Decoding Property Buying Intentions – “You Ain’t Seen Nothing Yet”

We have completed the latest round of our 52,000 household surveys, and today we discuss the results relating to property buying intentions by extracting the data from our Core Market Model. It was this data six months back which enabled us to predict the currently observed slowdown in sales, auction clearances and home prices.

So what is in store for the next few months? Well, in short its more of the same, only more so, with more households reporting difficulties in obtaining finance, fewer expecting to transact in the next year and to see home prices rise.

So we start with transaction intentions.  The first startling observation is the fall in the number of property investors, including those who hold portfolios of investment properties intending to transact.  20% of portfolio investors are expecting to transact, and the bulk of these intend to sell a property, compared with a year ago when 50% said they would transact, and most were looking to add to their portfolios. Most solo property investors are now on the side lines, with around 10% expecting to transact, and most of these on the sell side. Demand for investment property will continue to fall, as rental yields and capital appreciation fall.

On the other hand, the number of people trading down is rising, with more than 50% of these looking to sell before prices fall further.  There is some demand from first time buyers, and up-traders, but the net conclusion is there will be more property coming to market and fewer buyer, so prices are set to fall further, and quite quickly.  The spring season appears all but shot.

These trends are mirrored in the demand for credit.  Property investors are now less likely to borrow, while those trading-up and first time buyers are still in the market (but in terms of volumes this is a smaller group). Refinance households are still in the market for a replacement loan, but these do not add to new demand for credit.

As a result, we expect demand for credit to wilt further in the months ahead. Of course for the banks to maintain their profit output they need to see real growth in new credit, we do not expect that will eventuate, so credit will continue to ease.

Universally, households are less bullish on home price growth, than a year ago, with a sharp down turn since June 2018. Down traders are the least likely to expect rises at 18%, while 35% of those trading up were bullish on home price values.  Property investors are getting less and less positive about future price accumulation.

Turning to the specific segments, 36% of those wanting to buy, but who cannot, reported their barrier related to the (non) availability of finance. This is a record, and reflects the tighter underwriting standards now in force.

We find the same thematic among first time buyers where 42% report a problem with finance availability, a record.

Investors have a similar problem with 36% saying they have issues with finance, and more are now concerned about potential changes in regulation (including Labor’s changes to negative gearing).

In fact, Investors are ever more reliant on the tax breaks, as capital growth eases. 40% are banking on the tax benefits, while 15% expect future capital appreciation.

When we look at the motivations of those seeking to trade down, 48% are looking to capital release, and now few are interested in acquiring an investment property.  Increased convenience remains a significant driver.

Households seeking to refinance are mainly being driven by a quest to reduce monthly repayments (49%) and there is a high correlation with those experiencing mortgage stress, as we reported yesterday.  Lender service, or the lack of it, does not seem to count for much.

And finally, to ice the cake, as it were, the number of loan rejections continues to rise, especially among refinance and investor cohorts.

Add this new data to the other factors:

  • Tighter Lending Standards – focus on income AND expenses, not HEM
  • Mortgage Borrowing Power dropped up to 40%
  • Foreign Buyers dropped 35%, and significant hike in extra fees and taxes
  • SMSF borrowing restricted
  • Interest Only Borrowing Restricted ($120 billion for reset each year)
  • Investors less likely to transact, as capital growth reverses
  • Tighter returns on rentals (half under water in cash flow terms)
  • Higher interbank funding costs
  • Rising mortgage costs and rates (NAB holds)
  • Risk from Class Actions and Royal Commission
  • Etc…

and there is plenty to suggest further home price falls are in the offing. We will add this new set of data into our scenarios, and we will update our findings in a future post.

But our conclusion is “you ain’t seen nothing yet” to quote an old Bachman Turner Overdrive song from 1974!

 

 

 

 

Mortgage Stress Busts The 1 Million Households

Digital Finance Analytics (DFA) has released the September 2018 mortgage stress and default analysis update. We have just crossed the 1 million, for the first time ever in our history.

The latest RBA data on household debt to income to June reached a new high of 190.5[1].  This high debt level helps to explain the fact that mortgage stress continues to rise.

Across Australia, more than 1,003,000 households are estimated to be now in mortgage stress (last month 996,000). This equates to 30.6% of owner occupied borrowing households. In addition, more than 22,000 of these are in severe stress. We estimate that more than 61,000 households risk 30-day default in the next 12 months. We continue to see the impact of flat wages growth, rising living costs and higher real mortgage rates.  Bank losses are likely to rise a little ahead.

Martin North, Principal of Digital Finance Analytics says this rise in stress is to be expected, and should be of no surprise at all. Indeed, the fact that significant numbers of households have had their potential borrowing power crimped by lending standards belatedly being tightened, and are therefore mortgage prisoners, is significant. More than 40% of those seeking to refinance are now having difficulty. This is strongly aligned to those who are registering as stressed.  These are households urgently trying to reduce their monthly outgoings”.

“Continued rises in living costs – notably child care, school fees and fuel – whilst real incomes continue to fall and underemployment is causing significant pain. Many are dipping into savings to support their finances.”

Our analysis uses the DFA core market model which combines information from our 52,000 household surveys, public data from the RBA, ABS and APRA; and private data from lenders and aggregators. The data is current to end September 2018. We analyse household cash flow based on real incomes, outgoings and mortgage repayments, rather than using an arbitrary 30% of income.

Households are defined as “stressed” when net income (or cash flow) does not cover ongoing costs. They may or may not have access to other available assets, and some have paid ahead, but households in mild stress have little leeway in their cash flows, whereas those in severe stress are unable to meet repayments from current income. In both cases, households manage this deficit by cutting back on spending, putting more on credit cards and seeking to refinance, restructure or sell their home.  Those in severe stress are more likely to be seeking hardship assistance and are often forced to sell.

Probability of default extends our mortgage stress analysis by overlaying economic indicators such as employment, future wage growth and cpi changes.  Our Core Market Model also examines the potential of portfolio risk of loss in basis point and value terms. Losses are likely to be higher among more affluent households, contrary to the popular belief that affluent households are well protected.  This is shown in the segment analysis below:

 Stress by the numbers.

Regional analysis shows that NSW has 276,132 households in stress (270,612 last month), VIC 276,926 (270,551 last month), QLD 176,528 (175,102 last month) and WA has 132,700 (134,333 last month). The probability of default over the next 12 months rose, with around 11,589 in WA, around 11,300 in QLD, 15,300 in VIC and 16,252 in NSW.

The largest financial losses relating to bank write-offs reside in NSW ($1.1 billion) from Owner Occupied borrowers) and VIC ($1.45 billion) from Owner Occupied Borrowers, though losses are likely to be highest in WA at 3.4 basis points, which equates to $1,082 million from Owner Occupied borrowers.

Here is a more detailed regional breakdown.

[1] RBA E2 Household Finances – Selected Ratios June 2018

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Discussing Home Price Dynamics – Live Event Recording

I recently ran our monthly YouTube live stream event, in which we discussed the trajectory of home prices, and why we expect more falls in the months ahead.

The event is available to watch on YouTube, complete with the chat room questions and answers in real-time.

You can learn more about the 60 Minutes segment I participated in, as well as the latest trends in lending, home prices and sales transactions.

The “killer slide” is this one:

The number of property transfers are way, way down, and not just in Sydney. This is based on ABS data released yesterday.

Household Financial Confidence Still Under Pressure In July 2018

The latest edition of the DFA Household Financial Confidence Index to end July 2018 remains in below average territory, coming in at 89.6, compared with 89.7 last month.  We had expected a bounce this month, in fact the rate of decline did slow, thanks to small pay rises for some in the new financial year, and refinancing of some mortgage loans to the “special” rates on offer currently.  However, the index at this level is associated with households keeping their discretionary spending firmly under control. And the property grind is still impacting severely.

Looking at the results by our property segmentation, owner occupied households overall remain around the neutral reading, while property investor confidence continues to fall, into territory normally associated with those who are renting or living with family.  This signals significant risks in the property investment sector ahead.

 

Owner occupied property owners who have been able to refinance (lower LVR loans) have been able to shave their monthly repayments, while for some in rented accommodation they have found it easier to find a rental at a lower rent. Investment property holders reported continued concerns about servicing their loans, and of potentially higher interest rates ahead. Those on interest only loans were particularly concerned about their next reset review, given the tighter underwriting standards now in play. The peak of the resets however is well more than a year away.

The spread of scores across the states continues to bunch, as NSW and VIC households react to lower home prices.  WA continues to show little real recovery in household finance (despite the hype) although there was a small rise in Queensland, thanks to recent pay lifts for some.

Across the age bands, younger households remain the least confident, while those aged 50-60 were more bullish, thanks to recent stock market lifts, and access to lower rate refinance mortgages.  The inter-generational dynamic is in full force, with younger households not in the property market seemingly unable to access the market (despite the recent incentives in NSW and VIC) and those with a property, and mortgage wrestling with the repayments.

Looking in more detail at the index components, job security improved a little this month, with 12.5% feeling more secure, up 0.67%, 27% less secure, down 0.92% and those about the same at 58.8%, up 2%. However, we see many households in multiple part-time jobs, and around 20% of households are actively seeking more work/hours.

There was a small rise in those reporting an income improvement, thanks to changes which kicked in from July. 2.3% said their income has improved, up 1.5% from last month, while 43.7% stayed the same, and there was a drop of 2.2% of those reporting a fall in income, to 50.5%.

Households continue to see the costs of living rising, with 82.3% reporting higher costs, up 1%, 13% reporting no change, and 2.5% falling.  The usual suspects included power bills, child care costs, the price of fuel, plus health care costs and the latest rounds of council rate demands.  The reported CPI appears to continue to under report the real experience of many households. Many continue to dip into savings to pay the bills.

In terms of debts outstanding, there was a small fall in those reporting they were less comfortable, with 42% reporting compared with 44% last month. This is attributable to changes in interest rates, and refinancing, especially for owner occupied households with a lower Loan to Income ratio.  Many with large mortgages also have other debts, including credit cards and personal loans which also require servicing. Around 52% reported no change in their debt, up 3.5%.  Property Investors were more concerned overall.

Looking at savings, those with stocks and shares have enjoyed significant gains (at least on paper) and recent dividends, so tended to be more confident. Some were able to benefit from higher savings rates on selected term deposits, though rates attached to on-call accounts continue to languish as lenders manage their margins. Around a quarter of households have less than one months spending in savings, so many are facing a hand to month situation with regards to their finances. Many of these households are in the younger age bands and have no savings to protect them should their personal situations change.

We noted in the survey that a number of households were actively seeking alternative savings vehicles as property and bank deposits look less interesting. We will have to see whether these alternatives are as attractive (in terms of risk-return) as some are claiming. We have our doubts.  But then risk is relative.

So finally, putting this all together, the proportion of households who reported their new worth was higher than a year ago continues to slide as property price falls continue to hit home, and as savings are raided to maintain lifestyle. 42% said their net worth had improved, down 3.75% from last month. 25.6% said their net worth had fallen, up 2.5% and 28% reported no real change.

We had expected to see a small bounce in the index this month as some incomes rise in the new tax year and other changes take effect. But the impact of the fading property sector, and cash flow constraints are likely to dwarf this impact. The only “get out of jail card” will be income growth above inflation, and as yet there is little evidence of this occurring.  Thus we expect the long grind to continue.

Finally, the spate of attractor rates from the banks continues, in an attempt to keep mortgage volumes up. However, our research shows that many households cannot access them in the new tighter lending environment.

By way of background, these results are derived from our household surveys, averaged across Australia. We have 52,000 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.

We will update the index next month.

Household Financial Pressure Tightens Some More

Digital Finance Analytics (DFA) has released the July 2018 mortgage stress and default analysis update. The latest RBA data on household debt to income to March reached a new high of 190.1[1], and CBA today said in their results announcement ”there has been an uptick in home loan arrears as some households experienced difficulties with rising essential costs and limited income growth, leading to some pockets of stress”.

So no surprise to see mortgage stress continuing to rise. Across Australia, more than 990,000 households are estimated to be now in mortgage stress (last month 970,000). This equates to 30.4% of owner occupied borrowing households. In addition, more than 23,000 of these are in severe stress. We estimate that more than 57,900 households risk 30-day default in the next 12 months. We expect bank portfolio losses to be around 2.7 basis points, though losses in WA are higher at 5.1 basis points.  We continue to see the impact of flat wages growth, rising living costs and higher real mortgage rates.

Martin North, Principal of Digital Finance Analytics says “households remain under pressure, with many coping with very large mortgages against stretched incomes, reflecting the over generous lending standards which existed until recently. Some who are less stretched are able to refinance to cut their monthly repayments, but we find that the more stretched households are locked in to existing higher rate loans”.

“Given that lending for housing continues to rise at more than 6% on an annualised basis, household pressure is still set to get more intense. In addition, prices are falling in some post codes, and the threat of negative equity is now rearing its ugly head”.

“The caustic formula of coping with rising living costs – notably child care, school fees and fuel – whilst real incomes continue to fall and underemployment is causing significant pain. Many households have larger mortgages, thanks to the strong rise in home prices, especially in the main eastern state centres, and now prices are slipping. While mortgage interest rates remain quite low for owner occupied borrowers, those with interest only loans or investment loans have seen significant rises. Many are dipping into savings to support their finances.”

Recent easing interest rate pressures on the banks has decreased the need for them to lift rates higher by reference to the Bank Bill Swap Rates (BBSW), despite the fact that a number of smaller players have done so already.

Our analysis uses the DFA core market model which combines information from our 52,000 household surveys, public data from the RBA, ABS and APRA; and private data from lenders and aggregators. The data is current to end June 2018. We analyse household cash flow based on real incomes, outgoings and mortgage repayments, rather than using an arbitrary 30% of income.

Households are defined as “stressed” when net income (or cash flow) does not cover ongoing costs. They may or may not have access to other available assets, and some have paid ahead, but households in mild stress have little leeway in their cash flows, whereas those in severe stress are unable to meet repayments from current income. In both cases, households manage this deficit by cutting back on spending, putting more on credit cards and seeking to refinance, restructure or sell their home.  Those in severe stress are more likely to be seeking hardship assistance and are often forced to sell.

Probability of default extends our mortgage stress analysis by overlaying economic indicators such as employment, future wage growth and cpi changes.  Our Core Market Model also examines the potential of portfolio risk of loss in basis point and value terms. Losses are likely to be higher among more affluent households, contrary to the popular belief that affluent households are well protected.

The outlined data and analysis on mortgage stress does not occur in a vacuum. The revelations from the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (the Commission) have highlighted deep issues in the regulatory environment that have contributed to the household debt “stress bomb”. However, most of the media commentary on the regulatory framework has been superficial or poorly informed. For example, several commentators have strongly criticised the Australian Securities and Investments Commission (ASIC) for not doing enough but have failed to explain what ASIC has in fact done, and what it ought to have done.

The Commission has highlighted major concerns regarding the law and practice of responsible lending. North has published widely on responsible lending law, standards and practices over the last 3-4 years, and continues to do so. Her latest work (which is co-authored with Therese Wilson from Griffith University) outlines and critiques the responsible lending actions taken ASIC from the beginning of 2014 until the end of June 2017. This paper was published by the Federal Law Review, a top ranked law journal, this month. A draft version of the paper can be downloaded at https://ssrn.com/author=905894.

The responsible lending study by North and Wilson found that ASIC proactively engaged with lenders, encouraged tighter lending standards, and sought or imposed severe penalties for egregious conduct. Further, ASIC strategically targeted credit products commonly acknowledged as the riskiest or most material from a borrower’s perspective, such as small amount credit contracts (commonly referred to as payday loans), interest only home loans, and car loans. North suggests “ASIC deserves commendation for these efforts but could (and should) have done more given the very high levels of household debt. The area of lending of most concern, and that ASIC should have targeted more robustly and systematically, is home mortgages (including investment and owner occupier loans).”

Reported concerns regarding actions taken by the other major regulator of the finance sector, the Australian Prudential Regulation Authority (APRA), have been muted so far. However, an upcoming paper by North and Wilson suggests APRA (rather than ASIC) should be the primary focus of regulatory criticism. This paper concludes that “APRA failed to reasonably prevent or constrain the accumulation of major systemic risks across the financial system and its regulatory approach was light touch at best.”

Stress by The Numbers.

Regional analysis shows that NSW has 267,298 households in stress (264,737 last month), VIC 279,207 (266,958 last month), QLD  174,137 (172,088 last month) and WA has 132,035 (129,741 last month). The probability of default over the next 12 months rose, with around 11,000 in WA, around 10,500 in QLD, 14,500 in VIC and 15,300 in NSW.

The largest financial losses relating to bank write-offs reside in NSW ($1.3 billion) from Owner Occupied borrowers) and VIC ($943 million) from Owner Occupied Borrowers, which equates to 2.10 and 2.7 basis points respectively. Losses are likely to be highest in WA at 5.1 basis points, which equates to $744 million from Owner Occupied borrowers.

Top Post Codes By Stressed Households

[1] RBA E2 Household Finances – Selected Ratios March 2018

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HILDA Data Confirms Household Financial Pressure

From Nine.com.au.

Single-parent families are experiencing a near-unprecedented level of housing stress as soaring house prices force many into unaffordable rental properties.

Analysis conducted by the Melbourne Institute as part of its annual HILDA survey revealed over 20 percent of single-parent families are stretching their budgets further than ever to keep up with annual rent rises or changes in their mortgage.

Amongst all Australians, household stress peaked at an all-time high in 2012, when 11.2 percent of all Australians were classified as having to make “unduly burdensome” mortgage repayments.

In economic terms, housing stress is technically defined as spending more than 30 percent of a household’s disposable income on housing costs, not including council rates.

In 2016, where the HILDA survey data ends, 9.6 percent of the population were experiencing housing stress.

Although single-parent families were found to be under the most dire levels of housing stress, the survey found that single elderly Australians and renters are also suffering under the weight of paying rent or covering their mortgage.

Couples without children were found to have the lowest levels of housing stress.

“Among those with housing costs, private renters have the highest rate of housing stress and owners with mortgages have the lowest rate,” wrote HILDA survey researchers.

“Moreover, over the HILDA Survey period, housing stress has increased considerably among renters—particularly renters of social housing—whereas it has decreased slightly for home owners with a mortgage.”

The survey also found that the type of home you owned or rented was directly correlated to the likelihood of having difficulty in making rent or mortgage repayments.

Australians living in apartments were found to have the highest rates of housing stress, followed by those living in semi-detached houses.

People living in separate, free-standing homes were found to have the lowest rates of housing stress – most likely because they live away from heavily-populated urban centres.

“Housing stress is generally more prevalent in the mainland capital cities, with Sydney in particular standing out,” wrote the researchers.

“However, differences across regions are perhaps not as large as one might expect given the differences in housing costs across the regions.

“Also notable is that housing stress is very high in other urban Queensland. It is only in the last sub-period (2013 to 2016) that it is not the region with the highest rate of housing stress, and even in that period only Sydney has a higher rate.”

The HILDA survey follows the lives of more than 17,000 Australians over the course of their lifetimes and published information on an annual basis on many aspects of their lives including relationships, income, employment, health and education.

The latest findings back up analysis from Digital Finance Analytics (DFA), which estimates that more than 970,000 Australian households are now believed to be suffering housing stress.

That equates to 30.3 percent of home owners currently paying off a mortgage.

Of the 970,000 households, DFA estimates more than 57,100 families risk 30-day default on their loans in the next 12 months.

“We continue to see households having to cope with rising living costs – notably child care, school fees and fuel – whilst real incomes continue to fall and underemployment remains high,” wrote DFA principal Martin North.

“Households have larger mortgages, thanks to the strong rise in home prices, especially in the main eastern state centres, and now prices are slipping.

“While mortgage interest rates remain quite low for owner occupied borrowers, those with interest only loans or investment loans have seen significant rises.”

The Phony Wars – The Property Imperative Weekly 21 July 2018

Welcome to the Property Imperative weekly to 21th July 2018, our digest of the latest finance and property news with a distinctively Australian flavour.

By the way if you value the content we produce please do consider joining our Patreon programme, where you can support our ability to continue to make great content. Here is the link.

Watch the video, listen to the podcast, or read the transcript.

It’s important to look past the headlines and examine the data, because we need to see the truth beneath.

Let’s start with the housing market this week. Auction clearance rates and volumes continue to fall and Sydney recorded the lowest clearance rate the city has seen since December 2012. CoreLogic says that last week saw 1,178 homes taken to auction across the capital cities, returning a clearance rate of 52.0 per cent. Compare this with 52.6 per cent across 1,411 auctions last week and 69.4 per cent on 1,627 homes this time last year.

Melbourne’s final clearance rate came in at 56.2 per cent across 559 auctions last week, similar to the previous week when 631 auctions were held and a clearance rate of 56.1 per cent was recorded. This time last year auction volumes were higher across the city with 756 homes going under the hammer returning a clearance rate of 74.9 per cent.

Sydney’s final clearance rate dropped to 46.9 per cent last week across 408 auctions, the lowest clearance rate the city has seen since December 2012. In comparison, 552 auctions were held across Sydney over the previous week returning a clearance rate of 50.1 per cent while this time last year, 609 homes went under the hammer, returning a clearance rate of 69.2 per cent.

Across the smaller auction markets, clearance rates improved everywhere except Brisbane. In terms of volumes, Adelaide was the only city to see an increase with an additional 8 homes taken to auction over the week.  Of the non-capital city markets, the Hunter region recorded a 70.6 per cent final auction clearance rate across 17 results, followed closely by Geelong where 70.4 per cent of the 27 auction results were successful.

CoreLogic says auction activity is expected to remain relatively subdued this week with 1,155 homes scheduled for auction across the combined capital cities, similar to last week.  And they also reported that home prices slid further across all the centres other than Brisbane, down another 0.11% in the past week. So absolutely no indication of any improvement.  Today I had the chance to visit five auctions in our area, none sold, and no-one serious made any bids at three of the events.

But this should come as no surprise, as credit is still less available than a few months ago. Indeed, around forty percent of households seeking to refinance their mortgages have been knocked back compared with just 5% a year ago. We discussed these findings as part our analysis of Household Financial Confidence, which overall was lower again – see our post “Household Financial Confidence On The Blink Again” .  The June 2018 edition of the index, which draws information from our rolling household surveys, registered just 89.7, well below the 100 neutral setting and down from 90.2 last month.  Debt remains a major issue, with mortgages being the front line. Households remain highly leveraged. Some households with lower Loan to Value ratios have been able to switch to other, cheaper loans. We also continue to see many households adding to their overall debt via credit cards, or other loans. The new positive credit environment which commenced 1 July 2018 will change the game ahead and credit may become harder to source for some. On the other hand, households continue to dip into their savings to maintain lifestyle and budgets. Significantly more than one third of households with an owner occupied mortgage had savings LESS than the equivalent of one month’s mortgage repayment. The other two thirds had significantly larger resources which would insulate them in a down turn, at least for a time.

CoreLogic has looked at the changes in property values by area from their peaks, with Perth showing a 28% fall alongside Darwin, Brisbane down 12.5%, Adelaide down 7.4%, Canberra down 6.8%, Sydney down 5.3% and Melbourne down 0.9%.  And over the past decade, house values fell on average 27% across Mackay, in Queensland, and more than 34% across the WA outback. These are big falls, and puts the movements in Sydney and Melbourne into perspective – or perhaps provides a better view of where we are headed.

S&P Global Ratings did a job on the banks this week, saying they recently negatively revised their view of the Australian banking sector’s industry risk. Developments over the past two years in the Australian banking sector, including information coming out of hearings at the ongoing Royal Commission, highlight some weaknesses in the effectiveness of regulation in the banking sector, and the conduct, governance, and risk appetite shown by Australian banks. This is a big deal, as we discussed in our post “And Now For The Bad News, At Least For The Banks”.

In addition, The latest S&P Ratings SPIN index to May 2018, based on their portfolio of mortgage backed securities showed a further move up in defaults compared with last month, from 1.36% to 1.38%. There were rises in New South Wales of 0.02%, Queensland of 0.04% and Northern Territory up 0.52%. Significantly, the larger hikes were seen in the major bank portfolios, with the prime spin rising from 1.36% last month to 1.38% in May. There was a rise in 61-90 day past due loans, from 0.22% last time to 0.25%. While these moves are small, arrears are now as high as they were back in 2011, and interest rates are much lower today, so this highlights the risks in the system. This does not appear to be a seasonal issue either; it is more structural.

In addition, personal insolvencies were higher again, according to the Australian Financial Security Authority who released their statistics for 2017–18 and the June quarter 2018. The data reveals a sharp rise in total personal insolvencies to the highest level since the Global Financial Crisis a decade ago, with record high insolvencies reached in WA and NT, and debt agreements also hitting an all-time high.  The pressure on households continues to bite.

Even the RBA minutes, out this week discussed the problem.  And the latest SQM Research data on rentals also showed that Sydney vacancy rates are the highest in 13 years, at 2.8%, potentially putting more pressure on property investors in city.

We also ran some alternative mortgage scenarios this week, showing that even if incomes started to move up, to nearer 3% that’s 1% higher than now, the number of households struggling with their finances would remain well above the long term trends. We remain, as a nation, highly exposed to debt, especially if interest rates rise.   You can watch our video on this analysis “Alternative Mortgage Stress Scenarios”.

Even CBA’s Gareth Aird, their Senior Economist, in a fairly bullish piece, admitted that for many households, the number one headwind that they face with respect to consumption is debt repayment.  Australia has one of the most indebted household sectors globally.  Debt to income ratios have risen from around 148% in mid-2012 to a record high of 190% in Q 2018.  This measure includes all households regardless of whether they actually have a mortgage. For households that have a mortgage, that figure is significantly higher. It has increased steadily as interest rates have come down despite lower rates making it easier to repay debt. Basically growth in the net flow of credit (i.e. new credit less repayments) has been higher than growth in income. He says a high debt burden relative to income acts as a constraint on future household consumption growth.  It means that interest payments as a share of income are higher than otherwise.  And of course the principal must be paid too.  This leaves households with less income that can be spent on goods and services. And it means that households have a much greater sensitivity to interest rate changes.  From a demographic perspective, it is younger households feeling the debt burden most acutely.  There are also about $120bn of interest only loans in aggregate that are scheduled to roll over to principle and interest (P&I) loans annually over the next three years.  Borrowers shifting to P&I loans will face higher monthly loan repayments. Could not have put it better myself.

The plight of households in the current environment even reached New York in an excellent piece in the New Your Times. “Australian Housing Costs Rival New York’s, but Boom May Be Ending“. I was quoted extensively:     “We are on the edge of a precipice,” said Martin North, principal analyst for Digital Finance Analytics, an independent research and advisory firm. “All of the forces that have driven the home sector and the debt sector higher in the last 20 years are all coming to a critical inflection point.”    “Almost everywhere you look, you can see icebergs,” Mr. North said. Signs of stress are showing. Mr. North, the analyst from Digital Financial Analytics, estimates that of 3.5 million mortgages where the owner lives in the home, almost a third of the households have incomes close to or less than their expenditures. He predicts that at least 50,000 homeowners may default in the next 12 months.

If you want to get deep and dirty into our analysis, and the potential consequences for Australian Households, and mitigation strategies, then you might want to watch the recording of our Live Stream from last Tuesday. It’s just over the hour in length, and we have some excellent interactions in the chat room. In fact there are two versions available, the live edition, including real-time chat, and the odd technical glitch (helps to turn the sound on), or the slightly shorter version, at higher quality and tidied up, but without the chat. You can choose. We plan more live events down the track.  The links are below.

The apparent bright spot this week was the latest employment data which was above market expectations. The number of people employed rose 50,900 from May to June in seasonally adjusted terms, which was well ahead of forecasts of around 16,500. And that wasn’t just a lot of new part-time jobs. Full-time employment rose by 41,200. On a year-on-year basis that represents an increase in employment of 2.8%. But even then, the number of people unemployed fell from 715,200 in May to 714,100 in June. This is explained by the participation rate – the proportion of people participating or trying to participate in the paid labour market. The participation rate rose from 65.5% in May to 65.7% in June, leaving the unemployment rate unchanged at 5.4%. The Australian labour force participation rate is actually pretty high. A useful comparison is the United States – probably the world’s most robust labour market – where the current rate is 62.9%. The key point is that if more people are going to come into the labour market when it looks better – as they have been consistently – then a continued reduction in the unemployment rate is going to require creating a whole lot more jobs. And in any case the basis for counting employed people is suspect. We discussed this in our post “And Now for The Good News”.  Little sign of wages growth at the moment.

The local stock markets had a pretty good week, again, with the ASX All Ords up 0.35% on Friday to 6,377. The S&P ASX 100 was up 0.38% to 5,168, encouraged by the employment data, and the economic news from China.  Westpac, the largest investment mortgage lender was up 0.67% to 29.90, but well below its 12 month highs, and CBA rose 0.68% to 75.90, but again well below prices from a year ago. The overhang from the Royal Commission, tighter funding, and higher risks explain why they are priced down.

Looking across to the US markets, the earnings season was in full flight for the week and the majority hit or beat Wall Street expectations. The Down Jones Industrial was down 0.3% to 25,058 on Friday and the S&P 500 fell a little to 2,801. The Volatility Index, the VIX was also a little lower, but remains above its level last year. The financial sector continued to perform well. Morgan Stanley led the broker-dealer reports and Goldman Sachs also topped estimates, although concerns about its succession plan hit the stock later in the day. But even so, these stocks are off their 12 month highs, and Macquarie Bank, in comparison, has been performing more strongly in our local market up 0.84% on Friday to 125.40.

On the tech-heavy NASDAQ, which fell just a little on Friday, down 0.07% to 7,820, it was a tale of two techs as a momentum stock fell short of what investors wanted and an old stalwart came through. Netflix tumbled at the start of the week after the company missed expectations on new subscribers, a key metric for the streaming company. Netflix added 5.14 million subscribers in the latest quarter, shy of analysts’ expectations for more than 6.2 million. But after the bell on Thursday, Microsoft reported second-quarter earnings that beat consensus thanks to cloud services revenue.

The prospect for the path of U.S. interest rates took an interesting turn at the end of the week. At first things seemed to jibe with market expectations that the Federal Reserve will raise rates once and possibly twice before the year is out. At his Humphey-Hawkins testimony before the Senate Banking Committee and the House Financial Services Committee, Federal Reserve Chairman Jerome Powell reiterated the central bank should gradually increase interest rates.

But President Donald Trump shook some of the market’s confidence, saying on Thursday he’s “not thrilled” about the Fed hiking rates and going into more specifics on Twitter on Friday.

The tweets had little overall impact on the market forecasts for upcoming rate hikes. But they did take the legs from the dollar on Friday. The U.S. Treasury Department has long had a policy of simply stating that a strong dollar is in America’s best interest.

The yield curve continues to converge across the long and short term, and this has often been seen as an early warning of trouble ahead. This from Bloomberg.

The 30-year bond is sitting at 3.03% and the 3 Month at 1.98%. The 3 Month LIBOR rates remained above 2.3% and the 10 year benchmark is at 2.9%, just a little off its highs, and this also reflected in a lower BBSW rate in Australia, suggesting a small fall in margin pressure for the banks locally compared with a few weeks ago.

Trade-war concerns took a back seat through most of the week, but were revived on Friday and could weigh more heavily next week, despite another full earnings calendar. President Trump said in an interview on CNBC that he is ready to impose tariffs on $500 billion worth of Chinese goods to the U.S. if China does not back down on its trade policies. “I’m not doing this for politics, I’m doing this to do the right thing for our country” he said on CNBC’s “Squawk Box.” “We have been ripped off by China for a long time.”

In fact, Moody’s highlighted that already the trade-wars is hitting base metal prices, yet is hardly mentioned. Since worries surrounding a trade war came to the fore, the base metals price index has sunk by 13.0%. The copper futures are well down from their highs a couple of months back, as is steel. This could crimp Australian GDP in the months ahead. And both Gold and Silver were weaker, suggesting that at the moment “risk” investors are preferring the US Dollar.

It’s also worth noting the Chinese Yuan slide against the US dollar and the Australian Dollar and some are suggesting that this is a sign of the Chinese Government answering the Trade wars by taking their currency lower (so reducing the cost of their goods in the local economies). The Aussie Dollar continues to drift lower against the US Dollar, and we expect this to continue, indeed one economist suggested it could end up around 60c in the months ahead.

Crude oil prices posted a second-straight weekly decline and may continue to weigh on energy stocks, as they have of late. On the New York Mercantile Exchange crude futures for September delivery rose $1.30 to settle at $70.46 a barrel Friday. Investors continue to weigh up the prospect of a global shortage in supplies, despite Saudi Arabia’s pledge to hold off flooding the market with more output. That said, crude oil prices were supported on Friday by the plunge in the dollar following Trump’s remark about the greenback and other currencies.

Bitcoin lifted a little, and continues in a less volatile mode, though well below earlier highs.

Finally, for today, another lens on the debt bomb, as featured in my recent discussions with Economist John Adams, including those on the debt bomb itself, the international debt bubble and more recently the meaning of money. We have more planned, so watch out for those, and there is also dedicated web page on the DFA blog. Again the link is below.

The McKinsey Global Institute says that since the GFCs, many large corporations around the world have shifted toward bond financing as commercial bank lending has been subdued. Today, 19 percent of total global corporate debt is in the form of bonds, nearly double the share in 2007. Annual nonfinancial corporate bond issuance has increased 2.5 times, from $800 billion in 2007 to $2 trillion in 2017. The global value of corporate bonds outstanding has increased 2.7 times since 2007 to $11.7 trillion, doubling as a share of GDP.

The average quality of blue-chip borrowers has declined. In the United States, almost 40 percent of nonfinancial corporate bonds are now rated BBB, just one notch above speculative-grade “junk bonds.” Growth in speculative-grade bonds has been particularly strong. Globally, the value of corporate high-yield bonds outstanding increased from $500 billion in 2007 to $1.9 trillion in 2017. In the coming five years, and unprecedented amount of these bonds will come due. Bond issuance by companies in China and other developing countries has soared. The value of China’s nonfinancial corporate bonds outstanding rose from $69 billion in 2007 to $2 trillion at the end of 2017, making China one of the largest bond markets in the world. Outside China, growth has been strongest in Brazil, Chile, Mexico, and Russia.

From 2018 to 2022, a record amount of bonds—between $1.6 trillion and $2.1 trillion annually—will mature. Globally, a total of $7.9 trillion of bonds will come due during those five years, based on bonds already issued. However, some bonds have maturities of less than five years and may still be issued and come due during that period. If current issuance trends continue, then as much as $10 trillion of bonds will come due over the next five years. At least $3 trillion of this total will be from US corporations, $1.7 trillion from Chinese companies, and $1.7 trillion from Western European companies.

Now overlay the rising interest rate environment, and you can see the problem. Such high leverage will cost the global economy dear, and sooner rather than later.

Mortgage Stress And Defaults – Alternative Scenarios

When we released our mortgage stress report for June 2018, we said that the number of households exposed to risks is rising, and if rates were to increase then around 1 million of households will fall into stress and some may default, up from 970,000 now.


The RBA minutes yesterday focussed in on the problem of household debt.

Members held a detailed discussion of the high level of household debt in Australia, informed by a special paper prepared for this meeting. Household debt has increased by more than household income over the preceding three decades in many countries, but particularly so in Australia. Two key drivers of this trend across countries have been the decline in nominal interest rates, predominantly reflecting lower inflation, and financial deregulation, both of which have increased households’ access to finance. Members noted that a distinguishing feature of the Australian housing market is that the bulk of dwellings are owned by the household sector. This has contributed to greater borrowing for housing by households in Australia compared with other countries, where the corporate sector owns a larger proportion of rental properties. Another feature of the Australian housing market that has contributed to greater borrowing by households is the higher cost of housing in Australia on account of a larger share of the Australian population living in urban centres, typically in large detached dwellings.

Survey data indicate that much of Australian household debt is owed by higher-income and middle-aged people, who tend to have more stable employment and often larger savings buffers. However, members recognised that a material share of household debt is held by lower-income households, which generally have higher debt relative to their income. Household assets in aggregate are valued at around five times the value of household debt and total assets exceed the value of debt for most households. Members noted, however, that most household assets are housing and superannuation, and that both of these are illiquid.

Members noted that high levels of household debt could affect economic outcomes. For example, households with high debt levels are more vulnerable to economic shocks and therefore more likely to reduce consumption in the face of uncertainty about their future income. Members also noted that changes in interest rates have a larger effect on disposable income for households with high debt levels, but that these households may be less inclined to borrow more at times when interest rates fall. Accordingly, members agreed that household balance sheets continued to warrant close and careful monitoring.

In fact our research says, yes, debt is a problem, and it is hitting many different types of household, including more affluent ones.

Our analysis of stress and defaults created a stir in the media, several radio and TV interviews, and some interesting discussions on social media.

One of these, with Peter on Twitter led to a question about how we make our assessment and scenarios and our definitions of mortgage stress (cash-flow based).  We include estimates of expected wages growth, inflation, cpi, interest rates etc.

So this led to a discussion where I volunteered to run a scenario using Peter’s parameters.

We also added in the tax changes and child care subsidy (in both scenarios).  We do not impose a particular family structure, but capture that in our surveys (which aligns to the ABS census distribution).

So, we ran our model with a 3% wage growth, 2.1% CPI and small rise in mortgage rates. Stress levels would begin to fall, but will still be higher than since 2000, because of the greater leverage and debt burden.

Here are the results, one year down the track.

So the impact of potential wages rises, in real terms is significant. A “good outcome!” However even then the risk in the system remains higher than we have been use to.  Defaults reduced by 6% while stress fell by more than 8%.

 

Financial Resilience – DFA Live Show

We ran a live session last night via YouTube where we discussed a range of issues across property, lending and housing finance using data from our Core Market Models.  Note data in the show was current at 16th July 2018.

This stream, and the comments through the hour session is now available to watch at your leisure. Thanks to all those who took part in a wide ranging and important discussion.

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Property Concerns Drives June 2018 Household Financial Confidence Lower

We have released the June 2018 edition of our household financial confidence index, which draws information from our rolling household surveys. In June the overall index fell once again to 89.7, well below the 100 neutral setting down from 90.2 last month.

Looking at the results across the states, we see further falls in New South Wales and Victoria, a small fall in Western Australia, but small rises in Queensland and South Australia.

Looking across our property segments, those who are renting or living with families or friends returned a small rise, reflecting expected tax changes and increments on some wages for the new financial year. However, those owning or investing in property were significantly less bullish (drowning out any benefit from the tax changes etc.). Property Investors are getting very nervous as prices decline, interest rates are expected to rise, and rental streams are crimped. We noted a rise in vacancy rates in a number of areas.  Owner occupied (OO) households are more positive, relatively speaking, although they have dipped below the neutral setting in April.

Across the age bands, older households are more bullish, with those over 60 years and 50-60 years a little more positive on the back of the recent tax changes from 1 July 2018. On the other hand, younger households are consistently less positive, especially those who purchased property in the past couple of years. Those aged thirty to forty years are under most pressure.  Those with savings in the banks remain concerned.

We can examine the drivers across the dimensions in our survey.  In terms of job security there was a small rise last month, with those feeling more secure up 0.65% to 11.8%. On the other hand, those less secure also rose by 0.78% to 27.9%, with a consistent theme of limited hours being to the fore. We continue to see a rise in households managing multiple concurrent part time jobs to make ends meet.

Turning to income, there was no indication of significant income rises before the new financial year, next month may be different.  52.7% said their incomes had fallen in real terms over the past year, and 44% reported no change. Once again we see evidence of limited hours driving underemployment higher, so on a gross income there is no light at the end of the tunnel, yet.

Costs of living continue to rise with 81.3% seeing their expenditure  rising, thanks to the usual suspects, including electricity, child care, school fees and health insurance costs. There were also signs of pressure from food costs and council rates. Only 2.2% reported said their costs have fallen over the past 12 months. The reported CPI rates appear to be disconnected from reality.

Debt remains a major issue, with mortgages being the front line. Households remain highly leveraged. Some households with lower Loan to Value ratios have been able to switch to other, cheaper loans, but more than 40% of households seeking to refinance have been knocked back in the past 3 months, up from 5% a year ago. A hallmark of the current lending environment. We also continue to see many households adding to their overall debt via credit cards, or other loans. The new positive credit environment which commenced 1 July 2018 will change the game ahead. Credit may become harder to source for some.

On the other hand, households continue to dip into their savings to maintain lifestyle and budgets. 46% of households are less comfortable with the level of their savings compared with a year ago. Many responses highlighted the recent collapse in bank deposit rates as ADI’s try to manage their margins.  Around the same, 46% of household reported no change. Significantly more than one third of households with an owner occupied mortgage had savings LESS than the equivalent of one months mortgage repayment. The other two thirds had significantly larger resources which would insulate them in a down turn, at least for a time.

Finally, we see that more households are reporting a fall in net worth – total assets less loans and other liabilities, with 23% now saying they are worth less (up 0.95% on the month). 28% reported no change over the past year, and 46% reported growth in net worth, helped by the still significant run up in home prices in recent years (now correcting) and rises in stocks in recent months.

Generally those with more assets are still seeing rises compared with an average Australian household, highlighting the two-speed story across the country, depending on affluence.

But we also continue to see a tranche of highly leveraged high net-worth households having to cope with financial pressures as home prices and rentals move against them and the impact of switching from interest only to principal and interest loans hits home.

We would expect a small bounce in the index next month as some incomes rise in the new tax year and other changes take effect. But the impact of the fading property sector, and cash flow constraints are likely to dwarf this impact. The only “get out of jail card” will be income growth above inflation, and as yet there is little evidence of this occurring.  Thus we expect the long grind to continue.

Finally, we see a number of attractor rates from the banks in an attempt to keep mortgage volumes up, but many households cannot access them in the new tighter lending environment. In addition the reduction in rates on some deposit accounts is also hitting the hip pockets of many who rely on income from them. We noted in the survey that a number of households were actively seeking alternative savings vehicles as property and bank deposits look less interesting. We will have to see whether these alternatives are as attractive (in terms of risk-return) as some are claiming. We have our doubts.  But then risk is relative.

By way of background, these results are derived from our household surveys, averaged across Australia. We have 52,000 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.

We will update the index next month.