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.
- Income is being overstated and expenses understated.
- 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.
