Charles Schwab Re-enters Australian Market

From Investor Daily.

American wealth management giant Charles Schwab Corporation has re-opened an office in Sydney after exiting the Australian market in 2000.

The San Francisco-headquartered financial advice firm, custodian and brokerage has “re-established” its presence in Australia following the acquisition of Chicago-based “broker-dealer” optionsXpress.

Charles Schwab Australia managing director JP Drysdale told InvestorDaily the decision to re-enter the Australian market was due to growth of SMSFs in Australia that exhibited the “clear demand for self-directed investment opportunities”.

“The acquisition and integration of the optionsXpress business presented opportunities in both the Australian and Singapore markets,” Mr Drysdale said.

“The time was right to enter both, to give investors in both markets the ability to trade in US markets through a platform that’s cost effective, secure and time-tested.”

Prior to 2000, Charles Schwab had an Australian presence but decided to physically exit the market due to a “range of market circumstances at that time”.

Where optionsXpress only offered an online trading platform, Charles Schwab had the capacity to cater to the needs of Australian investors more broadly, Mr Drysdale said.

“Globally, Charles Schwab is a wealth management and advisory firm that focuses on helping clients invest for their future,” Mr Drysdale told InvestorDaily.

“This is a far broader approach to customers investing needs than optionsXpress.

“Charles Schwab Australia is now in a position to assist many more Australians who need to manage they investments and diversify in the US, but don’t see themselves as short-term traders.”

Through its electronic trading platform, the broker firm will offer Australian investors access to US-listed equities, offshore mutual funds, ETFs, fixed income, options and futures at US$4.95 per online equity trade.

He added that local investors, through a variety of channels, were now able to have cost effective access to the US market.

“Typically, access to US markets for self-directed investors, including SMSFs, is expensive compared to the costs of transacting in the Australian market,” he said.

“However, we believe there need not be trade-offs between price and customer service.

“From the high-quality research content mentioned above to the ability for clients to pick up the phone and talk to a financial consultant, Charles Schwab provides many ways for clients to access investment experts.

“We see our role as working with clients to help them develop a strategy for increasing the diversity of their investments and therefore managing the risk in their portfolios.”

The Incredible Shrinking Home

Interesting research from CommSec, who commissioned the ABS to look at trends in the size of Australian homes. They says the average floor size of an Australian home (houses and apartments) has fallen to a 20-year low, the average new home is 189.8 square metres, down 2.7 per cent over the past year and the smallest since 1997.

Australians continue to build some of the biggest houses in the world. But an increasing proportion of Australians – especially in Sydney, Melbourne and Brisbane – also want smaller homes like apartments, semi-detached homes and town houses. As a result, the average home size continues to fall – now at 20-year lows.

Generation Y, Millennials, couples and small families want to live closer to work, cafes, restaurants, shopping and airports and are giving up living space for better proximity to the desirable amenities.

So consolidation is occurring in the eastern states. Older free-standing houses are making way for apartments. And while building completions hit record highs in the year to March, approvals to build homes are rising again.

It is important to note that there are differences in house size across Australia. In the past year the average size of houses built in both South Australia and Western Australia has lifted. In fact South Australia built the biggest homes on records going back 30 years. And on average Western Australian houses built in 2016/17 were just short of record highs for the state.

Clearly the changes in housing demand and supply, and the differences across the country, have major implications for builders, developers, investors, building material companies, financiers and all levels of Government.

OCCUPANCY RATES

Since the first Census was conducted in 1911, and up to 2006, the number of persons per dwelling consistently fell. In 1911 there was an average of 4.5 people in every home. But by 2006 this ratio had almost halved to around 2.4 people in every home. Not only were more homes being built but other factors like families with fewer children, more divorces fewer marriages taking place had resulted in smaller families.

From 2006 to 2013, the number of people per dwelling rose. At face value, the modest increase in average household size may not seem significant. But it was the first increase in household size – and as a consequence, the average number of people in Australian homes – in at least a century.

Children were staying home longer with their parents – no doubt the cost of homes and rising rents being key influences. With the ageing population, more generations were choosing to stick together in the one dwelling – a trend that is a consequence of the increased size and quality of homes. New migrants also chose to stay with family or friends. And given the increased preference to attend universities and colleges, Generation Y was forced to share accommodation and save longer to buy a home.

But according to quarterly ABS data, since 2014 the number of people per dwelling has again been falling. Lower interest rates and the increased supply of cheaper apartments (compared with houses) have prompted older couples to down-size. More Generation Y have been looking to move out of home and take ownership of accommodation more appropriate to their needs.

In part, the decline in household size explains some of the lift in home building. Higher population growth – especially in NSW and Victoria – also explains the lift in home building. The question is whether household size continues to fall over the next few years or whether higher home prices acts to stall demand, again prompting greater co-habitation of dwellings.

STATE DATA

Victorians are building the biggest houses in Australia. In 2016/17 the average floor area of houses built in Victoria was 242.8m², ahead of Western Australia (242.5m²), NSW (230.0m²) and Queensland (227.3m²).

The smallest new houses built were in Tasmania (195.5m²) and the ACT (197.0m²).

In 2016/27 the biggest apartments could be found in the Northern Territory (154.5m²). However, the data may be distorted by the small number of completions in the year (1,173).

Of the states, South Australia built the biggest apartments in 2016/17 with the average floor area at 152.3m², ahead of Victoria (131.0m²) and Tasmania (129.8m²).

Of all homes built in 2016/17, the average floor area was biggest in Western Australia (214.3m²), then South Australia (201m²). In Western Australia over 69 per cent of homes built were free-standing houses, and in South Australia houses were 73.2 per cent of the total. By comparison, only 43.6 per cent of homes built in NSW were free-standing or detached houses.

 

Auction Results 18 Nov 2017

The preliminary auction results from Domain are in. The trend looks like it is continuing to ease compared with last year, though a little up from last week so far. Melbourne is sitting on 72.1% stronger than last weekend.

Brisbane cleared 33% of 136 listed, Adelaide 62% of 98 listed and Canberra 69% of 96 listed.

Walking The Tightrope – The Property Imperative Weekly 18 Nov 2017

A really mixed bag of news this week, with stronger business and employment data, lower mortgage defaults and yet weak wage growth, and more evidence of the pressure on households. We pick over the coals and try to make sense of what’s going on.

 Welcome to the Property Imperative Weekly to 18 November 2017. Watch the video or read the transcript.

We start with some good news.

The latest National Australia Business (NAB) survey — a composite indicator that measures trading activity, profitability and employment — surged by a massive 7 points to +21, leaving it at the highest level since the survey began in 1997. On this measure, Australian businesses have not had it so good in at least two decades. There were enormous increases recorded in trading and profitability, suggesting that demand was rampant during October. However, beware, this included a massive unexplained jump in manufacturing and the survey’s lead indicators softened over the month, which, along with an unchanged reading on business confidence, raises questions as to whether the bounce in the conditions index can be sustained.

Deputy Governor Guy Debelle spoke at the UBS Australasia Conference on “Business Investment in Australia“. He argued that investment has been strong over the last decade, thanks to the mining sector. This is now easing back, and the question is will the non-mining sector start firing or not? Even if it does, they have huge boots to fill!

Luci Ellis RBA Assistant Governor (Economic) delivered the Stan Kelly Lecture on “Where is the Growth Going to Come From?“. An excellent question given the fading mining boom, and geared up households! But we really got few answers. Australia’s population is growing faster than in almost any other OECD economy. That has remained true over the past couple of years. The rate of natural increase is higher than many other countries, but most of the difference is the large contribution from immigration. Of course, just adding more people and growing the economy to keep pace wouldn’t boost our living standards. Next, employment participation has been rising recently. The increase has been concentrated amongst women and older workers and is linked with the increase in health and education employment. Finally, productivity can improve, especially if innovation can be leveraged, although she noted the rate of technology adoption has slowed down since the turn of the century. We wonder if this has something to do with the sluggish and underpowered NBN rollout currently underway.

The monthly trend unemployment rate remained at 5.5 per cent in October 2017, according to figures released by the Australian Bureau of Statistics. While the trend is down, it was not as strong as some analysts were expecting.  The seasonally adjusted unemployment rate decreased by 0.1 percentage points to 5.4 per cent and the labour force participation rate decreased to 65.1 per cent.

The ABS released their analysis of individual state accounts to Jun 2017. This includes an estimate of average gross household disposable income per capita. The variations across states are significant and interesting. Of note is the astronomical value, and trajectory of individuals in the ACT, at more than $90,000. We saw a decline in gross incomes in WA (one reason why mortgage defaults are rising there) at around $50,000. NSW was also around $50,000 while VIC was around $45,000 and TAS was $40,000.

Wages rose 0.5 per cent in the September quarter 2017 and 2.0 per cent over the year, according to the ABS. This was below consensus expectation, and continues the slow grind in household income, for many falling below the costs of living.  Those in the public sector continue to do better than those in the private sector. In original terms, wage growth to the September quarter 2017 ranged from 1.2 per cent for the Mining industry to 2.7 per cent for Health Care and Arts and recreation services. Western Australia recorded the lowest growth through the year of 1.3 per cent and Victoria, Queensland and Tasmania the highest of 2.2 per cent.

The legislation to tighten some aspects of investment property, and levy a charge on vacant foreign owned property has been passed in the Senate. The legislation prevents property investors from claiming travel expenses when travelling between properties, as well as tightening depreciation on plant and equipment tax deductions. Foreign owners will be charged a fee if they leave their properties vacant for at least six months in a 12-month period, in an attempt to release more property to ease supply. The latest Census showed that there are 200,000 more vacant homes across Australia than there were ten years ago.

Turning to the mortgage industry, Fitch Ratings says Australia’s RBMS mortgage arrears fell to 1.02% in 3Q17, a 15bp decrease from the previous quarter; consistent with the nine-year long seasonal trend where 30+ days arrears have eased in the third quarter. They say the curing of third-quarter arrears was helped by borrowers using tax return receipts to make repayments. The 30+ days arrears were 4bp lower than in 3Q16, reflecting Australia’s improved economic environment and lower standard variable interest rates for owner-occupied lending. They said the gap between investor lending and owner-occupied rates has widened, as banks respond to regulatory investment and interest-only limits on new loan origination. Historically, investors paid a 25bp-30bp premium over owner-occupied loans, but this widened to 60bp in September 2017.

S&P Global Ratings said RMBS Mortgage arrears fell to 1.08% in September across Australian down from 1.10% in August 2017. They say mortgage arrears rose in both the Northern Territory and the ACT during September but fell elsewhere. The ACT mortgage arrears it is only at a low 0.64%, compared with Western Australia who has the highest arrears of 2.21%. However, while outstanding loan repayments on 30-to-60-day arrears also declined in most states between January and September, 90-day+ arrears rose in Western Australia and Queensland. This is the same as we saw recently in the bank reporting season. S&P expects arrears to rise over the coming months, as they “traditionally start to increase in November and continue through to March.”

There was more evidence of poor mortgage lending practice this week, following the recent UBS “Liar Loans” research study. A liar loan is a loan that is approved on the basis of unverified and possibly false information about income, assets or capacity to repay. This is important because mortgage delinquency and default may rise due to excessive risk taking in mortgage lending combined with deteriorating economic conditions; or due to falling income and rising unemployment during a housing downturn.

Connective remained brokers of their obligations, and pointed to findings from the 2016 Veda Cybercrime and Fraud Report, which recorded a 27 per cent year-on-year increase in falsifying personal information. “Falsified documentation — particularly documents that verify a customer’s income — is the most common type of fraud that a mortgage broker is likely to encounter,” the aggregator said. Back in June, Equifax informed brokers at a Pepper Money roadshow that 13 per cent of frauds reported were targeting home loans and there has been a 25 per cent year-on-year increase in frauds originating from the broker channel.

In the same vein, NAB has said it has commenced a remediation program for some of its customers, after a review identified their home loan may not have been established in accordance with NAB’s policies. NAB identified around 2,300 home loans since 2013 that may have been submitted without accurate customer information and/or documentation, or correct information in relation to NAB’s Introducer Program. As a result of NAB’s review, 20 bankers in New South Wales and Victoria had their employments terminated, or are no longer employed by NAB, and an additional 32 bankers had consequences applied including the reduction of remuneration. NAB has commenced writing to these customers – many of whom live overseas – asking them to participate in a detailed review of their loan, which may include verification of documents submitted at the time of their home loan application. Affected customers may be offered compensation as appropriate.

More evidence of the risks in the system came when The Reserve Bank in New Zealand said that Westpac New Zealand has had its minimum regulatory capital requirements increased after it failed to comply with regulatory obligations relating to its status as an internal models bank. Internal models banks are accredited by the Reserve Bank to use approved risk models to calculate how much regulatory capital they need to hold. Westpac used a number of models that had not been approved by the Reserve Bank, and materially failed to meet requirements around model governance, processes and documentation.

Still talking of risks, there was an interesting paper from the Federal Reserve Bank of Cleveland “Three Myths about Peer-to-Peer Loans” which suggested these platforms, which have experienced phenomenal growth in the past decade, resemble predatory loans in terms of the segment of the consumer market they serve and their impact on consumers’ finances and have a negative effect on individual borrowers’ financial stability. This is of course what triggered the 2007 financial crisis. There is no specific regulation in the US on the borrower side.  Given that P2P lenders are not regulated or supervised for antipredatory laws, lawmakers and regulators may need to revisit their position on online lending marketplaces.

We published two research reports this week. First our Quiet Revolution Banking Channel and Innovation Report, which is available for free download. And second the impact of rising interest rates on households.

It seems that eventually mortgage rates will rise in Australia, as global forces exert external pressure on the RBA, and as the RBA tries to normalise rates (at say 2% higher than today). Timing is, of course, not certain. But it is worth considering the potential impact. While our mortgage stress analysis takes a cash flow view of household finances, our modelling can look at the problem another way. One algorithm we have developed is a rate sensitivity calculation, which takes a household’s mortgage outstanding, at current rates, and increments the interest rate to the point where household affordability “breaks”.  We use data from our household survey to drive the analysis.

So we start with the average across the country. We find that around 10% of households would run into affordability issues with less a 0.5% hike in mortgage rates, and around another 8% would be hit if rates rose 0.5%, and a larger number would be added to the “in pain” pile, giving us a total of around 25% of households across the country in difficulty if rates went 1% higher. [Note that the calculation does not phase the rate increases in]. Around 40% of households would be fine even if rates when more than 7% higher. At a state level we found that around 40% of households in NSW would have a problem, compared with 27% in VIC and 24% in WA. We can also take the analysis further, to a regional view across the states. This reveals that the worst impacted areas would be, in order, Greater Sydney, Central Coast, Curtain and Greater Melbourne. These are all areas where home prices relative to income are significantly extended, thus households are highly leveraged.

CoreLogic said Mortgage clearance rates have continued to track below 70 per cent since June the year; this is a considerably softer trend than what was seen over the same period last year when clearance rates were tracking around the mid 70 per cent range for most of the second half 2016.  Results across each of the individual markets were varied this week, with Canberra recording the highest preliminary auction clearance rate of 72.9 per cent, while in Brisbane only 45.7 per cent of auctions cleared.

So to, two important reports.

According to the eighth edition of the Credit Suisse Research Institute’s Global Wealth Report, in the year to mid-2017, total global wealth rose at a rate of 6.4%, the fastest pace since 2012 and reached USD 280 trillion. But wealth distribution has become more uneven. This reflected widespread gains in equity markets matched by similar rises in non-financial assets (home prices), which moved above the pre-crisis year 2007’s level. Household wealth in Australia grew at an average annual growth rate of  12%, with about half the rise due to exchange-rate appreciation against the US dollar. Australia’s wealth per adult in 2017 is USD 402,600, the second highest in the world after Switzerland.

However, the composition of household wealth in Australia is heavily skewed towards non-financial assets, which average USD 303,200, and form 60% of gross assets. The high level of real assets partly reflects a large endowment of land and natural resources relative to population, but also results from high property prices in the largest cities.

Finally, Industry Super Australia, published an excellent discussion paper on “Assisting Housing Affordability” which endeavours to identify the underlying causes of affordability issues, and  considers some useful policy responses in the current and historical context. They rightly consider both supply and demand related issues.

They call out specifically the impact of incoming migration, especially around university suburbs in the major centres as one major factor.

More broadly, they articulate the problem facing many, in that access to affordable housing – a basic need – is now more difficult than ever and the issue is affecting household spending decisions:

  • Key workers like police officers, teachers and nurses can’t afford to live near the communities they serve.
  • Children are staying at home for longer, marrying later and taking longer to save for a home deposit.
  • Many older Australians are locked into big houses that no longer suit their needs while a greater number of near retirees are renting or paying off a mortgage.
  • Commuters spend too much time on congested roads and trains which are now the norm in certain Australian cities.
  • More Australians are renting.

The report is worth reading because it knits together the complex web of issues, and confirms the complexity which is housing affordability, and that there are no simple single point solutions.

And that’s the point. Sure, employment looks strong, but the nature of that employment is favouring lower wage occupations. Business confidence is strong, because business profits are up, but this is not translating into higher wages. As a result, wealth distribution is becoming more skewed, as home prices and stock prices rise. But the risks remain. Property is overvalued, and we lack joined up thinking to address the fundamental structural issues which exist. So meantime we muddle on, hoping that wage growth will start to rise before home prices fall too far and mortgage rates rise. Don’t look down, we are walking a tightrope!

So that’s the Property Imperative weekly to 18th November 2017. If you found this useful, do leave a comment below, subscribe to receive future updates, and check back next time.  Thanks for watching.

Housing Affordability, A Complex Equation

Industry Super Australia, a research and advocacy body for Industry super funds, has published an excellent discussion paper on “Assisting Housing Affordability” which endeavors to identify the underlying causes of affordability issues, and to consider some useful policy responses in the current and historical context. They rightly consider both supply and demand related issues.

They call out specifically the impact of incoming migration, especially around university suburbs in the major centres as one major factor.

More broadly, they articulate the problem facing many, in that access to affordable housing – a basic need – is now more difficult than ever and the issue is affecting household spending decisions:

  • Key workers like police officers, teachers and nurses can’t afford to live near the communities they serve.
  • Children are staying at home for longer, marrying later and taking longer to save for a home deposit.
  • Many older Australians are locked into big houses that no longer suit their needs while a greater number of near retirees are renting or paying off a mortgage.
  • Commuters spend too much time on congested roads and trains which are now the norm in certain Australian cities.
  • More Australians are renting.

This has been a long standing issue, but they say from 2013 the problem of housing affordability became more serious.

Many property developers (small and large) entered the market, chasing short-term speculative capital gains. This coincided with a ramping up of student arrivals who drew on their parents’ savings (a safe haven strategy) to acquire bricks and mortar, usually near centres of education. Alarm bells did not ring for Australian governments, even though most new arrivals were settling in a limited number of localities. These factors and market dynamics combined to drive record house prices in key centres. The key drivers of low housing affordability are due to imbalances in demand and supply in certain key markets.

  • On the demand side, key factors include the extent of unanticipated or uncoordinated immigration flows to growth centres; the relationship between international student intake and the dynamics of foreign investment in established dwellings; the interaction between record low interest rates and investors chasing future capital gains via gearing-oriented tax concessions; and lax lending practices.
  • On the supply side, key factors include poorly coordinated land release and infills approvals and the outright restriction of supply by state governments; private land developers stockpiling tracks of land around the urban fringe, and restrictive town planning and zoning rules by local governments that have produced very long lead-times for the construction of new, denser housing stock in areas where affordability is worsening.

There are significant risks attached to ignoring affordability issues.

The lack of coordination in housing policy across all levels of Australian government has generated hotspots in property markets that have undermined macroeconomic stability. Destabilising wealth effects and the continuing expansion of household debt are feeding an unsustainable cycle of property price inflation. Net foreign indebtedness has risen to concerning levels for a small open economy that lacks a diversified economic structure and runs persistent current account deficits. Australia is far too dependent on property and pits (extraction of iron ore, coal and now liquefied natural gas) as the launch pad of its economic advance. This is very risky and may end in tears.

Booming house prices are good news for existing owners and bad news for those entering the market for the first time. Prospective buyers paying 2017 prices must have faith, at a time when even investment professionals believe a purchase now is, over the short to medium term, ill-advised. They must also have faith in their capacity to maintain an adequate income to service their debt, or hope that prices will just keep rising. In Sydney, where prices have risen 87 per cent over five years, whilst incomes have risen around 15 per cent on average, that is a tough call. Yet so many people (mostly Australians below age 35) have been prepared to take out home loans valued at over six times their income, facilitated by the relatively lax lending standards of banks.

The paper confirms the complexity which is housing affordability, and that there are no simple single point solutions.

The key findings of the paper are:

  • Australia’s housing affordability problem has developed over several decades and will require a long-term commitment by all levels of government to resolve.
  • Destabilising wealth effects and the continuing expansion of household debt are feeding a cycle of property price inflation which looks unsustainable.
  • Policy responses that increase the buying power of households (for example, through grants, or reduced taxes) will only increase demand, and therefore prices.
  • Ignoring the emerging crisis in assisted housing (affordable, public and community) now risks major future social and productivity costs.
  • Simply increasing overall housing stock will not ensure that more assisted housing becomes available. Instead, increasing the supply of assisted housing specifically is required.
  • Waitlists for social housing remain intractable and this system no longer serves as a safety net.
  • Achieving the necessary growth in assisted supply is beyond the capacity of Australian governments, and private investment is required.

To resolve the issues in assisted housing, Federal, state and local governments need to coordinate their activity without duplication or political interference. The core elements of any strategy will require:

  • A central body to provide rigorous housing supply forecasting, which will assist with planning.
  • Developing appropriate incentives (for example, tax policy) to encourage institutional investment in a new assisted housing asset class.
  • Expanding the capacity and professionalism of the community housing sector to deal with larger scale developments and tenant administration.

Additionally, some general policy suggestions to address broader housing affordability issues are as follows:

  • Explicitly linking state and local government planning and housing approvals to estimates of regional housing supply gaps.
  • Encouraging more work and student visa holders to reside outside of property market hot-spots.
  • Directing all foreign investment in residential property to new buildings.
  • Streamlining town planning procedures by mandating the removal of unreasonable height restrictions within urban infill development zones (including ‘inner’ and ‘middle-ring’ suburbs).
  • Discouraging land hoarding by identifying underutilised assets for redevelopment (including assisted housing), and providing recycling bonuses to incentivise the release of public and private sites.
  • Reorienting some current tax concessions for existing property towards investment in new housing and institutional investment in new assisted housing.
  • Reforming land taxes in Australia via the abolition of stamp duties and replacing them with a mix of land and betterment taxes.
  • Promoting stability around property – the largest asset class held by ordinary Australians.

Australian 3Q17 Mortgage Arrears See Seasonal Falls

Australia’s RBMS mortgage arrears fell to 1.02% in 3Q17, a 15bp decrease from the previous quarter; consistent with the nine-year long seasonal trend where 30+ days arrears have eased in the third quarter. Fitch Ratings believes the curing of third-quarter arrears was helped by borrowers using tax return receipts to make repayments.

The 30+ days arrears were 4bp lower than in 3Q16, reflecting Australia’s improved economic environment and lower standard variable interest rates for owner-occupied lending. Unemployment improved by 10bp and real wage growth, although low, was positive. Underemployment has continued to improve, reflecting an increase in available work for underemployed workers.

Prepayment rates remained low during 2017, with the conditional prepayment rate (CPR) staying below 20% for three consecutive quarters; the longest period this rate has remained below 20% since 2011. The CPR increased slightly qoq to 19.6%, from 19.1%, while the Dinkum RMBS Index borrower payment rate increased to 21.6% qoq, from 21.2%.

The gap between investor lending and owner-occupied rates has widened, as authorised deposit-taking institutions respond to regulatory investment and interest-only limits on new loan origination. Historically, investors paid a 25bp-30bp premium over owner-occupied loans, but this widened to 60bp in September 2017.

Losses experienced after the sale of collateral property remained extremely low, with lenders’ mortgage insurance payments and excess spread sufficient to cover principal shortfalls in all transactions during the quarter.

Fitch’s Dinkum RMBS Index tracks arrears and the performance of mortgages underlying Australian residential mortgage-backed securities.

Is The Global Banking Network Really De-globalising?

An IMF working paper “The Global Banking Network in the Aftermath of the Crisis: Is There Evidence of De-globalization?” released today, shows that contrary to popular belief, the Global Banking Network has not shrunk since the GFC in the simple way often thought. Using complex and innovative modelling, they conclude that the banking world in some ways is connected more deeply, and with greater complexity than before. This means that players in one location could be impacted more severely by events in other geographies. They conclude that the hidden dynamics of the global banking network after the crisis suggest that the assertion that cross-border lending has shrunk globally seems to miss out significant details. They refrain from assessing the risk impact of this observation.

However, we conclude, like our digital world, global banking is more financially networked than ever, suggesting that risks could be propagated widely and in unexpected directions.

The global financial crisis in 2008-09 underscores the unique role of financial interconnectedness in transmitting and propagating adverse shocks. Previous literature stresses the significance of network structure in generating contagion,  lays out detailed mechanisms of contagion through balance-sheet effects, is followed by a large body of theoretical and empirical research on interbank markets, mostly within a single country or region, that focuses on modeling banks’ behavior in response to shocks in the financial system. Cross-border implications of the banking network, however, are mostly ignored due to scarcity of data and rich country-level heterogeneity that may lower the explanatory power of a unified framework.

The sharp fall in global cross-border banking claims after the crisis has been persistent, either measured in Bank for International Settlements (BIS) Locational Banking Statistics (LBS) or BIS Consolidated Banking Statistics (CBS). This persistent aggregate decline in cross-border banking claims has been considered evidence of financial deglobalization. In this paper, we consider the validity of the financial de-globalization argument by studying the evolution of the global banking network before, during and after the crisis, with a particular focus on the aftermath of the crisis. Instead of trying to establish the role of the network in propagating the crisis at a global level, we take the role of the global banking network as given and seek to investigate the impact of the crisis on the network. In this context, our key contributions to the literature are twofold: (i) we measure and map the global banking network using a model-free and data driven approach; and (ii) we analyze the evolution of the network using network analysis tools, including some novel applications, that are relevant given the  characteristics of the global banking network and the available data.

The foremost challenge in constructing the global banking network is to map and identify an accurate and comprehensive network structure using the available data on cross-border banking flows. Researchers face a tradeoff between data coverage and frequency. High frequency data, such as banks’ daily transactions, often contain a limited number of banks within a country, while datasets with a good coverage of global lending mainly report country-level aggregate statistics, and are updated infrequently. This challenge is further complicated by the difficulty in identifying the composition, sources and destinations of bank flows, primarily due to the use of offshore financial centers as important financial intermediaries. Not only are global banks able to conduct cross-border lending via entities in their headquarters and offshore financial centers, but also they can lend domestically through subsidiaries and/or branches within the border of the borrower countries. BIS International Banking Statistics (IBS), through its two datasets (LBS and CBS), offer the best available data to map the international bank lending activity across countries. This is especially the case of the CBS dataset, which consolidates gross claims of each international banking group on borrowers in a particular country, aggregating those claims following the nationality of the parent banks. This nationality-based nature of CBS is an advantage over LBS, which follows a residency-based principle, and thus obscures the linkages between the borrower country and the parent bank institution, when lending originates in affiliates located in third countries (e.g., off-shores financial centers). A disadvantage of using CBS is that it registers the full claims of the affiliates, independent of how those assets were funded (e.g., a claim of a foreign affiliate that is fully funded with local domestic depositors is still counted as a claim from the country of the parent bank on the borrower country where the affiliate is located). In order to avoid this overstatement of financial linkages, which are large in the case of emerging countries as shown in the next section, we combine BIS CBS data with bank level data, taking into account the claims of foreign affiliates and the local deposit funding used by subsidiaries and branches.

We use the improved measure of cross-border banking linkages to  onstruct a sequence of global banking networks, and apply tools from network theory to analyze the evolution of economic and structural properties of the network. We take a step further to incorporate this important discussion into our choice of metrics to identify important players and trace the structural evolution of the global banking network. We provide an in-depth discussion of network measure choice based on the structural context of a core-periphery, asymmetric and unbalanced network structure and in the economic context of characterizing banking flows at the country level.

We introduce measures of node importance that capture  distinct aspects of global banking linkages. In particular, we use recursively defined Katz-Bonacich centrality and authority/hub measure to characterize country importance based on its connection to and dependence on other important countries, as well as a novel application of modularity in order to capture the regional fragmentation of the network. The flexibility of our network configuration allows us to use a small number of network metrics to reveal distinct aspects of network structure and node importance.

We find that the overall shrinkage of cross-border bank lending after the crisis, which has been the key argument behind the claims on financial de-globalization, is also reflected in the average number of links and their strength in the global banking network.

However, rich details on the evolution of the network suggest that this argument is overly simplified.

While connections within traditional major global lenders (banks in France, Germany, Japan, UK, and US) became sparser, many non-reporting countries located at the periphery of the network are more connected, mainly due to the rise of non-major global lenders out of Europe. Measured in metrics of node importance, these lenders have been steadily climbing up the rank, resulting in a corresponding decline of European lenders in status and borrowers’ decreasing dependence on traditional lending countries. Moreover, we find substantial evidence indicating increasing level of regionalization of the global banking network. Even though post-crisis retrenchment of major global and non-major European banks’ operation in the aggregate was just partially offset by the rest of the BIS reporting countries’ regional expansion, their targeted expansions have increased regional interlinkages through both direct cross-border and affiliates’ lending. More formally, using network modularity as a novel application to assess the quality of network cluster structure based on region divisions, we find that this measure increases after the crisis, thus indicating, from the perspective of network theory, that some form of regionalization characterizes the post-crisis dynamics of the global banking network. Finally, we also confirm this regionalization process through a regression analysis of the evolution of cross-border lending. After controlling by geographical distance and trade relationships as well as lender and borrower characteristics, we find a statistically significant increase in cross-border lending when both borrower and lender belong to the same region, especially in the case of peripheral lenders during the post-crisis period.

We show that without proper adjustment, country-level banking statistics suffer from multiple data issues that distort the actual role of each country in cross-border lending, and increase the difficulty of accurately detecting key players in the network. We find evidence confirming the overall shrinkage in the scale of cross-border bank lending using a variety of network analysis tools. Moreover, these methods capture rich dynamics that occur inside the global banking network and are not captured by traditional aggregate indicators.

Using a set of centrality measures with meaningful economic interpretations, we delve substantially deeper to capture the interconnectedness faced by each country. While the structural stability of the highly concentrated global banking network is mainly due to the stability of major global lenders, we observe decline in importance for non-major global European lenders and a corresponding rise in the ranks for lenders from other region, comprised of mostly emerging market lenders. The hidden dynamics of the global banking network after the crisis suggest that the assertion that cross-border lending has shrunk globally seems to miss out significant details.

NOTE: IMF Working Papers describe research in progress by the authors and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the authors and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

The ACT Is Another Country

The ABS has released their analysis of individual state accounts to Jun 2017.

This includes an estimate of average gross household disposable income per capita. The variations across states are significant and interesting. Of note is the astronomical value, and trajectory of individuals in the ACT, relative to everywhere else.  In addition, we see a decline in gross incomes in WA (one reason why mortgage defaults are rising there).

Households in TAS and SA are, on average on the lower rungs. The slowdown in income growth is also visible.

This goes a long way to explaining the high current levels of mortgage stress we observe, because home prices, mortgages and credit growth are all rising faster than income. NSW and VIC, then QLD are worse hit.

 

RMBS Mortgage Arrears Lower Again, But…

S&P Global Ratings said RMBS Mortgage arrears fell to 1.08% in September across Australian down from 1.10% in August 2017.

They say mortgage arrears rose in both the Northern Territory and the ACT during September but fell elsewhere. While the ACT tops the list with a rise mortgage arrears it is only at a low 0.64%, compared with Western Australia who has the highest arrears of 2.21%.

However, while outstanding loan repayments on 30-to-60-day arrears also declined in most states between January and September, 90-day+ arrears  rose in Western Australia and Queensland. This is the same as we saw recently in the bank reporting season.

S&P said the growth in full-time jobs is positive for mortgage arrears. In addition, the rises rates on in more risky investor loans have minimal impact on RMBS.

This is a myopic view of mortgage portfolios as securitised loans are selected, and seasoned to manage risks. To that extent, it is not necessarily a good indicator of the wider market – including investor loans.

S&P expects arrears to rise over the coming months, as they “traditionally start to increase in November and continue through to March.”

This from Macquarie shows the trends.

 

Assessing China’s Residential Real Estate Market

The IMF just published a working paper examining real estate in China.

After a temporary slowdown in 2014-2015 China’s real estate market rebounded sharply in 2016. As signs of overheating emerged, the government turned to tighten real estate markets through a range of macroprudential and administrative measures. Many empirical studies point out that the house price surge is driven by fundamentals, while others consider the pickup of real estate activity is unsustainable. This paper uses city-level real estate data to estimate the range of overvaluation of real estate markets across city-tiers, and assesses the main risks of a real estate slowdown and its impact on economic growth and financial stability.

Real estate has been a key engine of China’s rapid growth in the past decades. Real estate investment grew rapidly from about 4 percent of GDP in 1997 to the peak of 15 percent of GDP in 2014, with residential investment accounting for over two thirds of the total real estate investment.

Bank lending to the sector makes up 25 percent of total bank loans, about half of all new loans in 2016, and banks’ increasing exposures to real estate, including through property developers and household mortgages, may pose financial stability concerns. Real estate also has strong linkages to upstream and downstream industries (about a quarter of GDP is real-estate related).2 In addition, land sales are a key source of local public finance, accounting for about 30 percent of local government revenue in 2016, while general government net spending financed by land sales is about 9 percent of the headline revenue in 2016. There has been a rapid expansion of government subsidies on social housing, consisting of nearly 6 million apartment units in 2015-2017.

Real estate markets vary significantly in China because of its large economic size, economic and social diversity, and fragmented local government policies. The real estate cycles tend to be more pronounced in top-tier cities in terms of price volatility, but they account for a small fraction of real estate inventory and investment.  Smaller cities constitute over half of residential real estate investment, but the price increase on average was much lower during 2013-16.

Distortions render China’s property market susceptible to both price misalignment and overbuilding. On the supply side, the market is distorted by local governments’ control over land supply and their reliance on land sales to finance spending. On the demand side, the market is prone to overvaluation—housing is attractive as an investment instrument given a history of robust capital gains, high savings, low real deposit interest rates, a lack of alternative financial assets, as well as capital account restrictions.

The government has closely monitored real estate activity given its importance in the economy. Policies are highly decentralized, with local governments (often with local branches of the financial regulators) deciding land sale and infrastructure development, granting construction and sales permits to developers, and setting purchases restrictions. The central government and financial regulators can also affect the housing market through financing conditions and macro-prudential tools for mortgage lending.

If house prices rise further beyond “fundamental” levels and the bubble expands to smaller cities, it would increase the likelihood and costs of a sharp correction, which would weaken growth, undermine financial stability, reduce local government spending room, and spur capital outflows. Empirical analysis suggests that the increasing intensity of macroprudential policies tailored to local conditions is appropriate. The government should expand its toolkit to include additional macroprudential measures and push forward reforms to address the fundamental imbalances in the residential housing market.

Note: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.