The Property Imperative Weekly Launched

Today we launch the first of our regular Property Imperative Weekly Update Blogs and Vlogs; the next stage in the development of the Digital Finance Analytics site and in response to requests for a summary service.

We have been publishing regular reports on the residential property and mortgage industry in Australia for many years, in our Property Imperative series. Volume 8 is still available.

With so much happening in the property and mortgage sector, we will discuss the events of the past week in an easy to watch summary. We also will deploy the video blog on our YouTube channel and provide a transcript here, with links to the key articles.

This is the first.  Watch it here.

We start with the latest data from the Reserve Bank and APRA for March showed that investment mortgage lending grew more strongly than owner occupied loans, and also that the non-banks are getting more active in this less regulated segment of the market. Pepper for example reported strong loan growth.

Smaller regional banks are getting squeezed, and mortgage lending overall is accelerating despite regulatory pressure. As the total mortgage book grew at more than 6% in the past year, when household incomes are static, the record household debt is still growing. More definitive action from the regulators is required.

APRA Chairman Wayne Byers discussed the residential and commercial property sectors this week at CEDA, and indicated the 10% speed limit on investment loan growth was maintained to protect the pipeline of dwellings under construction. This seems a bit circular to me!

In the past week, the upward momentum in mortgage rates continued with both Westpac and ANZ lifting fixed rate and interest only loan rates, by up to 30 basis points, though some owner occupied loans fell a little. These moves follow recent hikes from CBA and NAB, and continues the cycle higher in response to regulatory pressure, funding costs, competitive dynamics and the desire to repair net interest margins. The regulators have given the banks a perfect alibi!

For investors, these out of cycle rises are now getting close to 1%, though owner occupied borrowers, on principal and interest loans have not been hit as hard. However, even small rises are hitting households in a low income growth environment.

Mortgage stress was in the news this week, with a good piece on the ABC’s 7:30 programme, looking at stress in Western Australia, and citing the example of a property investor who is now in trouble. Our research into stress was also covered in the media, with a focus on Melbourne. Our latest analysis, for April shows a further rise in households in mortgage stress. More of that later.

Meantime, Finder.com published analysis which suggested more than half of mortgage holders were close to a tipping point if mortgage repayments rose by just $100. This would equate to a rate of just 5.28%, not far from current rates at all.

Mortgage Brokers were in the news again thanks to evidence given to the Senate Standing Committee on Economics looking at a consumer protection in the banking and finance industry. Evidence suggested commission aligned to achieving specific volume targets and the use of lender lists may mean the interest of consumers are compromised. We discussed this on the DFA blog last year. In addition, ASIC highlighted deficiencies in the information flows between brokers and banks, and suggested that more robust systems and processes are needed, especially around commission data and broker performance.

Also, the risk of loans originated via brokers was discussed again, with the argument being mounted that financial incentives make broker loans intrinsically riskier.

Meantime whilst the government switched the narrative to good and bad debt, housing affordability remained in the news, with the HIA arguing again that supply side issues are the key, despite the fact that the average number of people living in each dwelling across Australia has hardly changed in years.

We think supply is not the big issue. Yes, there should be more focus on building more affordable social housing, but the main focus needs to be the reduction in investor tax incentives. The financialisation of property is the real underlying issue, but this is hard to address, and explains why the government is now wanting us to look elsewhere.

In broader economic news, inflation rose a tad, thanks to a strong rise in Victoria, and as a result there is less reason to expect an RBA cash rate cut. That said, the official CPI understates the real experience of many households, not least because housing costs are so significant now. We maintain our view that the next RBA rise will be up, not down, unless we get a significant external shock. Of course a cash rate rise will likely flow on to mortgage holders, putting them under more under pressure.

Finally, in preliminary news from CoreLogic they suggest that Sydney home prices may have stalled in April. Whilst some reports say this is the top, there are a range of technical issues which suggests it is too early to make this call. We need to see more data, and the Auction clearances may be an indicator of what is to come.

Nevertheless, we hold the view that we have probably reached the peak, and as mortgage lending tightens, and investors become more sanguine, prices in the major centres are likely to slide, mirroring the falls in WA, now, in some places down more than 20%. It then becomes a question of whether is turns into a rout, or whether prices drift sideways for some long time.

And that’s the Property Imperative week to the 29th April!

 

Prudential perspectives on the property market

Wayne Byers APRA  Chairman spoke at  CEDA’s 2017 NSW Property Market Outlook in Sydney  today.  Of note, he explains the reason why the 10% investor speed limit was not reduced, because of the potential impact on commercial propery construction!

My remarks today come, unsurprisingly, from a prudential perspective. Property prices and yields, planning rules, the role of foreign purchasers, supply constraints, and taxation arrangements are all important elements of any discussion on property market conditions, and I’m sure the other speakers today will touch on most of those issues in some shape or form. But I’ll focus on APRA’s key objective when it comes to property: making sure that standards for property lending are prudent, particularly in an environment of heightened risk.

Sound lending standards

Our recent activity in relation to residential and commercial property lending has been directed at ensuring banking institutions maintain sound lending standards. Our ultimate goal is to protect bank depositors – it is, after all, ultimately their money that banks are lending. Basic banking – accepting money from depositors and lending to sound borrowers who have good prospects of repaying their loans – is what it’s all about. Of course, banking is about risk-taking and it is inevitable that not every loan will be fully repaid, but with appropriate lending standards and sufficient diversification, the risk of losses that jeopardise the financial health of a bank – and therefore the security offered to depositors – can be reduced to a significant degree. The banking system is heavily exposed to the inevitable cycles in property markets, and our goal is to seek to make sure the system can readily withstand those cycles without undue stress.

Our mandate goes no further than that. We also have to take many influences on the property market – tax policy, interest rates, planning laws, foreign investment rules – as a given. And there are credit providers beyond APRA’s remit, so a tightening in one credit channel may just see the business flow to other providers anyway. For those reasons, there are clear limits on the influence we have. Property prices are driven by a range of local and global factors that are well beyond our control: whether prices go up or go down, we are, like King Canute, unable to hold back the tide.

Of course, that is not to ignore the fact that one determinant of property market conditions is access to credit. We acknowledge that in influencing the price and availability of credit, we do have an impact on real activity – and this may feed through to asset prices in a range of ways. But I want to emphasise that we are not setting out to control prices. Property prices will go up and they will go down (even for Sydney residential property!). It is not our job to stop them doing either of those things. Rather, our goal is to make sure that whichever way prices are moving at any particular point in time in any particular location, prudentially-regulated lenders are alert to the property cycle and making sound lending decisions. That is the best way to safeguard bank depositors and the stability of the financial system.

Residential property lending

APRA has been ratcheting up the intensity of its supervision of residential property lending over the past five or so years. Initially, this involved some fairly typical supervisory measures:

  • in 2011 and again in 2014, we sought assurances from the Boards of the larger lenders that they were actively monitoring their housing lending portfolios and credit standards;
  • in 2013, we commenced more detailed information collections on a range of housing loan risk metrics;
  • in 2014, we stress-tested around the largest lenders against scenarios involving a significant housing market downturn;
  • also in 2014, we issued a Prudential Practice Guide on sound risk management practices for residential mortgage lending; and
  • we have conducted numerous hypothetical borrower exercises to assess differences in lending standards between lenders, and changes over time.

These steps are typical of the role of a prudential supervisor: focusing on the strength of the governance, risk management and financial resources supporting whatever line of business is being pursued, without being too prescriptive on how that business should be undertaken.

But from the end of 2014, we stepped into some relatively new territory by defining specific lending benchmarks, and making clear that lenders that exceeded those benchmarks risked incurring higher capital requirements to compensate for their higher risk. In particular, we established quantitative benchmarks for investor lending growth (10 per cent), and interest rate buffers within serviceability assessments (the higher of 7 per cent, or 2 per cent over the loan product rate), as a means of reversing a decline in lending standards that competition for growth and market share had generated.

I regard these recent measures as unusual, and not reflective of our preferred modus operandi. We came to the view, however, that the higher-than-normal prescription was warranted in the environment of high house prices, high household debt, low interest rates, low income growth and strong competitive pressures.  In such an environment, it is easy for borrowers to build up debt. Unfortunately, it is much harder to pay that debt back down when the environment changes. So re-establishing a sound foundation in lending standards was a sensible investment.

Since we introduced these measures in late 2014, investor lending has slowed and serviceability assessments have strengthened. But at the same time, housing prices and debt have got higher, official interest rates have fallen further and wage growth remains subdued. So we recently added an additional benchmark on the share of new lending that is occurring on an interest-only basis (30 per cent) to further reduce vulnerabilities in the system.

Each of these measures has been a tactical response to evolving conditions, designed to improve the resilience of bank balance sheets in the face of forces that might otherwise weaken them. We will monitor their effectiveness over time, and can do more or less as need be. We have also flagged that, at a more strategic level, we intend to review capital requirements for mortgage lending as part of our work on establishing ‘unquestionably strong’ capital standards, as recommended by the Financial System Inquiry (FSI).

Looking at the impact so far, I have already noted that our earlier measures have helped slow the growth in investor lending (Chart 1), and lift the quality of new lending. Serviceability tests have strengthened, although as one would expect in a diverse market there are still a range of practices, ranging from the quite conservative to the less so. Lenders subject to APRA’s oversight have increasingly eschewed higher risk business (often by reducing maximum loan-to-valuation ratios (Chart 2)), or charged a higher price for it.

For example, there is now a clear price differential between lending to owner-occupiers on a principal and interest basis, and lending to investors on an interest-only basis (Chart 3). And as a result of our most recent guidance to lenders, we expect some further tightening to occur.

Looked at more broadly, the most important impact has been to reduce the competitive pressure to loosen lending standards as a means of chasing market share. We are not seeking to interfere in the ability of lenders to compete on price, service standards or other aspects of the customer experience. We do, however, want to reduce the unfortunate tendency of lenders, lulled by a long period of buoyant conditions, to compete away basic underwriting standards.

Of course, lenders not regulated by APRA will still provide competitive tension in that area and it is likely that some business, particularly in the higher risk categories, will flow to these providers. That is why we also cautioned lenders who provide warehouse facilities to make sure that the business they are funding through these facilities was not growing at a materially faster rate than the lender’s own housing loan portfolio, and that lending standards for loans held within warehouses was not of a materially lower quality than would be consistent with industry-wide sound practices. We don’t want the risks we are seeking to dampen coming onto bank balance sheets through the back door.

Commercial real estate lending

For all of the current focus on residential property lending, it has been cycles in commercial real estate (CRE) that have traditionally been the cause of stress in the banking system. So we are always quite interested in trends and standards in this area of lending. And tighter conditions for residential lending will also impact on lenders’ funding of residential construction portfolios – we need to be alert to the inter-relationships between the two.

Overall, lending for commercial real estate remains a material concentration of the Australian banking system. But while commercial lending exposures of APRA-regulated lenders continue to grow in absolute terms, they have declined relative to the banking system’s capital (partly reflecting the expansion in the system’s capital base). Exposures are now well down from pre-GFC levels as a proportion of capital, albeit much of the reduction was in the immediate post-crisis years and, more recently, the relative position has been fairly steady (Chart 4).

The story has been broadly similar in most sub-portfolios, with the notable exception of land and residential development exposures (Chart 5).

These have grown strongly as the banking industry has funded the significant new construction activity that has been occurring, particularly in the capital cities of Australia’s eastern seaboard. At the end of 2015, these exposures were growing extremely rapidly at just on 30 per cent per annum, but have since slowed significantly as newer projects are now being funded at little more than the rate at which existing projects roll off (Chart 6).

(As an aside, this is one reason why we opted not to reduce the 10 per cent investor lending benchmark for residential lending recently. There is a fairly large pipeline of residential construction to be absorbed over the course of 2017, and there is little to be gained from unduly constricting that at this point in time.)

In response to the generally low interest rate environment, coupled with relatively high price growth in some parts of the commercial market, low capitalisation rates and indications that underwriting standards were under competitive pressure, we undertook a thematic review of commercial property lending over 2016. We looked at the portfolio controls and underwriting standards of a number of larger domestic banks, as well as foreign bank branches which have been picking up market share and growing their commercial real estate lending well above system growth rates.

The review found that major lenders were well aware of the need to monitor commercial property lending closely, and the need to stay attuned to current and prospective market conditions. But the review also found clear evidence of an erosion of standards due to competitive pressures – for example, of lenders justifying a particular underwriting decision not on their own risk appetite and policies, but based on what they understood to be the criteria being applied by a competitor. We were also keen to see genuine scrutiny and challenge that aspirations of growth in commercial property lending were achievable, given the position in the credit cycle, without compromising the quality of lending. This was often being hampered by inadequate data, poor monitoring and incomplete portfolio controls. Lenders have been tasked to improve their capabilities in this regard.

Given the more heterogeneous nature of commercial property lending, it is more difficult to implement the sorts of benchmarks that we have applied to residential lending. But that should not be read to imply we have any less interest in the quality of commercial property lending. Our workplan certainly has further investigation of commercial property lending standards in 2017, and we will keep the need for additional guidance material under consideration.

Concluding remarks

So to sum up, property exposures – both residential and commercial – will remain a key area of focus for APRA for the foreseeable future. Sound lending standards are vital for the stability and safety of the Australian banking system, and given the high proportion of both residential mortgage and commercial property lending in loan portfolios, there will be no let up in the intensity of APRA’s scrutiny in the foreseeable future. But despite the fact the merit of our actions are often assessed based on their expected impact on prices, that is not our goal. Prudence (not prices) is our catch cry: our objective is to make ensure that, whatever the next stage of the property cycle may bring, the balance sheet of the banking system is resilient to it.

ANZ Hikes Investor Loans (Again)

From news.com.au.

ONE of the nation’s largest banks ANZ has lifted interest rates on home loan deals.

The bank has followed in the footsteps of rivals the Commonwealth Bank and Westpac, moving interest rates on both owner occupier and investor loans.

Some of the moves also include decreases and are effective immediately.

The moves come ahead of the Reserve Bank of Australia board meeting on Tuesday where it’s expected they will keep the cash rate on hold at 1.5 per cent.

Owner occupiers and investors signing up to interest-only fixed rate deals will be the worst hit with some hikes as high as 0.4 per cent.

On 2, 4, and 5 year fixed owner occupier interest-only loans the rates will rise by 0.4 per cent on the bank’s Breakfree products (this is one of the bank’s most popular products).

On one of the most popular fixed loans terms, three-year owner occupier interest-only loans will rise by 0.3 per cent to 4.49 per cent increasing repayments on a $300,000 30-year loan by $75 per month to $1123.

For investors on a three-year fixed-rate interest-only Breakfree deal the rate will rise 0.3 per cent 4.69 per cent, pushing up repayments by $75 per month to $1173.

For both owner occupiers and investors on principal and interest fixed rate deals rates on nearly all these products will fall.
Borrowers have been hit by fixed rates increases in recent weeks.

Borrowers have been hit by fixed rates increases in recent weeks.Source:Supplied

The three-year fixed rate owner occupier principal and interest deal will fall by 0.2 per cent to 3.99 per cent saving customers $34 per month and making repayments $1431.

On a three-year fixed rate investor principal and interest deal the rate will fall by 0.1 per cent to 4.44 per cent.

An ANZ spokesman said the “reflect our need to closely manage our regulatory obligations, portfolio risk and the competitive environment.”

Mozo spokeswoman Kirsty Lamont said the increases by ANZ are a result of the financial regulator, the Australian Prudential and Regulation Authority limiting their interest-only lending.

Mozo spokeswoman Kirsty Lamont said there’s increasing pressure on financial institutions to limit interest-only lending.Source:News Corp Australia

“It’s now more important than ever for interest only borrowers to do their homework on where to find the best rates in this current climate of tighter regulation,’’ she said.

“With the Federal Reserve jacking up rates in the US and inflation just scraping within the Reserve Bank target, we expect a cash rate increase in the next 12 months which means these fixed rates are unlikely to be around for a long time.”

Investor Loan Growth Outpaces Owner Occupied In March

The latest data from the RBA, the credit aggregates, shows that loan growth was strongest for investment home loans, at an annualised rate of 7.1% compared with owner occupied loans at 6.2%. Business lending fell again, and personal credit continues to fall.

The proportion of lending to business fell to 32.8% (a record low) and the proportion of home lending for investors sat at 34.9%

Total credit grew $9.7 billion (up 0.4%), owner occupied lending rose $6.7 billion (up 0.6%), investment loans rose $2.5 billion (up 0.4%) and lending to business up $1 billion (up 0.1%).

However, the RBA adjusts these numbers to take account of $1.2 billion restatement between owner occupied and investment loans. Overall housing rose 6.5% in the past 12 months, way above income growth, so higher household debt once again.

Comparing the RBA and APRA data, it looks like the share of non-bank investor home lending is rising, and of course these lenders are not under the APRA regulatory control, but fall under ASIC (and they are not required to hold capital, as they are not ADIs). This is a loophole.

The RBA notes:

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 $51 billion over the period of July 2015 to March 2017, of which $1.2 billion occurred in March 2017. 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.

Mortgage Lending Strong in March 2017

APRA have just released their monthly banking statistics for March 2017. Overall lending by the banks (ADI’s) rose $7.1 billion to $1.54 trillion, up 0.47% or 7.5% over the past 12 months, way, way ahead of income growth!

Owner occupied  loans grew by 0.49% to $998 billion and investment loans rose 0.43% to $545 billion. No slow down yet despite the recent regulatory “tightening” and interest rate rises. Investment loans are 35.3% of all book.  Housing debt will continue to climb, a worry in a low income growth environment, and unsustainable.

In fact the rate of lending is ACCELERATING!

Looking at the banks share of loans, the big four remain in relatively similar places.

The four majors grew the fastest whilst the regional banks  lost share.

Looking at the investment loan speed limits, the majors are “comfortably” below the 10% APRA limit. Some smaller players remain above.

So, the current changes to regulatory settings are not sufficient to control loan growth. Perhaps they are relying on tighter underwriting and rising mortgage rates to clip the speed, but remember many investors are negatively geared, so rising mortgage interest costs are actually born by the tax payer! The only thing which will slow the loan growth is if home prices start to fall.

The RBA data comes out shortly, this will give a view of all lending, including the non-bank sector (though partial, and delayed).

 

Brokers Under The Microscope At Senate Standing Committee

From Australian Broker.

Lender-imposed conditions that brokers write a certain number of loans per month or year to retain accreditation need to go, said Peter White, executive director of the Finance Brokers Association of Australia (FBAA).

Speaking in front of the Senate Standing Committee on Economics in a government inquiry into consumer protection in the banking, insurance and financial sector on Wednesday (26 April), White said these restrictions – called minimum volume hurdles – were reducing a broker’s ability to write loans for whatever lender they desired.

“What that creates is a very bad consumer outcome because a broker can only give guidance on loans for lenders that they’re accredited to,” he said.

These restrictions mean that while a broker may be doing the right thing for the borrower with regards to the panel of accredited lenders they have access to, there may be another outside that scope which is more suitable.

“Unfortunately they can’t reach into that because they are constrained by the aggregator’s agreements and those accreditations. That’s generally restricted because they don’t have volumes to reach that lender,” he told the panel.

“Those sorts of things need to go.”

White also criticised elite broker clubs, saying he would outlaw them if he could. With brokers given access to better speed of applications, this was “unreasonable” and “completely unfair” to the borrower.

“You have an innocent borrower at the backend there. He’s sitting behind a broker who may only give a specific lender one deal every three months,” he said. “That gets penalised because they don’t have the volume. It’s got nothing to do with the borrower.”

When asked about soft dollar benefits, White said that these incentives needed to become more transparent although completely outlawing them may not be the best solution.

There was also nothing wrong with the current base model of commissions that brokers are paid today, he said, referring to the FBAA’s global research that found Australian brokers were paid below the global average. As for trail, this provided a number of positive consumer outcomes when it was introduced.

“With trail being brought into place, that was there to minimise the outcome of churn and also to provide a greater level of service to the borrower that wasn’t necessarily being provided by the banks.”

The FBAA’s research showed that taking away trail led to higher upfront commissions, a greater level of churn, and sales of additional products that may not be acceptable in the market.

Finally, White expressed his opposition to the fixed upfront commission recommended by consumer advocacy group CHOICE.

“The baseline of lending is very standard,” he said. “But it’s the knowledge and capabilities of what adds onto that to make it appropriate to that borrower’s specific needs or their lending structure. That becomes quite a significant skill set and it’s not the same.

“If you do a mum and dad home loan for example, that’s a very different transaction to doing development finance and working through feasibility studies and presales and all the research and due diligence that goes into that.”

Although these are generally higher loan sizes, the amount of work definitely increased as well, he said.

Separately, ASIC said Improved tracking of broker data is required

Difficulties by lenders to compile clear, robust data on brokers has prompted the Australian Securities & Investments Commission (ASIC) to call for improved systems that allow banks and non-banks to track and report on broker activity.

Speaking in front of a Senate Standing Committee on Economics in a government inquiry into consumer protection in the banking, insurance and financial sector on Wednesday (26 April), ASIC deputy chair Peter Kell said that collecting data for the regulator’s recent Review of Mortgage Broker Remuneration was a challenge.

The main difficulty was that some lenders could not track simple issues such as the loans that were originated from and the amount of remuneration paid to each individual broker. Certain lenders also had no way to track the soft dollar benefits offered.

“One of the recommendations we have made is that this information should be provided through a new public reporting regime of consumer outcomes,” Kell said. “[This will] require lenders to set up systems to allow them to track this [and] also provide some transparency in the market.”

Kell emphasised that these gaps in information were not as a result of any unwillingness by the lenders to provide data. However, “it was apparent that the systems that some of the lenders had in place were not as robust and didn’t give them as clear a picture as I think they themselves would wish,” he told the committee.

The exercise was a “wakeup call” for some of the lenders, he said.

ASIC recommended a public reporting regime to eliminate current issues with the non-consistent structures between lenders with different systems, metrics and numbers.

“Having a public reporting regime is a good discipline to ensure that this data will be collected going forward,” Kell said.

However, the challenge for ASIC now is determining how to compile the collated information in a manner that both the industry and the public can see.

Housing affordability is worsening, warns ratings agency

From Mortgage Professional Australia.

Moody’s report shows regulatory crackdowns and low-interest rates will not protect affordability, putting pressure on Government to take action in the Budget

Housing affordability is deteriorating in Australia despite the impact of regulatory crackdowns and low interest rates, a report by international ratings agency Moody investors Service has found.

Affordability worsened in the year to March 2017, with interest repayments requiring for 27.9% of household income on average, compared with 27.6% in March 2016. Affordability declined steeply in Sydney, Melbourne and Adelaide, according to the report, although it improved in Brisbane and Perth, which is currently the most affordable city in Australia, with the proportion of income going to repayments at 19.9%.

Moody’s expect that housing affordability will continue to deteriorate, blaming “rising housing prices, which outstripped the positive effects of lower interest rates and moderate income growth”. Whilst APRA’s restrictions on interest-only mortgage lending could dampen demand for apartments they could also reduce affordability, Moody’s claims: “the new regulatory measures have prompted some lenders to raise interest rates on interest-only and housing investment loans, which will make such loans less affordable.”

Proportion of joint-income required to meet interest repayments, March 2016:

  • Sydney 37.5%
  • Melbourne 30.3%
  • Brisbane 23.9%
  • Adelaide 23%
  • Perth 19.9%
  • Australia: 27.9%

Coming just weeks ahead of the 2017-18 Federal Budget, Moody’s report indicates the Government cannot rely on regulators and the RBA if it wants to improve affordability. In March Treasurer Scott Morrison said repayment affordability would play a major part in the Budget and was a bigger issue then the difficulty of first home buyers, whilst ruling out any changes to negative gearing.

In a series of sensitivity tests, Moody’s demonstrated the risks faced by Australian homeowners. Looking at the effect of house prices continuing to rise, income decreasing and interest rates increasing, Moody’s found Sydney homeowners were particularly vulnerable. A 10% rise in property values – far from unknown in the harbour city – meant an extra 3.8% of income needed to meet mortgage repayments.

Moody’s report did find that affordability was unchanged for apartments. Apartment owners spent an average of 24.5% of their income on repayments, compared to 29.3% for house owners. This is a national average: affordability of apartments did decline in Sydney and Melbourne.

Banks exposed to mortgage broker risk

From Investor Daily.

The Australian mortgage market’s heavy reliance on brokers increases system-wide bank risk, warns Spectrum Asset Management.

In a ‘Spectrum Insights’ article released recently, Spectrum Asset Management principal Damien Wood put forward his views that the third-party channel is a significant risk that could spark problems for Australia’s banks.

Mr Wood noted that while high levels of household debt and interest-only mortgages have received plenty of attention, Australia’s preferred home loan channel is also a cause for concern.

“Spectrum sees another potential source of pain for Australian banks – the heavy reliance on mortgage brokers,” he said.

“Around half of the mortgage market originates from brokers. These agents can be far more financially motivated than bank branch employees to sell mortgages.”

Mr Wood likened the risks associated with Australia’s use of mortgage broking to the pre-financial crisis in the United States, where he said controls and borrowers’ best interests are “subordinated behind brokers’ financial gain”.

“System-wide, this high reliance on brokers is a concern. At the individual bank level, it may also be a key differentiating factor in a bank’s financial health should Australian mortgage losses start to rise,” he said.

The crux of Mr Wood’s argument came down to remuneration. He argues that brokers are primarily motivated by commissions, unlike bank staff, who, he says, are motivated by a “broader range of benefits – cornerstone of these factors is a career as a banker”.

Mr Wood said that the downside for a mortgage broker, if bad loans are written, is some foregone trailing commission in the future.

“However, the downside for a bank employee is job loss and potentially lost hopes of continuing in the field of banking,” he said.

Mr Wood fears that the “extensive use of mortgage brokers and embellished loan applications” will cause financial pain among lenders when borrowing conditions in Australia deteriorate.

“At Spectrum, should we foresee mortgage stress rising, we will look to further scale back our underweight position in Australian banks,” he said.

In an effort to compare the current Australian home loan market to pre-GFC America and the era of ‘liar loans’, Mr Wood pointed to a 2016 UBS study in Australia that found 28 per cent of mortgagors claimed to have factually inaccurate applications.

“The ratio rose to 32 per cent for those using brokers. What is worse is that the study found 41 per cent of those who lied in their applications did so at the encouragement of their brokers!” he said.

“Of course, many brokers are honest and we suspect the bulk of the borrowers using them are creditworthy. Banks, however, are leveraged around 15 times. It takes just a small amount of mortgage losses to make a big dent on profits.”

The UBS report was condemned by the FBAA when it was first released in October last year.

The FBAA’s Peter White questioned the accuracy of the entire survey, highlighting that the number of people purportedly surveyed represented only an estimated 0.09 per cent of all mortgages settled over the two-year time period.

He also pointed out that the study’s figures were inconsistent with APRA and industry data, and emphasised that there was “zero credibility” in the claims of borrowers who admit to falsifying documents.

“Let’s be honest — if you are admitting to misrepresentation on a legal document it’s very easy to blame someone else and claim they made you do it,” he said.

Housing’s Echo Bubble Now Exceeds The 2006-07 Bubble Peak

From Of The Two Minds Blog.

If you need some evidence that the echo-bubble in housing is global, take a look at this chart of Sweden’s housing bubble.

A funny thing often occurs after a mania-fueled asset bubble pops: an echo-bubble inflates a few years later, as monetary authorities and all the institutions that depend on rising asset valuations go all-in to reflate the crushed asset class.

Take a quick look at the Case-Shiller Home Price Index charts for San Francisco, Seattle and Portland, OR. Each now exceeds its previous Housing Bubble #1 peak:

Is an asset bubble merely in the eye of the beholder? This is what the multitudes of monetary authorities (central banks, realty industry analysts, etc.) are claiming: there’s no bubble here, just a “normal market” in action.

This self-serving justification–a bubble isn’t a bubble because we need soaring asset prices–ignores the tell-tale characteristics of bubbles. Even a cursory glance at these charts reveals various characteristics of bubbles: a steep, sustained lift-off, a defined peak, a sharp decline that retraces much or all of the bubble’s rise, and a symmetrical duration of the time needed to inflate and deflate the bubble extremes.

It seems housing bubbles take about 5 to 6 years to reach their bubble peaks, and about half that time to retrace much or all of the gains.
Bubbles have a habit of overshooting on the downside when they finally burst. The Federal Reserve acted quickly in 2009-10 to re-inflate the housing bubble by lowering interest rates to near-zero and buying over $1 trillion of mortgage-backed securities.

When bubbles are followed by echo-bubbles, the bursting of the second bubble tends to signal the end of the speculative cycle in that asset class. There is no fundamental reason why housing could not round-trip to levels below the 2011 post-bubble #1 trough.

Consider the fundamentals of China’s remarkable housing bubble. The consensus view is: sure, China’s housing prices could fall modestly, but since Chinese households buy homes with cash or large down payments, this decline won’t trigger a banking crisis like America’s housing bubble did in 2008.

The problem isn’t a banking crisis; it’s a loss of household wealth, the reversal of the wealth effect and the decimation of local government budgets and the construction sector.

China is uniquely dependent on housing and real estate development. This makes it uniquely vulnerable to any slowdown in construction and sales of new housing.

About 15% of China’s GDP is housing-related. This is extraordinarily high. In the 2003-08 housing bubble, housing’s share of U.S. GDP barely cracked 5%.

Of even greater concern, local governments in China depend on land development sales for roughly 2/3 of their revenues. (These are not fee simple sales of land, but the sale of leasehold rights, as all land in China is owned by the state.)

There is no substitute source of revenue waiting in the wings should land sales and housing development grind to a halt. Local governments will lose a majority of their operating revenues, and there is no other source they can tap to replace this lost revenue.

Since China authorized private ownership of housing in the late 1990s, homeowners in China have only experienced rising prices and thus rising household wealth. The end of that “rising tide raises all ships” gravy train will dramatically alter China’s household wealth and local government income.If you need some evidence that the echo-bubble in housing is global, take a look at this chart of Sweden’s housing bubble. Oops, did I say bubble? I meant “normal market in action.”

Who is prepared for the inevitable bursting of the echo bubble in housing? Certainly not those who cling to the fantasy that there is no bubble in housing.

APRA releases final revised Prudential Practice Guide APG 120 Securitisation

APRA has released the final revised Prudential Practice Guide APG 120 Securitisation (APG 120) in response to feedback from industry submissions.

Whilst the final changes may appear technical, they do provide more latitude to securitisers than originally envisaged.

The final revised APG 120 will have effect from 1 January 2018.

In November 2016, APRA released the final revised Prudential Standard APS 120 Securitisation (APS 120) (effective 1 January 2018). APRA also released for consultation a draft revised APG 120.

APRA received two submissions in response to the draft revised APG 120. APRA’s responses to the key matters raised are set out below.

Derivatives transactions

The final revised APS 120 requires ADI swap providers in securitisation schemes to be senior in the cash flow waterfall. The draft revised APG 120 clarifies that this ranking includes where the ADI is a defaulting party under the swap, and for uncollected break costs.

Comments received

Both submissions commented that requiring ADI swap providers to be senior where the ADI is a defaulting party under the swap, and for uncollected break costs, may increase the overall costs of securitisations and reduce the number of swap counterparties that provide swaps to securitisations.

APRA response

APRA has reconsidered this position and has clarified in the final revised APG 120 that swaps may be treated as senior ranking for regulatory capital purposes where the ADI is a defaulting party under the swap, and for uncollected break costs. APRA recognises that default of an ADI swap provider would not necessarily relate to the performance of the underlying exposures. In the case of uncollected break costs, these amounts are at the discretion of the ADI and therefore certainty of cashflow to the securitisation trust, for these amounts, is not assured.

Shared collateral and trust-back agreements

Under the final revised APS 120, trust-back loans (non-securitised loans) are ineligible for risk weights of less than 100 per cent, unless the ADI has a formal second mortgage in regard to the securitised loans used as collateral.

Comments received

Both submissions reiterated that the requirement for an ADI to obtain a formal second mortgage in these circumstances is operationally burdensome and impractical. Both submissions asserted that trust-back agreements are structured to legally operate so as to afford equivalent rights to a formal second mortgage.

APRA response

In light of industry comments, including the operational burden of obtaining formal second mortgages and that shared collateral agreements can be constructed to legally operate so as to afford equivalent rights, APRA has clarified in the final revised APG 120 that, subject to certain conditions, a shared collateral agreement may be considered equivalent to a formal second mortgage for the purposes of APS 120 only.

Warehouse arrangements

The draft revised APG 120 provides some flexibility for originating ADIs to agree a new funding rate to extend a warehouse funding line, provided no other terms and conditions of the securitisation are amended.

Comments received

Both submissions commented that additional flexibility to change the terms and conditions of a warehouse, including credit enhancement and subordination levels and pool parameters, should be permitted for both capital relief and funding-only warehouses.

Both submissions also requested that existing warehouses ineligible for regulatory capital relief should be permitted to be amended prior to 1 January 2018 to minimise increases in regulatory capital requirements under the final revised APS 120. In the absence of this flexibility, the originating ADI may incur substantially higher funding costs.

APRA response

With the exception of self-securitisations, the final revised APS 120 prohibits an ADI from increasing a first loss position or providing a credit enhancement after the inception of a transaction. APRA considers additional flexibility to change the terms and conditions of a warehouse contrary to this requirement.

However, for existing warehouses ineligible for regulatory capital relief, APRA is prepared as a transitional measure to allow ADIs some flexibility to restructure the terms and conditions of these securitisations, provided this occurs by 1 January 2018. APRA supervisors will be in contact with ADIs with respect to any plans to utilise these transitional arrangements.