The Rule of Thirds

On average, according to our surveys, one third of households are living in rented accommodation, one third own their property outright, and one third have a mortgage. Actually the trend in recent years has been to take a mortgage later and hold it longer, and given the current insipid income growth trends this will continue to be the case. Essentially, more households than ever are confined to rental property, and more who do own a property will have a larger mortgage for longer.

Now, if we overlay age bands, we see that “peak mortgage” is around 40% from late 30’s onward, until it declines in later age groups. The dotted line is the rental segment, which attracts high numbers of younger households, and then remains relatively static.

But the mix varies though the age bands, and across locations. For example, in the CBD of our major cities, most people rent. Those who do own property will have a mortgage for longer and later in life.

Compare this with households on the urban fringe. Here more are mortgaged, earlier, less renting, and mortgage free ownership is higher in later life.

Different occupations have rather different profile. For example those employed in business and finance reach a peak mortgage 35-39 years, and then it falls away (thanks to relatively large incomes).

Compare this with those working in construction and maintenance.

Finally, across the states, the profiles vary. In the ACT more households get a mortgage between 30-34, thanks to predictable public sector wages.

Renting is much more likely for households in NT.

WA has a high penetration of mortgages among younger households (reflecting the demography there).

Most of the other states follow the trend in NSW, with the rule of thirds clearly visible.

Victoria, for example, has a higher penetration of mortgages, and smaller proportions of those renting.

We find these trends important, because it highlights local variations, as well as the tendency for mortgages to persist further in the journey to retirement. This explains why, as we highlighted yesterday, some older households still have a high loan to income ratio as they approach retirement. To underscore this, here is average mortgage outstanding by age bands.


Latest Loan To Income (LTI) Data

We have updated our core market model with household survey data this week. One interesting dynamic is the LTI metrics across the portfolio. We calculate the dynamic LTI, based on current income and loan outstanding.  This is not the same a Debt Servicing Ratio (DSR), and is less impacted by changes in mortgage rates. It is also a better measure of risk than Loan To Value (LVR)

LTI has started to become an important measure of how stretched households are. For example the Bank of England issued a recommendation to the PRA and the Financial Conduct Authority (FCA) advising that they should ‘ensure that mortgage lenders do not extend more than 15% of their total number of new residential mortgages at loan to income ratios at or greater than 4.5’.

In response, UK banks trimmed their offers. For example,

NatWest is lowering its loan-to-income ratio for some borrowers, which means they won’t be able to borrow as much to buy a home.

House buyers who stump up a deposit between 15 and 25 per cent will only be able to borrow up to 4.45 times their annual income, down from the previous maximum of 4.75 per cent.

The new multiple will apply to both single and joint earners.

The move suggests a rising number of borrowers are having to stretch themselves to be able to afford to buy a home as prices continue to rise.

Turning to Australia, we start with a state by state comparison.  The AVERAGE loan in NSW is sitting at close to 7, ahead of Victoria at over 5, and the others lower. This highlights the stress within the system for property purchasers in Sydney, with affordability a major barrier.

Across our household segments however, the three most exposed segments are the most affluent. Wealthy Seniors sits about 9, followed by Young Affluent at 8 and Exclusive Professionals at 7.5. On the other hand, Young Growing Families are at around 5.5 (still above the Bank of England threshold).

Looking at type of buyer, First Time Buyers are sitting at 7.5%, with those trading up at 6%. Holders are sitting at 4.5%

Finally, here is an average by age bands, and plotted against relative volumes of mortgages. Pressure is highest in the 60+ age groups, this is because incomes tend to fall as households move towards part-time or retirement, but these days more will still have a mortgage to manage.

The dip in volumes in the 25-29 group is explained by many in this band choosing education, or starting a family, rather than home purchase, and the peak volume for purchase in after 30.

Overall LTI is a good indicator of affordability pressure, and the regulators could [should?] impose an LTI cap to slow lending growth, counter building affordability risks and rising housing debt.


Property Investor Sentiment All Over The Place

The latest weekly data from our household surveys includes our regular question on intention to transact. Property Investors are clearly confused. In recent weeks this measure has been gyrating widely, in response to the broader media coverage of the sector and the complex interplay of issues. Last week it was up significantly, this week down.

Behind this movement is uncertainty, as interest rate rises work though, concerns about regulatory intervention reemerge, and yet on the other hand, on some measures home prices are still rising fast and auction clearances remain high.

We now expect this random movement to continue as the shake-down in the investor sector continues. Prepare for a wild ride.

Investors warned to brace for mortgage interest rate rises

From ABC News.

Real estate investors stand to be hardest hit as banks reprice mortgages to meet tougher regulatory requirements, according to a report out today.

JP Morgan’s Australian Mortgage Industry Report surveyed 52,000 households and identified that around 10 per cent of investor loans could be at risk.

The report warns that pressure for banks to increase capital levels on certain types of investor lending by three or four times current requirements could create “extreme effects”.

The most “significant changes afoot” are for investor loans that are “materially dependent on property cash flows” to service the repayments.

As a result, banks with loans dependent on cash flows could be forced to raise rates incrementally to manage the risk, potentially by as much as 3 percentage points in an extreme scenario.

Investors dependent on cash flows from rental income would also be “most sensitive” to interest rate rises of between 2 and 3 percentage points according to the research.

The warning comes as banks such as the Commonwealth and its wholly owned subsidiary BankWest consider further restrictions on investor loans to keep under regulatory requirements for growth capped at 10 per cent per year.

Investors most exposed in NSW

The report’s co-author, Martin North of Digital Finance Analytics, said investors most exposed were in New South Wales which has been the epicentre of steep real estate price growth.

“The highest sensitivity has been in New South Wales where house prices are significantly higher, as are borrowing commitments,” Mr North said.

The report also identifies risk in Western Australia and Queensland because of the mining downturn and Victoria due to an oversupply of inner-city apartments.

It warns that “wealthy seniors” and “young affluent” investors could be the most severely affected, while others such as rural families and low-income households would be least exposed.

JP Morgan banking analyst Scott Manning said it will be important for the Australian Prudential Regulation Authority (APRA) to determine how it defines loans that are “materially dependent” on cash flows flows.

Mr Manning said APRA could “reverse engineer” concerns about investor loan exposure for outcomes that would meet the need for banks to be “unquestionably strong”.

The report found that banks will be positioning themselves to minimise exposure and to meet capital requirements.

It identified the Commonwealth Bank and Westpac as having “the most to lose if heightened churn becomes a reality”, while ANZ was best placed of the big four.

New Report On Mortgage Industry With JP Morgan Released

The report, released today highlights that property investors will be hit hard as banks re-price their mortgages.

Volume 24 of the mortgage report, a collaboration between J.P. Morgan and Digital Finance Analytics (DFA), explores how to practically define the term ‘materially dependent on property cash flows’ and looks to translate that into potential incremental capital requirements for the Australian major banks. The report also considers different re-pricing strategies and competitive dynamics, particularly around the issue of dynamic Loan-to-Value Ratios (LVR).

Significant changes are afoot for investor loans defined as being ‘materially dependent on property cash flows’ to repay the loan. Amidst the transition to Basel 4, these mortgages will see the most extreme effects on their capital intensity and pricing – with capital levels somewhere between 3x and 5x current requirements, which could have a significant impact on pricing of investor loans down the track.

The report draws heavily on modelling completed by Digital Finance Analytics from our household surveys, as presented in the recently published The Property Imperative 8, available here. Our survey is based on a rolling sample of 52,000 households and is the largest currently available. It includes data to end February 2017.

“The dispersion of impacts across the portfolio highlights the fact that assessing the mortgage by Probability of Default band or LVR band isn’t necessarily ‘good enough’. Although banks may have access to significant pools of data, the new regulatory regime is forcing them to become ever-more granular in their analysis – top-down portfolio analytics just won’t cut it anymore,” said Martin North, principal, DFA.

“Rather than managing the portfolio with ‘macro-prudential’ drivers, banks need to move to the other end of the analysis spectrum and become ‘micro-prudential’,” Mr North concluded.

Unfortunately because of compliance issues, the JPM report itself is only available direct from them, and not via DFA.

DFA is not authorized nor regulated by ASIC and as such is not providing investment advice. DFA contributors are not research analysts and are neither ASIC nor FINRA regulated. DFA contributors have only contributed their analytic and modeling expertise and insights. DFA has not authored any part of this report.

A Perspective On Investor Loans

Using data from our household surveys, we can look at investor loans by our core master household segments. These segments allow us to explore some of the important differences across groups of borrowers.  We believe granular analysis is required to see what is really going on.

Today we look at the distribution of these segments by loan to value (LVR) and amount borrowed and also compare the footprint of loans via brokers, and by loan type.

Looking at LVR first, there is a consistent peak in the 60-70% LVR range, with portfolio investors (those with multiple investment properties) below the trend above 70%.

However, the plot of loan values shows that portfolio investors are on average borrowing much more, thanks to the multiple leverage across properties. A small number of portfolios are north of $1.4 million.

Investors who borrow with the help of a mortgage broker, on average is more likely to get a larger loan.

But there is very little difference in the relative LVR by channel.

On the other hand, interest only loans will tend to be at a higher LVR.

The average balance of interest only loans is also higher, especially in the $400-600k value range.

Microprudential analysis reveals interesting insights! The loan type and segment are better indicators of relative risk than LVR or origination channel.

Household Finance Security Index Higher Again In February

We have published the February 2017 edition of the Digital Finance Analytics Household Finance Confidence index (FCI) today, which shows a further small rise from the January 102.7 to 103.4. This is above the long term neutral setting, and after a significant dip in the past couple of years, the FCI is maintaining positive momentum.

However, the positive boost in predominately centered on momentum in the property market, with both owner occupied and investment property holders in positive territory, whilst those excluded from the property market, including renters and those living with family or friend get none of the upside, so their financial security is degrading further. This highlights the risks if the property market momentum were to reverse, and the bind that regulators face at the moment – do you keep the current settings and allow the market to continue to run, or tighten and risk reversing household sentiment and thus spending?

The state by state picture shows how uneven the confidence is, with households in the eastern states significantly more positive that in WA or SA.  WA grinds down, thanks to the pressure on the economy there, falling home prices and flat to falling incomes. Will the election result today make a difference?

Finally, here is the scorecard, which shows that real income in under pressure (up 1%), costs of living are rising (up 1%), concerns about debt levels are up a little (thanks to recent rate increases) but net worth is being bolstered by strong home price growth and rising stock markets.  The property sector is firmly linked to household confidence, and vice-versa.

By way of background, these results are derived from our household surveys, averaged across Australia. We have 26,000 households in our sample at any one time. We include detailed questions covering various aspects of a household’s financial footprint. The index measures how households are feeling about their financial health. To calculate the index we ask questions which cover a number of different dimensions. We start by asking households how confident they are feeling about their job security, whether their real income has risen or fallen in the past year, their view on their costs of living over the same period, whether they have increased their loans and other outstanding debts including credit cards and whether they are saving more than last year. Finally we ask about their overall change in net worth over the past 12 months – by net worth we mean net assets less outstanding debts.

Property Investors Show Stronger Buying Intentions

The ABS data today showed that investor lending in January was very strong. Our weekly household surveys ask about buying intentions – a forward looking estimate based on whether they are likely to transact in the next 12  months.

We have an indication earlier in the year from our weekly tracker than perhaps investors were getting cold feet – there was talk of changes to negative gearing, lifting rates and slower home price growth. Last week the buying signals were back to normal, as investors relished in the recent strong home price growth, and Government statements that negative gearing was safe. Despite slow rental income growth it is all about capital gains.

Now here is the latest chart, with the January loan volumes also added and the latest intentions plotted. Investors are still piling into the market – expect strong auction results this weekend. Intentions are stronger than ever!

No, Housing Affordability Is Hitting Households Across ALL States

CoreLogic posted an interesting blog today, in which the redoubtable Cameron Kusher says “It is really important to note that the housing affordability challenges are largely a Sydney and Melbourne phenomena”.

Now, I have to say, that just not chime with our household finance analysis. Whilst I agree affordability issues are partly a function of home price movements, other factors are in play. We discussed the distribution of those unable to afford to enter the market recently. You can read our post here.

A detailed analysis of household finances, and expectations show the affordability issues is spread across the states. It would be a mistake to address affordability in just NSW and VIC. In fact if you do, you risk excluding more from other states. You need a national plan.

He is right though when he says:

From a political perspective, politicians do not want to see the cost of housing falling.  We are taught that deflation is undesirable and deflation in the value of the country’s most valuable asset class would have a much broader impact on the economy.  Keep in mind as well that every property that is rented is owned by someone, some are owned by Government but most rental properties are owned by private citizens.

Supply and demand side reforms will be no easy feat and will require cooperation from all levels of government.


Latest Greater Perth Mortgage Stress Mapping

We now look across to the west, with mortgage stress modelling across WA, and mapping in Greater Perth. Read about our approach here.

The postcode with the higher number of households in mortgage stress in WA is Merriwa 6030, a suburb of South Western, Heartlands and  about 35 kms from Perth.  The average age here is 35 years and 40.6% of households have a mortgage. Some are in severe stress here.

Next is Samson, 6163, a suburb of Perth, Southern Suburbs, about 14 kms from the CBA and the federal electorate of Fremantle.  The average age here is 45 years and 36.8% of households have a mortgage.

Third is Carey Park, 6230, a suburb of South Western, South West, WA, and about 157 kms from Perth. 28.3% of households have a mortgage.

Next is Innaloo, 6018, a suburb of Perth, Other Western Suburbs and about 10 kms from the CBD. The average age here is 35 years and 32.8% of homes are mortgages. There are a number of households in serve stress here.

Meadow Springs follows on 6210, is a suburb of South Western, Heartlands, and about 61 kms from Perth. The average age is 37 years and 39.5% of households have a mortgage. Some are in serve stress here.

Note Wembley, 6014, a suburb of Perth about 5 kms from the CBD. The average age is 34, and 31.6% of households have a mortgage, but here there are the highest number in severe stress across Greater Perth.

Here is the geo-mapping for Greater Perth. The Blue areas are the post codes with the highest number of stressed households.