May 2016 – Digital Finance Analytics (DFA) Blog

Resurgence in multi-unit dwelling approvals

From HIA. Having shown signs of easing in late 2015 and during the first three months of 2016, ABS data released today show that residential building approvals increased by 3 per cent in April, once again exceeding a monthly total of 20,000.

“Approvals for multi-unit dwellings provided the impetus for the headline growth in April, with approvals in this part of the market growing by 8.1 per cent during the month” said HIA Economist, Geordan Murray.

“The growth in multi-unit approvals was driven by the eastern sea-board states, where we saw multi-unit approvals jump by 20 per cent in Queensland, 19 per cent in New South Wales, and 7 per cent in Victoria. South Australia also posted an increase of 3 per cent.”

“Approvals for detached houses continue to flow through at a steady rate. While there was a decline of 2 per cent in the month, there were a total of 9,695 detached dwellings approved which is still on par with the monthly average over the last couple of years.”

“In contrast to the situation with multi-unit approvals, the number of detached house approvals fell across the eastern sea-board states while all other states and territories posted improvements. It’s pleasing to see the likes of South Australia post the strongest month of detached house approvals in more than two years.”

“Today’s strong result goes against the easing trend that we’ve observed over the last six months. We maintain our view that the level of new home building activity in to 2016 is likely to be lower than we saw during 2015, however this result suggests the 2016 level may be closer to the peak than initially expected.”

During April 2016, total seasonally adjusted new home building approvals saw the largest increase in South Australia (+13.7 per cent) with growth also occurring in Tasmania (+13.6 per cent), New South Wales (+10.4 per cent), and Queensland (+6.7 per cent). Approvals fell by 2.7 per cent in Victoria and
by 0.6 per cent in Western Australia. In trend terms, approvals saw a 15.1 per cent fall in the Northern Territory and an increase of 6.8 per cent in the Australian Capital Territory.

Home Lending Rises Again To New Record $1.56 trillion

Latest credit aggregate data from the RBA today, shows lending momentum to business and the housing sector remained strong. As a result, total lending to residential property rose by $6.7 billion or 4.3% to $1.56 trillion, seasonally adjusted, with loans for owner occupation comprising $6.0 billion and $0.7 billion for investment housing. Business lending rose by $6.5 billion, or 0.76% to $854 billion. Housing lending is still growing at 7% annualised, well above inflation and income growth. This is sufficient to maintain home price growth.

Investment lending makes more than 35.4% of all lending for housing, and all lending for housing comprises more than 60% of all lending in Australia. So the banks remain strongly leveraged to the housing sector.

Looking at the 12 month growth rates, we see investment lending sliding from about 10% last year to around 6.5%, business lending growing at 7.4% and lending for owner occupation growing at 7.3%. These growth trends contain the adjustments between owner occupied and investment lending due to reclassification.

The RBA says:

Following the introduction of an interest rate differential between housing loans to investors and owner-occupiers in mid-2015, a number of borrowers have changed the purpose of their existing loan; the net value of switching of loan purpose from investor to owner-occupier is estimated to have been $40 billion over the period of July 2015 to April 2016 of which $1.2 billion occurred in April. These changes are reflected in the level of owner-occupier and investor credit outstanding. However, growth rates for these series have been adjusted to remove the effect of loan purpose changes.

Upside To GDP Likely

Latest data suggests that the GDP number will be higher than expected – with a 1.1% growth, compared with an expected 0.7%. If so, then momentum is stronger than many thought, and it may require some revisions to expectations.

The current account deficit decreased $1,837 million (eight per cent) to $20,794 million in the March quarter 2016 in seasonally adjusted, current price terms, according to latest figures from the Australian Bureau of Statistics (ABS).

Exports of goods and services fell $578 million (one per cent) and imports of goods and services fell $3,402 million (four per cent). The primary income deficit rose $979 million (nine per cent).

In seasonally adjusted chain volume terms, the net goods and services surplus rose $4,731 million (60 per cent) to $12,611 million in the March quarter 2016. This is expected to contribute 1.1 percentage points to growth in the March quarter 2016 volume measure of Gross Domestic Product.

Australia’s net International Investment Position was a liability of $1,012.1 billion at 31 March 2016. This was an increase of $51.4 billion (five per cent) on the revised 31 December 2015 position of $960.8 billion. Australia’s net foreign debt liabilities increased $9.2 billion (one per cent) to a net liability position of $1,027.8 billion. Australia’s net foreign equity assets decreased $42.2 billion (73 per cent) to a net asset position of $15.7 billion at 31 March 2016.

Dwelling approvals rise in April

The number of dwellings approved rose 1.2 per cent in April 2016, in trend terms, and has risen for five months, according to data released by the Australian Bureau of Statistics (ABS) today.

Dwelling approvals increased in April in the Australian Capital Territory (6.7 per cent), Queensland (2.9 per cent), South Australia (2.2 per cent), Tasmania (1.9 per cent) and New South Wales (1.4 per cent). Dwelling approvals decreased in the Northern Territory (15.2 per cent) and Western Australia (0.1 per cent) in trend terms, and were flat in Victoria.

In trend terms, approvals for private sector houses rose 0.2 per cent in April. Private sector house approvals rose in South Australia (2.0 per cent), Victoria (0.7 per cent) and New South Wales (0.7 per cent), but fell in Western Australia (1.4 per cent) and Queensland (0.6 per cent).

In seasonally adjusted terms, dwelling approvals increased 3.0 per cent, driven by private sector dwellings excluding houses which rose 8.7 per cent. Private sector house approvals fell 2.3 per cent in seasonally adjusted terms.

The value of total building approved rose 1.1 per cent in April, in trend terms, and has risen for three months. The value of residential building rose 1.6 per cent while non-residential building was flat.

Will Australia’s big banks reap $7.4 billion over ten years from company tax cuts?

From The Conversation.

Opposition Leader Bill Shorten’s line of attack during the leaders’ debate focused squarely on the Coalition’s long-term plan to cut the company tax rate from 30% to 25%.

Twice during the debate Shorten said the proposed tax cuts equated to giving A$7.4 billion over ten years to Australia’s big four banks (National Australia Bank, the Commonwealth Bank, ANZ and Westpac).

Is that right?

Checking the source

When asked for a source to support that assertion, a Labor spokeswoman referred The Conversation to modelling conducted by think-tank The Australia Institute.

The Labor spokeswoman said:

Bill was emphasising the clear point of contrast in this election campaign, which is that Malcolm Turnbull wants to spend $50 billion giving huge companies a tax cut while Labor wants to invest in schools, Medicare and growing good jobs.

The Australia Institute modelling

In a press release, The Australia Institute said that for their economic modelling:

The value of company tax provisions was derived from 2015 full year annual reports for the big four banks. That figure summed to $11,123 million. That figure was projected forward to 2026-27 to give the no-change scenario.

To arrive at the figure of $7.4 billion, The Australia Institute modelling assumed bank profit would increase in line with nominal Gross Domestic Product. Under this assumption, the amount of tax payable would also increase in line with nominal GDP. This would give nominal increases of:

2.5% in 2015-16;

4.25% in 2016-17; and

5% in 2017-18 and subsequent years.

As the think tank noted in its press release, the company tax cuts would not affect the big banks until 2024-25. That’s when the 30% company tax rate will fall to 27% for all companies with further reductions of 1% per year, hitting 25% in 2026-27.

The Australia Institute calculated the following results:

The Australia Institute

A reasonable guesstimate – but not a fact

On these calculations, the “$7.4 billion over the next ten years” claim is not a fact. But it’s also not an unreasonable guesstimate – although it is, of course, really over the three years from 2024-25 through 2026-27. There is no advantage to the big banks over the first seven of the next ten years.

According to the Australian Taxation Office, the four big banks paid a total of $9.5 billion in company tax in the 2013-14 financial year.

The government has proposed increasing the turnover threshold below which the rate of company tax payable is 27.5%, from $10 million in 2016-17 to $1 billion in 2022-23.

The government’s proposed policy says that the company tax rate for all companies (including the four big banks) with turnover exceeding $1 billion will fall from 30% to 27% in 2024-25, and then by a further one percentage point in 2025-26 and another percentage point (to 25%) in 2026-27.

So, on that basis, The Australia Institute’s maths checks out.

A grain of salt

As with all economic modelling, this modelling and any claims based on it should be taken with a large grain of salt.

Any assumption about the banks’ profit growth over the next ten years is entirely arbitrary, and I have no idea whether it is at all justified. Only time will tell.

If the banks’ profits grew by only 2% per annum over this period, then the benefit to them from the cut in the company tax rate proposed by the Coalition would be “only” $4.8 billion; if they grew by 10% per annum the benefit to them would be $12 billion (over the three years from 2024-25 to 2026-27).

Verdict

Shorten’s statement relies on modelling assumptions made by The Australia Institute think-tank about bank profit growth. It is not a statement of fact but rather a guesstimate. It is not an unreasonable guesstimate, but depends entirely on whether the think tank’s assumptions about bank profit growth come true or not. – Saul Eslake

Review

This article correctly reflects the analysis of The Australia Institute upon which the claim of a “windfall” for the large banks has been based. As the author notes, the baseline figure is a guesstimate based on not unreasonable assumptions about the growth of the economy and the impact of the proposed business tax cuts upon bank profits, albeit seven years out. – Pat McConnell

Author: Saul Eslake, Vice-Chancellor’s Fellow, University of Tasmania; Reviewer, Pat McConnell, Honorary Fellow, Macquarie University Applied Finance Centre, Macquarie University

Climate Risks For Property Owners And Their Bankers

Mortgage underwriting is all about correctly assessing risks. How much is the property worth? How big is the loan? How well placed are the borrowers to repay the loan? What is the credit risk? But, according to a new discussion paper There goes the neighbourhood: Climate change, Australian housing and the financial sector by the Climate Institute, banks and their customer need to be more alert to risks associated with Climate Change.

I spoke to the author, Kate Mackenzie, about the paper which highlights important issues for lenders and prospective purchasers. She says banks should be undertaking detailed portfolio modelling to analyse the current and future risks in their property loan portfolios (after all their insurers have the data), and prospective purchasers should be exploring the impacts from floods and other natural forces before purchase (there are tools available, or try getting online insurance quotes for a prospective property). She says that Local Authorities may sometime grant planning approvals on land which is or will become risk prone, and buyers should beware.

The report says that some of the homes built, bought and sold in Australia are vulnerable to flood, cyclone and bushfire, as well as growing risks such as storm surge, landslip and coastal erosion. Australia is highly exposed to climate change and this will exacerbate many of these risks. Whilst It is often possible to “defend” or “adapt” housing to some of these risks, not all are adaptable, and some only at a prohibitive expense.

Unsurprisingly, individual buyers and residents are often unaware of risk levels, particularly rising levels of risk or emerging risks. Even when public authorities, financial institutions and other stakeholders possess information about current and future risk levels, they are sometimes unwilling, and sometimes unable, to share it with all affected parties.Thus, foreseeable risks are allowed to perpetuate, and even to grow via new housing builds. The full scale of the risk may only be recognised either through disaster or damage, or when insurance premiums become unaffordable. Any of these events can in turn affect housing values. Damaged, destroyed or devalued housing has social costs – either to individuals, or to the broader public via government. Australia’s housing stock is expanding, and with continuing gaps in policy, regulations and industry, it is highly likely that some of this new stock is more vulnerable than buyers, residents and other stakeholders would assume.

Virtually all banks, in every year, clearly identified risks of climate impacts to their own operations, and describe measures taken to ameliorate this. Most banks, in most years, cited indirect risk via institutional financing, in particular to the agricultural sector. In some cases, banks described developing and deploying screening methods to ameliorate this risk.

However, references to climate impacts via residential property were far patchier. Several banks, for example, referred to material risks via their customers’ ability to repay mortgages, and even referred to studies of the aggregate exposure of Australian housing to climate impacts. Moreover, the banks’ own industry group, the Australian Banking Association, has been relatively silent on this matter.

Industry has tended to defend its position, but the paper offers some important commentary on their arguments.

1. Property value in land: The assertion that the property’s value is solely in the land rather than the building will be irrelevant in several scenarios, particularly when we consider climate change. For example, there are limitations to measures that can mitigate the effects of coastal erosion. Land that is at increasingly frequent risk of flooding may be still suitable for dwellings, but the increasing cost will reduce the value of the properties. This has been seen in bushfire prone areas.

2. Full-recourse loans protect banks: Australian mortgages are almost universally issued on a “non-recourse” basis. This means that, in contrast to some US states, borrowers cannot simply “hand back the keys” to their lender, thereby offloading their obligations. In Australia, the risk of property devaluation remains with the individual, while the banks are relatively protected from a scenario in which borrowers default on properties that become worth less than the amount of the outstanding loan.

3. Already incorporated into credit risk practices: A review of big four bank submissions to CDP (formerly Carbon Disclosure Project) reveals a broad range of approaches to physical climate risk in the residential mortgage portfolio. While all banks discuss climate impact resilience measures for their own property portfolio (bank branches etc.), and two banks mention incorporating physical climate risk into their commercial lending practices, there is little mention of incorporating physical climate risk into residential property lending risk assessments.

4. Size and distribution of property portfolios mean this couldn’t be material for big banks: Several banks have already disclosed exact amounts of provisioning following natural disasters. In fact, at least three of the big four banks have individually acknowledged there is some risk. Westpac has acknowledged in several CDP submissions that increased flood risk from climate change represents a risk to its mortgage and other loan assets, ANZ in 2007 said it would begin to devise a method to analyse this risk and NAB states that it is exposed to the physical effects of climate change to its customers, not only in residential property, but also as an agri-business lender.

It is true that all amounts of costs incurred to date are small relative to the banks’ overall balance sheets – for example, NAB reported a $76 million provision for bad and doubtful debts associated with the 2011 floods in Queensland and Victoria. However the nature of climate change means these risks will increase – particularly if urban, coastal development continues to grow without adequate resilience standards.

5. Use of mortgage insurance removes risk to banks: Mortgage insurance is taken out by banks to protect against loss from mortgage defaults, particularly where the loan-to-valuation ratio is high, or when the borrower is deemed high risk. Lenders mortgage insurers (LMIs) are the providers of this cover. In terms of financial risk, LMIs will specifically not cover loss due to natural hazards. There is also debate around the role of LMIs in Australia, in terms of their own financial stability and their role in the broader financial system. An RBA report in 2013 noted that while industry practices have mitigated some risks related to LMIs, they are highly correlated to the broader mortgage market. Therefore, in a credit market downturn, LMIs could be procyclical, or at least fail to be counter-cyclical. Another limitation of LMIs is that they only cover about a quarter of all mortgages. The limitations of LMIs as a hedge against mortgage losses are illustrated by mortgage-related losses suffered by several banks due to natural disasters. Finally, Australia’s prudential supervisor, APRA, has explicitly limited the amount of protection that banks can assign to LMI, by placing a floor of 20 per cent for “loss given default” on internal risk-based (IRB) models. This is the same whether or not the mortgage is covered by LMI.

6. Average mortgage duration: Average mortgage age in Australia is thought to be around 4.5 to 5 years. However this is an average from a market that has, in aggregate, grown every year for decades. Although definitive data is not collected on non-securitised mortgage age, it is likely a proportion is due to owners “cashing out” as prices rise. This is unlikely to be a mitigating factor for banks with up to 25-year mortgage exposures on risky properties.

The paper recommends Australian banks should:

examine climate risk to their own mortgage books and ensure it is integrated into their risk assessment processes
use their role as the predominant providers of property development finance to support good policy – both through individual commercial lending decisions and through submissions to and engagement with policymakers
work with other stakeholders – in the public, private and civil society sectors – to research and develop ways to minimise climate impact risk to housing, and to address losses that will occur in an equitable way
actively support the development of: an open and accessible platform for natural peril data, including both historical incidence and projected or emerging risks due to climate change and policy to achieve this outcome
make information publicly available so that market expectations can adjust gradually, avoiding sudden, detrimental impacts.

The Climate Institute is Australia’s leading climate policy and advocacy specialist. Backed primarily through philanthropic funding, the Institute has been marking solutions to climate change happen, through evidence based advocacy and research, since 2007.

Beware ‘rogue’ robo-advisers: StockSpot

From Fintech Business.

In a submission to ASIC’s consultation paper on regulating robo-advice, Stockspot chief executive Chris Brycki said it is important that several of the existing guidelines for human advisers also apply to digital providers.

“Relevant disclosure as well as best interest duty are equally important for digital and human-delivered advice, so we strongly believe that the principles should be applied equally to both types of advice rather than allowing service providers to ‘hide’ behind digital advice to avoid complying with specific product or advice regulatory requirements,” he said.

Mr Brycki said he has seen a number of “copycat” robo-advisers in the industry that are not acting in the best interests of clients.

Stockspot has had to issue copyright infringement notices to three separate businesses in the past for stealing information from its website, he said.

“We are concerned that there are a growing number of digital investment businesses with flashy websites that may not have robust systems, compliance and controls in place,” Mr Brycki said.

“The last thing we want is for one of these businesses to do the wrong thing by its customers, which would lead to a bad outcome for clients and also the entire robo-advice industry.

“Many robo-advice clients are first-time investors so [they] require more education and safeguards compared to more experienced investors,” he said.

Mr Brycki added that there are others who are taking advantage of the fact that some investors do not understand the difference between personal and general advice.

“This is leading to a situation where some new product providers are collecting customer information and advertising themselves as robo-advice but not actually providing any personal advice at all,” he said.

“It would certainly be in Stockspot’s interest, and I believe in [that of] everyone else involved in digital advice, to create a stable, well-regulated globally recognised environment that is fully trusted by investors and all other stakeholders. This will support a creative, trusted and globally recognised digital advice industry here in Australia.”

New Home Sales past their peak for the cycle – HIA

The HIA New Home Sales Report, a survey of Australia’s largest volume builders, shows that total new home sales declined in April following a strong rise in March, said the Housing Industry Association.

Total seasonally-adjusted new home sales declined by 4.7 per cent in April 2016. The decline in total sales was reflected in both detached house sales (-3.0 per cent) and sales of ‘multi-units’ (-10.8 per cent).

The monthly decline in detached house sales was widespread, with four out of the five mainland states recording reduced sales in April. Victoria bucked the trend – monthly sales of detached houses increased by 14.3 per cent due to broad-based strength in large volume builder activity in the state during the month.

In the month of April 2016 detached house sales declined in four of the five mainland states: Western Australia (-19.8 per cent); New South Wales (-8.1 per cent); Queensland (-7.8 per cent) and South Australia (-1.3 per cent). Only in Victoria did detached house sales increase (+14.3 per cent).

Sydney Auctions Still Hot

According to CoreLogic RP Data, this week 2,419 auctions were held across the combined capital cities, representing a substantial 26 per cent rise in auction activity compared to the previous week when 1,920 capital city auctions were held. This was the fourth highest number of weekly auctions held over the year to date. The rise in activity was coupled with a slight fall in preliminary combined capitals clearance rate, from 68.9 per cent last week, to 68.0 per cent this week. Much of the strength in the combined capitals clearance rate can be attributed to the two largest auction markets (Melbourne and Sydney), where clearance rates remained the strongest nationally. One year ago, however, both Sydney and Melbourne recorded a clearance rate in excess of 80 per cent, and the combined capital city clearance rate was 78.5 per cent across 2,792 auctions.

In Australia, All That Glitters Isn’t Gold

From Bloomberg View.

If Australia is an economic miracle — the so-called Lucky Country, beneficiary of more than a quarter century of uninterrupted growth — then its banks are its most visible sign of strength. After a near-death experience in the 1990s, they’ve reformed and bounced back dramatically: Returns on equity now average around 15 percent, compared to single digits in the U.S. Share prices and dividends have risen strongly over the past decade. At around twice book value, market valuations are well above global levels.

In fact, though, this ruddy good health masks some deeply worrying trends. The balance sheets of Australia’s biggest banks are far more vulnerable than they may seem on the surface — and that means Australia is, too.

To most observers, this might sound alarmist. Scared straight after a mountain of bad loans nearly brought them down at the beginning of the 1990s, the banks reformed and minimized their international exposure, which meant they were insulated from the worst effects of the Asian financial crisis and the 2009 crash. Today they face little competition in their home market and have benefited tremendously from Australia’s strong growth, underpinned by China’s seemingly insatiable demand for the country’s gas, coal, iron ore and other raw materials. During the 2012 European debt crisis, Australia’s banks were worth more than all of Europe’s.

But Australian financial institutions have made the same fundamental mistake the rest of the country has, assuming that growth based on “houses and holes” — rising property prices and resources buried underground — can continue indefinitely. In fact, despite a recent rebound in Chinese demand, commodities prices look set to remain weak for the foreseeable future. Banks’ exposure to the slowing natural resources sector has reached nearly $50 billion in loans outstanding — worryingly large relative to their capital resources.

If anything, their exposure to the property sector is even more dangerous. Mortgages make up a much bigger proportion of bank portfolios than before — more than half, double the level in the 1990s. And they’re riskier than they used to be: Many loans are interest-only, while around 80 percent have variable rates. With a downturn likely — everything from price-to-income to price-to-rent ratios suggests houses are massively overvalued — losses are likely to rise, especially if economy activity weakens.

Australian banks are also more vulnerable to outside shocks than they may first appear. Their loan-to-deposit ratio is around 110 percent. Domestic deposits fund only around 60 percent of bank assets; the rest of their financing has to come from overseas. While that hasn’t been a problem recently, Australia’s external position is deteriorating. The current account deficit is expected to grow to 4.75 percent in the current financial year. Weak terms of trade, a rising budget deficit, slower growth and a falling currency are likely to drive up the cost of funds. If Australia’s economy or the financial sector’s performance falters, or international markets are disrupted, banks’ access to external funds could be threatened.

Risks to the financial sector should be getting far more attention than they are in Australia’s ongoing — and terrifically anodyne — parliamentary election campaign. Banks have grown immensely since the 1990s and now make up a much bigger part of the Australian economy. The top four are among the country’s largest listed companies, accounting for more than a third of total market capitalization. Their combined assets are around 130 percent of GDP.

Any pain they feel could thus spread quickly throughout the real economy. Falling bank stocks could well drive down share prices more broadly. Shrinking dividends — which have traditionally been quite high, around three-quarters of earnings — would hammer investors, especially self-funded retirees, and threaten consumption. An economy addicted to a ready supply of cheap credit would struggle to keep growing.

Meanwhile, the government’s options are limited. Cutting interest rates further to spur economic activity would risk worsening the housing bubble and adding to sky-high levels of household debt, already around 130 percent of nominal GDP and nearly 200 percent of household disposable income. Raising rates, on the other hand, could trigger defaults, especially on riskier loans such as those to property developers. Fiscal policy is similarly constrained: Increasing debt beyond certain levels would threaten Australia’s credit rating and thus banks’ access to offshore funding.

Pundits have been saying for years that Australia needs to diversify its economy, boosting services exports — primarily tourism, education and health — rather than continuing to depend on resources and debt-fueled property growth. Banks need to do the same, reducing their exposure to the housing market and the mining industry. At the same time, they should move swiftly to shore up their balance sheets, aggressively increasing bad-debt reserves, raising capital and gradually trimming dividends. Even their otherwise enviable luck can’t last forever.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Author: Satyajit Das is a former banker, with more than 35 years of experience, and author of “Traders, Guns & Money” and “Age of Stagnation.” In 2014, Bloomberg named him one of the world’s 50 most influential financial figures.