorded. Across the smaller auction markets, Canberra was the only city to see an increase in auction volumes with 102 auctions held, up from 92 over the previous week. Clearance rates were varied with Adelaide, Brisbane and Perth recording lower clearance rates week-on-week. Of the non-capital city auction markets, Geelong returned the highest final clearance rate of 75.0 per cent across 58 auctions.
They are expecting lower auction volumes this Saturday with Melbourne, the busiest city at 1,012 auctions being tracked so far, down from 1,144 last week while Sydney has 696 auctions scheduled this week, down from 797 last week.
Lending criteria are tighter now with a focus on real expenses, supported by evidence. (Why this was not happening previously is a whole other discussion). Our household surveys reveal that more households simply cannot meet the current new and tighter borrowing requirements. Borrowing power has been reduced – significantly. For example, in one scenario, take a household with incomes of close to $200k. Previously they might have been able to get a $1million loan, but now if they provide more detailed expenses – including the fact they pay for child care, their borrowing power will now be scaled back closer to $650,000. Most lenders are applying stricter criteria – though we see in our data the non-banks are still more flexible. But the lending tap is being turned down, significantly.
It is already impacting the ABS housing finance data to March 2018. The trends are pretty clear, lending is slowing, and bearing in mind our thesis that lending and home prices are inextricably linked, this signals further home price falls ahead, which will be exacerbated by even tighter lending standards we think are coming. You can watch our recent video “The Absolute Link Between House Prices and Credit” for more on this. And remember debt is still rising faster than inflation or wages, so household debt will continue to rise from its already overextended level. The rolling 12 month rolling trend says it all, and we see that both owner occupied and investor loan flows are slowing, with investor lending shrinking faster. You can watch our separate video on the data “Housing Credit Goes into Reverse”. The proportion of investor loan flows slid again (excluding refinance) to 43.6%.
CoreLogic did a neat piece of analysis showing the strong correlation between home prices and investor property lending. They said that since macro prudential measures were announced and implemented by APRA, the trends in housing related credit have changed remarkably. Soon after APRA announced the ten percent annual speed limit for investment lending in December 2014, investment housing finance commitments peaked at 55% of mortgage demand and investment credit growth moved through a cyclical peak rate of annual growth at 10.8%. Around the same time, the quarterly rate of home value appreciation peaked in Sydney and Melbourne; the two cities where investment has been most concentrated. As credit policies were tightened in response to the APRA limits, then loosened as lenders overachieved their APRA targets, the housing market responded virtually in concert. Interest rate cuts in May and August of 2016 helped to support a rebound in the pace of capital gains, however as lenders came close to breaching the 10% limit, at least on a monthly annualised basis, credit once again tightened and the second round of macro prudential, announced in March 2017, saw credit availability restricted further. The result of changes in credit availability has been evident across most housing markets, but is very clear in Sydney and Melbourne; dwelling values started to track lower in Sydney from July last year and peaked in Melbourne in November last year.
And the latest trends in home price movements shows further falls in Sydney and Melbourne. In fact, from the start of the year, only Brisbane has shown any increase, all other capital cities fell with an average of 0.26%, and this before the tighter lending standards have started to bite. But of course, whilst we see some slippage now, this is small beer relative to the average gained since May 2012 of 46.7% with the strongest gains in Sydney at 60.9% followed by Melbourne at 43.8%.
Others are now revising their forecasts on future home price momentum with SQM research downgrading their estimates for Sydney, Melbourne, Brisbane, Darwin, Canberra and The Capital City Average. They have tended to be more bullish than some other analysts, but gravity is finally catching up and they also said property prices in Sydney and Melbourne are massively overvalued against fundamentals – by up to 45% we agree.
UBS also published analysis which suggests that home prices are likely to fall, on the back of weaker credit. Once again, gravity will win.
You may remember the RBA warned recently of the potential for credit availability to become more constrained. And economists are now all beginning to highlight the potential impact – the question now is, how tight will lending become? Will the regulators try to alleviate the impact, for example freeing up property investor lending, and will the next move in interest rates be up, or down in the months ahead. More importantly, if lending tanks as we expect, then the spill over effects on the broader economy, growth, home prices, all compound the problems. We are in for a credit crunch, so my scenario 2 – see our video on “Four Potential Finance and Property Scenarios – None Good”.
And if you want more evidence of the economic indicators, look at Retail turnover from the ABS this week which showed further evidence of the stress on households. Retail turnover showed no growth in March, in seasonally adjusted terms following a 0.6 per cent rise in February 2018. Our preferred trend estimates for Australian retail turnover rose 0.3 per cent in March 2018, following a rise (0.3 per cent) in February 2018. Compared to March 2017, the trend estimate rose 2.6 per cent. And across the states there were some significant variations, with NSW up 0.3%, VIC. Up 0.5%, QLD and SA up 0.1%, WA and flat, the Northern territories up 0.3% and ACT 0.4%.
And this is consistent with our Household Finance Confidence Index, to the end of April 2018, which showed that households remain concerned about their financial situation. This is consistent with rising levels of mortgage stress, as we reported recently. The index fell to 91.7, down from 92.3 in March. This remains below the neutral 100 setting, and continues the decline since October 2016. You can watch our separate video “Household Financial Confidence Takes Another Dive” Again, we continue to see little on the horizon to suggest that household financial confidence will improve. Currently, wages growth will remain contained, and home prices are likely to slide further, while costs of living pressures continue to grow. Whilst banks have reduced their investor mortgage interest rates to attract new borrowers, we believe there will also be more pressure on mortgage interest rates as funding costs rise, and lower rates on deposits as banks trim these rates to protect their net margins. In the last reporting round, the banks were highlighting pressure on their margins as the back-book pricing benefit from last year ebbs away.
We got half year results from Westpac this week which were an interesting counterpoint to recent announcements, with stronger NIM, including from Treasury. Their CET1 ratio fell a little, but they are still well placed. Mortgage delinquencies were a little higher but and they had been able to lift margin by reducing rates on some deposits, though they did signal higher funding at the moment and the risks of higher rates ahead. They defended the quality of their mortgage portfolio. One slide in the investor presentation said “Australian mortgages performing well”. The data showed that Westpac originated $5 billion in mortgages in the first half 18, or about $10 billion over a year, or the same as the bank funded as far back as 2014. Compare that with the $18 billion in 2017 and 17 billion the year before that. Momentum is slowing. Analysts, UBS, who called out potential “liar loans” at the bank said they say they remain concerned with the findings of APRA’s ‘Targeted Review’ into WBC’s mortgage serviceability assessment and in particular comments from Wayne Byres (APRA Chairman) that WBC was a “significant outlier” and WBC’s Board Papers which stated its performance was “poor, both absolutely and relative to peers”. Further, WBC stated in the March quarter ~20% of loans were approved with Debt-to-Income (DTI) > 6x. This as a very high level especially given the concerns that mortgagor gross household income appears to be overstated across the industry, and the total debt position of customers is not yet fully visible (the mandatory comprehensive credit reporting regime begins 1 July 2018). You can watch our separate video “Westpac and The Liar Loans Incident”
CBA reported their Q3 unaudited trading results, with a statutory net profit of approximately $2.30bn, in the quarter and unaudited cash net profit of approximately $2.35bn in the quarter. This is down 9% on an underlying basis compared with 1H18. We see some signs of rising consumer arrears, and a flat NIM (stark contrast to WBC earlier in the week!). Expenses were higher due to provisions for regulatory and compliance. They reputation is in question.
The impact of reputational risk is highlighted by AMP’s Q118 results. They said cashflows were subdued in Australian wealth management but there was continued strength in AMP Capital and AMP Bank. AMP Bank’s total loan book up 2 per cent to A$19.8 billion during the quarter. The portfolio review of manage for value businesses continues. In response to ASIC industry reports, AMP continues to review adviser conduct, customer fees, the quality of advice, and the monitoring and supervision of its advisers. They anticipate that this review will lead to further customer remediation costs and associated expenses and they will provide a further update at or before the 1H 18 results. This will include enhancements to AMP’s control frameworks, governance and systems.
AMP’s share price has fallen significantly, to levels not seen since 2003, and in a vote of no confidence, Australian Ethical has announced it will completely divest from AMP following revelations of “systemic prudential and cultural issues” at the royal commission. They will not reinvest until AMP demonstrates they have addressed their underlying issues. And they are watching the two of the four major banks they have holdings in, in the light of the findings from the royal commission too.
Finally, It’s worth looking at the impact of higher interest rates on the market. The Bank of England made small adjustments from a low base recently, and the results have been negative and predictable. The UK economy remains in the doldrums, so no surprise, the cash rate remained unchanged this month. In fact, the small rises made before have translated directly to lower home prices, reflecting the highly leverage state of many households. GDP is expected to grow by around 1¾% per year on average over the forecast period. Household consumption growth remains subdued. CPI inflation fell to 2.5% in March, lower than expected.
Indeed, Fitch Ratings says the UK household sector’s worsening financial health reduces consumer resilience to income or interest rate shocks and presents risks for UK consumer loan portfolios. Consumer credit has been a key driver of rising household debt. But weaker household finances reduce the resilience of consumer spending – by far the largest demand component of UK GDP – to shocks. A major interest rate shock appears unlikely (they forecast the UK base rate to rise gradually, to 1.25% by end-2019), but a more immediate shock could come from tightening credit supply. The impact of the Brexit referendum on real wages may be fading, but Brexit uncertainty creates risks of a bigger shock to growth and employment. They say that UK banks are highly exposed to UK households, but mostly through mortgages, with consumer credit accounting for just 10% of banks’ lending to the sector. High household debt is a constraint on UK banks’ operating environment. Does this sound familiar?
