The Debt Monster – The Property Imperative Weekly – 19 Aug 2017

Household Incomes are growing at the slowest rate for two decades, putting more strain on family budgets who are wrestling with rising costs and bigger mortgages and battling the debt monster.

What the implications for home prices, and the broader economy? Welcome the Property Imperative weekly to 19th August 2017, as we look at the latest finance and property news.

Last week we saw auction clearance rates accelerate. According to CoreLogic they rose to 2,011, compared with 1,857 over the previous week.  This was the largest number of auctions held since the last week of June 2017 and one third higher compared with the same week a year ago. Melbourne has held the record for the largest number of sales, but Sydney achieved a higher clearance rate at 72%. So not much sign of the property market flagging.

More data came from the RBA when Assistant Governor Christopher Kent discussed insights from a dataset which covers about 280 ‘pools’ of securitised assets and has information on 1.6 million individual mortgages with a total value of around $400 billion. Currently, this accounts for about one-quarter of the total value of home loans outstanding in Australia.

A couple of caveats. While the dataset covers a significant share of the market for housing loans, it may not be entirely representative across all its dimensions. In particular, the choice of assets in the collateral pool may be influenced by the way that credit ratings agencies assign ratings and by investor preferences. Also, in practice it may take quite a while until new loans enter a securitised pool.

But the first thing to note is that rates on owner-occupier loans and investor loans used to be similar, but investor loans became relatively more expensive from the latter part of 2015. In fact, up until most recently, actual rates paid on interest-only loans have been lower than those on principal-and-interest loans. But now, interest only loans are significantly more expensive for both owner-occupied and investor borrowers. This is reflecting recent bank repricing as they seek to repair margins and throttle back interest only lending in response to regulatory pressure. Monthly repayments are on the rise, and on large loans this is a significant impost.

Looking at loan to value ratios, we see that there is a large share of both owner-occupier and investor loans with current LVRs between 75 and 80 per cent. That is consistent with banks limiting the share of loans with LVRs (at origination) above 80 per cent. Also, borrowers have an incentive to avoid the cost of mortgage insurance, which is typically required for loans with LVRs (at origination) above 80 per cent. This is consistent with the DFA market model, and suggests that a common held view that the average LVR is circa 50% is not correct any more. Bigger loans, lower equity, larger repayments.

Finally, they looked at offset accounts, which showed strong growth up to 2015 probably related to the rise in the share of interest-only loans, with the two being offered as a package. Interestingly, we saw a significant slowing in growth in offset balances around the same time as growth in interest-only housing loans started to decline. Offset balances provide some security for borrowers in times of finance stress.  But the RBA highlights that for investor loans, even after accounting for offset balances, there is still a noticeable share of loans with current LVRs of between 75 and 80 per cent. And for both investor and owner-occupier loans, adjusting for offset balances leads to only a small change in the share of loans with current LVRs greater than 80 per cent. This suggests that borrowers with high current LVRs have limited repayment buffers.

Oh, and note there was no analysis at all on the most critical metric – loan to income ratios, which as we have been highlighting is a more reliable risk assessment tool, but one which in Australia we appear loathe to discuss.

This becomes important when we consider that home prices continue to rise in most states. Separate analysis from CoreLogic showed that the cost of housing has continued to rise across most parts of the country over the past 12 months, pushing the proportion of homes selling for at least one million dollars to new record highs.  Bracket creep should come as no surprise in markets like Sydney and Melbourne where dwelling values have increased by 77% and 61% respectively over the past five years.  While the rise in housing values has been most pronounced in Sydney and Melbourne, most other capital cities and regional areas have also seen a proportional lift in home sales over the million-dollar mark.

The banks continue to lend strongly in the mortgage sector, with system growth still sitting around 6% over the past year. ANZ, who reported their third quarter results this week revealed that they had grown their owner occupied lending at 1.3 times system growth, whilst investor loans grew at 0.8%. Lenders are still banking on mortgage credit growth.

The RBA minutes were more muted this month, perhaps because of the reaction to the 2% rate lift to neutral last month, which was hurriedly walked back subsequently! They mentioned concerns about high household debt again, and that inflation is running below 2%. They also mentioned that the Australian Bureau of Statistics intends to update the weights in the CPI in the December quarter 2017 CPI release, to reflect changes in consumers’ spending behaviour over recent years. This is expected to lead to lower reported CPI inflation because the weights of items whose prices had fallen were likely to be higher, whereas the weights of items whose prices had risen were likely to be lower.

Underlying inflation was expected to be close to 2 per cent in the second half of 2017 and to edge higher over the subsequent two years. Retail electricity prices were expected to increase sharply in the September quarter. They said “ongoing low wage growth and the high level of debt on household balance sheets raised the possibility that consumption growth could be lower than forecast”.

The income data from the ABS confirmed low wage growth, with seasonally adjusted, private sector wages up just 1.8 per cent and public sector wages up 2.4 per cent through the year to June quarter 2017. So wages for those not fortunate enough to work in the public sector continues to be devalued in real terms.  Also, whilst more jobs were created in July, the employment rate is still quite high, and underemployment remains a significant factor – one reason why wages growth is unlikely to shift higher.

So, what are the consequences of home lending rising 6%, inflation 2% and incomes below this? The short answer is more debt, and mostly mortgage debt.

To get a feel for the impact of this, look at our recent focus group results.  Around two thirds of the households in the session held a basic assumption that high debt levels were normal. They had often accumulated debts through their education, when they bought a house, and running credit cards. Even more interestingly, their concern from a cash flow perspective was about servicing the debts, not repaying them. One quote which struck home was “once I am dead, my debts are cancelled, I just keep borrowing until then”.

Debt, it seems has become part of the furniture, and will remain a spectre at the feast throughout their lifetime.  The banks will be happy!

So it is worth looking at some long term trends, as we did on Friday using RBA data.

The traditional argument trotted out is that household wealth is greater than ever, this despite low income growth and rising debt. But of course wealth is significantly linked to home prices, which in turn is linked to debt, so this is a circular argument. You get a different perspective by looking at some additional trends.  And if property prices fell it would all turn sour.

But let’s start with the asset side of the ledger. Since 1999, superannuation has grown by 181.2%, and at the fastest rate. But it is arguably the least accessible asset class.

Residential property values rose 160.2% over the same period, and grew significantly faster than equities which achieved 135.8% growth, so no wonder people want to invest in property – the capital returns have been significantly more robust. Deposit savings grew 159.1% (but the savings ratio has been declining recently). Overall household net worth rose 151.2%. So the story about households being more affluent can be supported on this view of the data. But it is myopic.

Overall household debt rose 161.9%, a growth rate which is higher than residential property values, at 160.2% and above overall household net worth at 151.2%.

But the growth in income, which is a puny 60.5%, under half the asset growth. OK, interest rates are lower now, but this increase in leverage is phenomenal – and explains the “debt is normal” findings from our focus groups. I accept debt is not equally spread across the population, but there are significant pockets of high borrowing, as can be seen from our mortgage stress analysis – and it’s not just among battling urban fringe mortgage holders.

Finally, it is worth noting the growth in the number of residential properties rose by just 29.8% over the same period. So the average value of individual properties has increased significantly. On paper.

To me this highlights we have learned nothing from the GFC. Our appetite for debt, supported by the low interest rate monetary policy, significant tax breaks, and salted by population growth has created a debt monster, which has the capacity to consume many if interest rates were to rise towards more normal levels. Unlike Governments, household debt has to be repaid, eventually.

This data series shows clearly the relationship between more debt and home prices, they feed of each other, and this explains why the banks have enjoyed such strong balance sheet growth. But the impact on households is profound, and long term. Our current attitude to debt will be destructive eventually.

If you are interested in this debate, try to watch ABC Four Corners on Monday night, as they will be looking at the housing bubble and mortgage stress, and using some of our data in the programme.

And that’s the Property Imperative to 19th August 2017. If you found this useful, do subscribe to get updates, and check back for next week’s installment. Thanks for watching.

Another Perspective On Debt

We had significant reaction to yesterday’s post on the “normal” status of high household debt. So today we take the argument further using data from the RBA Household Balance Sheet series (E1) and the recent ABS data on income growth.

The traditional argument trotted out is that household wealth is greater than ever, this despite low income growth and rising debt. But of course wealth is significantly linked to home prices, which in turn is linked to debt, so this is a circular argument. You get a different perspective by looking at some additional trends.

But lets start with the asset side of the ledger. We have base-lined the data series from 1999. Since then, superannuation has grown by 181.2%, and at the fastest rate. But it is arguably the least accessible asset class.

Residential property values rose 160.2% over the same period, and grew significantly faster than equities which achieved 135.8% growth, no wonder people want to invest in property – the capital returns have been significantly more robust. Deposit savings grew 159.1% (but the savings ratio has been declining recently). Overall household net worth rose 151.2%. So the story about households being more affluent can be supported on this view of the data. But it is myopic.

The chart below tracks overall household debt, house prices, household net worth, income growth and the growth in the number of residential properties.

Overall household debt rose 161.9%, a growth rate which is higher than residential property values, at 160.2% and above overall household net worth at 151.2%.

But look at the growth in income, which is 60.5%, under half the asset growth. OK, interest rates are lower now, but this increase in leverage is phenomenal – and explains the “debt is normal” findings from our focus groups. I accept debt is not equally spread across the population, but there are significant pockets of high borrowing, as can be seen from our mortgage stress analysis – and its not just among battling urban fringe mortgage holders.

Finally, it is worth noting the growth in the number of residential properties rose by just 29.8% over the same period. So the average value of individual properties have increased significantly. On paper.

To me this highlights we have learned nothing from the GFC, our appetite for debt, supported by the low interest rate monetary policy, significant tax breaks, and salted by population growth has created a debt monster, which has the capacity to consume many if interest rates were to rise towards more normal levels. Unlike Governments, household debt has to be repaid, eventually.

This data series shows clearly the relationship between more debt and home prices, they feed of each other, and this explains why the banks have enjoyed such strong balance sheet growth. But the impact on households is profound, and long term.

Our current attitude to debt will be destructive eventually.

Central Bank Inflation Targetting

The Reserve Bank of New Zealand has published a Bulletin article on “An international comparison of inflation-targeting frameworks“. The article compares the inflation-targeting frameworks of 10 advanced economy central banks.

The Reserve Bank of New Zealand (‘RBNZ’) began targeting inflation as a mechanism to ensure price stability in 1988. The RBNZ’s inflation target framework was then formalised with the Reserve Bank of New Zealand Act (1989) and when the first Policy Targets Agreement (‘PTA’) was set in 1990. The Bank of Canada was the second central bank to target inflation, in order to achieve price stability, in 1991. Since then inflation targeting has become internationally regarded as a conventional monetary policy framework. Inflation-targeting frameworks have continued to evolve based on individual country experiences; consequently it is useful to periodically compare the formal and informal inflation-targeting frameworks across advanced economies and understand the key similarities and differences. A previous article by Wood and Reddell (2014) compared the goals for monetary policy across inflation-targeting countries by focusing on primary legislation. This article expands on that analysis by comparing the inflation-targeting frameworks, including informal frameworks, with actual practices.

This article compares the frameworks and practices of 10 advanced economies that employ either full or partial inflation targeting.  This includes six ‘fully fledged’ inflation-targeting central banks: Reserve Bank of New Zealand, the Bank of England (‘BoE’), Norges Bank, the Bank of Canada (‘BoC’), the Reserve Bank of Australia (‘RBA’), and Sveriges Riksbank (‘Riksbank’). These banks explicitly target inflation over a specified time frame in order to achieve price stability, have monetary policy independence, regularly announce monetary policy decisions, and are accountable for policy decisions. Several large central banks also use elements of inflation targeting without either explicitly announcing an inflation target, or they have other objectives alongside low and stable inflation. These are the European Central Bank (‘ECB’), the Swiss National Bank (‘SNB’), the United States Federal Reserve (‘Fed’), and the Bank of Japan (‘BoJ’). Given their importance to international monetary policy, we also assess their frameworks and practices.

The comparison covers five components of an inflation-targeting framework: inflation target definition, communication of monetary policy, secondary considerations5, assessment of the inflation-targeting performance, and framework reviews and revisions. The comparison reveals four key findings.

  1. Despite large differences across inflation-targeting frameworks, the central banks operate and communicate monetary policy similarly.
  2. The central banks pursue forward-looking inflation targets and produce reports that support ex ante and ex post performance
  3. The central banks take account of secondary considerations when setting monetary policy, but not all inflation-targeting frameworks detail how central banks should make these secondary considerations, particularly with regard to financial stability.
  4. Several countries have published reviews of and made revisions to their inflation-targeting frameworks. However, the revisions to the frameworks are not always based on recommendations from published reviews.

The most striking observation from the paper however is the fact that most of the central banks do not expect inflation to return to target any time soon.

This would imply lower interest rates for longer, despite asset price bubbles. This begs the question, is inflation targetting really good and effective policy?

Broker loans almost reach $50bn mark in 2Q17

From Australian Broker.

Australian mortgage brokers have broken new records, bringing in $49.46bn worth of residential home loans through the June 2017 quarter.

This figure, which comes from the Mortgage & Finance Association of Australia’s (MFAA’s) latest quarterly industry survey, shows a growth in loan settlements of $3.4bn between the March and June quarters this year.

The research also found that finance brokers settled 51.5% of all new residential home loans in Australia between April and June. This was an increase of 1.4% from the same time period in 2016.

While this was a decrease from the 53.6% broker market share recorded in the March quarter of this year, this drop was merely seasonal, MFAA CEO Mike Felton told Australian Broker.

“The June quarter is always the seasonal low point in percentage terms in the reporting cycle for broker volumes followed by the December quarter. To get the best view you need to compare June quarters between 2016 and 2017.”

While the seasonal increase observed in the value of home loan business written by brokers in the June quarter was partly responsible for higher lending figures in dollar terms, home prices on the eastern seaboard will also have likely contributed to this result, he said.

The increased market share data reflects the ongoing strength of the industry as well as consumer confidence in the broker proposition, Felton noted.

“Finance brokers provide consumers with greater choice, better personal service, expertise and flexibility. Busy people often look for the convenience brokers offer when organising residential home loans.

“Many finance brokers operate outside of normal office hours and can visit clients in their homes when arranging finance. Such flexibility and personal service is one of many compelling reasons consumers continue to strongly support finance brokers.”

The survey was conducted by CoreLogic’s Comparator service which examined the value of loans settled by 19 leading brokerages and aggregators as a percentage of the Australian Bureau of Statistics (ABS) housing finance data.

US Housing Bubble 2.0: Number Of Homebuyers Putting Less Than 10% Down Soars To 7-Year High

From Zero Hedge.

A really long, long time ago, well before most of today’s wall street analysts made it through puberty, the entire international financial system almost collapsed courtesy of a mortgage lending bubble that allowed anyone with a pulse to finance over 100% of a home’s purchase price…with pretty much no questions asked.

And while the millennial titans of high finance today may consider a decade-old case study on mortgage finance to be about as useful as a Mark Twain novel when it comes to underwriting mortgage risk, they may want to considered at least taking a look at the ancient finance scrolls from 2009 before gleefully repeating the sins of their forefathers.

Alas, it may be too late.  As Black Knight Financial Services points out, down payments, the very thing that is supposed to deter rampant housing speculation by forcing buyers to have ‘skin in the game’, are once again disappearing from the mortgage market.  In fact, just in the last 12 months, 1.5 million borrowers have purchased a home with less than 10% down, a 7-year high.

Over the past 12 months, 1.5M borrowers have purchased a home by putting down less than 10 percent, which is close to a seven-year high in low down payment purchase volumes

– The increase is primarily a function of the overall growth in purchase lending, but, after nearly four consecutive years of declines, low down payment loans have ticked upwards in market share over the past 18 months

– Looking back historically, we see that half of all low down payment lending (less than 10 percent down) in 2005-2006 involved piggyback second liens rather than a single high LTV first lien mortgage

– The low down payment market share actually rose through 2010 as the GSEs and portfolio lenders pulled back, the PLS market dried up, and FHA lending buoyed the purchase market as a whole

– The FHA/VA share of purchase lending rose from less than 10 percent during 2005-2006 to nearly 50 percent in 2010

– As the market normalized and other lenders returned, the share of low-down payment lending declined consistent with a drop in the FHA/VA share of the purchase market

On the bright side, at least Yellen’s interest rate bubble means that today’s housing speculators don’t even have to rely on introductory teaser rates to finance their McMansions...Yellen just artificially set the 30-year fixed rate at the 2007 ARM teaser rate…it’s just much easier this way.

“The increase is primarily a function of the overall growth in purchase lending, but, after nearly four consecutive years of declines, low down payment loans have ticked upward in market share over the past 18 months as well,” said Ben Graboske, executive vice president at Black Knight Data & Analytics, in a recent note. “In fact, they now account for nearly 40 percent of all purchase lending.”

At that time half of all low down payment loans being made involved second loans, commonly known as “piggyback loans,” but today’s mortgages are largely single, first liens, Graboske noted.

The loans of the past were also far riskier – mostly adjustable-rate mortgages, which, according to the Black Knight report, are virtually nonexistent among low down payment mortgages today. Instead, most are fixed rate. Credit scores of borrowers taking out these loans today are also about 50 points higher than those between 2004 and 2007.

Finally, on another bright note, tax payers are just taking all the risk upfront this time around…no sense letting the banks take the risk while pretending that taxpayers aren’t on the hook for their poor decisions…again, it’s just easier this way.

RBA Minutes For August Says Little (In Many Words)

The latest RBA minutes really does not add much to our understanding, other than the bank continues to watch developments in the property market, they are holding to their forecasts on growth, and the signals across the economy are mixed.

Perhaps they were muted because of the reaction to the 2% rate lift to neutral last month, which was hurriedly walked back subsequently!

Domestic Economic Conditions

Members commenced their discussion of the domestic economy by noting that the June quarter inflation data had been in line with the Bank’s expectations and provided further confirmation that inflation had increased since 2016. Underlying inflation was ½ per cent in the June quarter and headline inflation was only slightly lower. Both Consumer Price Index (CPI) inflation and measures of underlying inflation were running at a little under 2 per cent in year-ended terms.

Non-tradables inflation had reached its highest year-ended rate in two years in the June quarter, boosted by rises in tobacco excise and utilities prices. Market services inflation had increased since 2016, but remained low; around half of total costs in the market services sector are labour costs, and these had been subdued over recent years. Inflation in the costs of constructing a new dwelling had also increased over the prior year in all capital cities other than Perth and Adelaide. In contrast, rents had been increasing at a below-average pace in Sydney and Melbourne, had been falling in Perth and had been broadly stable in most other capital cities.

The prices of tradable consumer durable items had declined over the year, partly reflecting the appreciation of the exchange rate and heightened competition from foreign retailers. Inflation in food prices (excluding fruit and vegetables) had been running at low rates for several years. Supply disruptions from Cyclone Debbie had had relatively little net effect on fruit and vegetables prices in the June quarter. Fuel prices had fallen in the quarter, but had contributed 0.2 percentage points to headline inflation over the year.

Members noted that the Australian Bureau of Statistics intends to update the weights in the CPI in the December quarter 2017 CPI release, to reflect changes in consumers’ spending behaviour over recent years. This was expected to lead to lower reported CPI inflation because the weights of items whose prices had fallen were likely to be higher, whereas the weights of items whose prices had risen were likely to be lower.

In their discussion of the outlook for the domestic economy, members noted that the Bank’s forecasts for output growth and inflation were largely unchanged from three months earlier. They noted that the forecasts were conditioned on the assumption of no change in the Australian dollar exchange rate during the forecast period, which extends to the end of 2019, and that this assumption was one source of uncertainty.

The available data on activity suggested that GDP growth had increased in the June quarter, following weaker-than-expected growth in the March quarter. Output growth was expected to reach around 3 per cent in year-ended terms during 2018 and 2019, which was a little higher than estimates of potential growth. The recent data had indicated that consumption growth had increased in the June quarter. The value of retail sales had risen strongly in April and May, and the increases had been broadly based both nationally and across spending categories. Beyond the June quarter, rising employment and stronger household income growth were expected to support consumption growth, which was forecast to be a little above its average of recent years.

Dwelling investment was expected to recover from the weakness in the March quarter, which was partly the result of wet weather in New South Wales, and remain at a high level over the following year or so, sustained by the large pipeline of residential building work already approved or under way. The number of new residential building approvals had stepped down since 2016 and members noted that, if approvals remained at current levels, construction activity could also begin to decline.

The established housing markets in Sydney and Melbourne had remained the strongest in the country, although conditions had eased since late 2016. Housing prices in Perth had declined a little further, while apartment price growth in Brisbane had been weak.

Turning to the business sector, members noted that activity in the mining sector was expected to be supported in the June quarter by stronger resource export volumes. Coking coal exports had returned to pre-cyclone levels in May, and liquefied natural gas exports had continued to increase. The decline in mining investment was expected to run its course in the following year or so and thereafter no longer be a drag on growth. Resource exports were expected to make a significant contribution to GDP growth over the forecast period.

Investment by non-mining businesses was expected to pick up later in the forecast period in response to stronger growth in demand. Businesses had continued to report above-average business conditions and members noted that many of the conditions that might typically be associated with stronger growth in investment were in place. Some indicators of non-mining investment, including recent strength in sales of commercial motor vehicles and the higher investment intentions recorded in the NAB survey, had been more positive in the period leading up to the meeting. The increase in the level of non-residential building approvals had also signalled a more positive outlook for private non-residential construction, although the pipeline of work to be done was at low levels. The pipeline of public infrastructure activity had increased over the previous few years, to be at its highest share of GDP since the mid 1980s. The expected increase in expenditure on public infrastructure had been reported as flowing into the order books of firms in the private sector.

Members observed that recent data had suggested further improvement in the labour market. Employment had increased in every state since the start of 2017, including solid growth in the mining-exposed states. This provided further evidence that the drag on economic activity from earlier declines in the terms of trade and falling mining investment were running their course. Over this period, around 165,000 full-time jobs had been created, labour force participation had risen and average hours worked had increased.

The unemployment rate had been little changed in June at 5.6 per cent and underemployment had edged lower over prior months. Indicators of labour demand had pointed to further employment growth and little change in the unemployment rate over coming quarters. By the end of the forecast period, the unemployment rate was expected to be just below 5½ per cent, slightly lower than forecast in May but still implying a degree of spare capacity in the labour market. Members observed that the recent improvement in labour market conditions and the increase in award wages should help support household incomes and thus spending. Some upside risk to spending could be envisaged if employment were to be higher than forecast. On the other hand, expectations of ongoing low wage growth could weigh on consumption growth. Spending could also be constrained by elevated levels of household debt, especially if housing market conditions were to weaken.

More broadly, members noted there was some uncertainty about the effect any decline in spare capacity in the labour market would have on wage and price inflation. Information from liaison indicated that some employers were finding it harder to attract workers with particular skills. If this were to broaden, wage growth could increase more quickly than forecast, which would see inflationary pressures also emerge more quickly. However, wage and price inflation had not increased by as much as expected in other economies around the world that are already close to full employment, which raised the possibility that low inflation in Australia might also persist longer than forecast.

Turning to the inflation forecast, members noted that underlying inflation was expected to be close to 2 per cent in the second half of 2017 and to edge higher over the subsequent two years. Most of the difference between headline and underlying inflation over the forecast period could be accounted for by further increases in tobacco excise and utilities prices. Retail electricity prices were expected to increase sharply in the September quarter, following the increases in retail prices in New South Wales, Queensland and Western Australia on 1 July, and the March quarter 2018, when similar increases were expected in Victoria. Members acknowledged that the second-round effects of higher utilities prices on retail prices through business costs were uncertain, partly because it was unclear when utilities contracts for businesses would be subject to renewal. Members also observed that energy is a relatively low share of costs for most businesses, although it is higher for some businesses that compete in international markets.

The inflation forecast partly reflected an expectation of a modest increase in wage growth as labour market conditions tightened further and the drag on activity and incomes from falls in mining investment and the terms of trade diminished. Working in the opposite direction were the effects of additional competition in the retail industry, the dampening effect of expanding housing supply on growth in rents, and the recent exchange rate appreciation. Headline inflation had been revised a little higher in the updated forecasts, mostly reflecting the prospect of faster growth in utilities prices, and was expected to be between 2 and 3 per cent over much of the forecast period.

International Economic Conditions

Members commenced their discussion of the global economy by noting that economic conditions had strengthened over the prior year and the improvement had broadened beyond international trade. In particular, growth in business investment had picked up in several advanced and emerging economies, including the United States, Canada, Japan and a number of economies in east Asia. Consumption growth had been resilient. Recent GDP data had generally confirmed earlier expectations and, accordingly, the forecast for global growth had been little changed since that published in the May Statement on Monetary Policy. A gradual increase in global inflationary pressures over the subsequent couple of years had seemed likely, as spare capacity in many advanced economies was expected to be absorbed, resulting in higher wage growth. However, as members noted, even though labour market conditions had already tightened in some advanced economies, wage growth and core inflation had remained subdued.

Growth in GDP in China had been a little stronger than expected in the June quarter, supported by accommodative financial conditions and expansionary fiscal policy. The strengthening in conditions in the industrial sector over recent months had been broadly based; construction activity had been resilient, although housing market policies introduced in some cities over the preceding year had been effective in lowering overall housing price inflation. Demand for both consumer goods and Chinese exports had picked up. The strength in manufacturing and construction activity had contributed to higher demand for steel. As a result, imports of iron ore, including from Australia, had trended higher and prices for iron ore and coking coal had increased since the previous meeting. The outlook for Australia’s thermal coal exports had not benefited to the same extent, partly because there had been an increase in domestic Chinese production. The forecast for Australia’s terms of trade had been revised up a little since May, but still implied a decline from their recent peak.

Growth in China was expected to ease in 2018 and 2019 because of structural factors such as a declining working-age population, as well as policies to address financial risks. Members noted that the outlook for the Chinese economy remained a significant source of uncertainty. In particular, it was unclear how the authorities would negotiate the difficult trade-off between growth and the build-up of leverage in the Chinese economy. To address risks in the shadow banking sector, the authorities had recently sought to improve coordination among financial regulators and had announced tighter regulatory measures. Members noted that such measures could be difficult to calibrate and that, as a result, financial conditions might tighten by more than expected.

GDP growth in the rest of east Asia looked to have been around estimates of potential in the first half of 2017, supported by accommodative policies as well as the increase in global trade growth. Members noted that many economies in this region were deeply integrated into global supply chains, particularly for semiconductors and other electronics. There had also been signs of a recovery in retail sales and a sharp increase in consumer confidence in South Korea, the largest economy in the region.

In the three largest advanced economies, investment growth had picked up and employment growth had supported growth in household incomes and consumption. GDP growth had picked up in the June quarter in the United States and had been above potential rates for some time in the euro area and Japan, which had experienced sizeable increases in exports as global economic conditions had improved. GDP growth in all three major advanced economies was expected to remain above estimates of potential growth over the forecast period. Unemployment rates had declined to low levels in all three economies and in the United States and Japan were below levels associated with full employment.

Financial Markets

Members noted that over recent months most attention in international financial markets had been on changes in expectations regarding monetary policy. In a number of advanced economies, monetary policy was expected to be somewhat less accommodative than previously anticipated.

At its June meeting, the US Federal Open Market Committee (FOMC) increased its policy rate and outlined plans for a gradual and predictable reduction in the size of the Federal Reserve’s balance sheet. More recently, the FOMC had indicated that the balance sheet reduction would be likely to begin relatively soon. Financial market participants continued to expect further increases in the US federal funds rate to occur more slowly than implied by the median projections of FOMC participants. At its July meeting, the European Central Bank had emphasised that monetary policy needed to remain very accommodative, but had also indicated that it will consider whether to reduce the pace of asset purchases at one of its forthcoming meetings. In July, the Bank of Canada raised its policy rate for the first time in seven years and financial market participants expected further increases. Central banks in several other advanced economies had also adjusted their communication over recent months so as to remove earlier biases towards easier monetary policy.

Long-term government bond yields had responded to the changes in expectations for the stance of monetary policy, with yields in most major financial markets, as well as in Australia, having risen from their levels in early June. Members noted, however, that yields remained at low levels. In Japan, yields on 10-year government bonds had remained around zero during 2017, consistent with the Bank of Japan’s policy of yield curve control.

Members observed that financial market conditions remained very favourable. Corporate financing conditions had continued to improve, with the increase in equity prices and decline in corporate bond spreads having continued over 2017 in the United States and the euro area.

In China, financial market conditions also remained accommodative, but had tightened since the end of 2016 as the authorities had instituted a range of measures to reduce leverage in financial markets. Bond yields had increased markedly since late 2016, despite a slight retracement in recent months, and corporate bond issuance had slowed following strong growth over the preceding several years. Members observed that credit availability to households and businesses had been relatively unaffected by the regulatory measures. The renminbi exchange rate had appreciated against the US dollar since the beginning of 2017, but had depreciated in trade-weighted terms. The Chinese authorities had increased their scrutiny of capital flows, resulting in a decline in net capital outflows, and the value of the People’s Bank of China’s foreign currency reserves had stabilised.

Members noted that there had been a broadly based depreciation of the US dollar over 2017, including against the Australian dollar. The appreciation of the Australian dollar over the previous two months had resulted in it returning to 2015 levels in US dollar terms and to the levels of late 2014 on a trade-weighted basis.

In Australia, housing credit growth had been steady over the first half of 2017, as a decline in growth in housing credit extended to investors had been offset by a slight increase in growth in housing credit to owner-occupiers. Members discussed the relative increases in housing lending rates to investors compared with owner-occupiers and for interest-only loans compared with principal-and-interest loans. Overall, the average actual interest rate paid on all outstanding housing loans was estimated to have increased slightly since late 2016. Housing loan approvals to investors had declined in recent months, which pointed to some easing in growth in housing credit to investors. The share of interest-only housing loans in total loan approvals appeared to have declined noticeably in the June quarter in response to recent measures introduced by the Australian Prudential Regulation Authority (APRA) to improve lending standards. Moreover, there was evidence of some switching of existing interest-only loans to principal-and-interest loans.

Australian share prices had been broadly steady in recent months. Over July, bank share prices had retraced some of their earlier decline, in line with a rise in bank share prices globally and following APRA’s announcement of additional capital requirements for the banking sector, which were only slightly higher than banks’ current actual capital ratios. The major banks had been issuing increasingly longer-dated bonds, including two large US-denominated 30-year bond issues in July. Members noted that longer-dated bonds are favoured under the Net Stable Funding Ratio requirement, which will come into effect in 2018. Members also noted that Australian issuance of residential mortgage-backed securities had continued at the relatively strong pace seen since late 2016.

Financial market pricing had continued to suggest that the cash rate was expected to remain unchanged over the remainder of 2017, with some expectation of an increase in the cash rate by mid 2018.

Considerations for Monetary Policy

In considering the stance of monetary policy, members noted that the improvement in global economic conditions had continued, particularly in China and the euro area. Demand growth from the Chinese industrial sector had been stronger than expected and had contributed to higher commodity prices. Labour markets had continued to tighten in a number of economies, but inflation had generally remained subdued. There had been a broadly based depreciation of the US dollar. Consistent with that, a number of currencies were close to their highs of the previous few years against the US dollar, including the euro and the Canadian dollar. The Australian dollar also had risen to levels last seen in 2015.

Domestically, the outlook was little changed. The forecast was for GDP growth to increase to around 3 per cent during the forecast period, supported by the low level of interest rates. Business conditions had improved further and faster growth in non-mining business investment was expected. Inflation was still expected to increase gradually as the economy strengthened. However, a further appreciation of the exchange rate would be expected to result in a slower pick-up in inflation and economic activity than currently forecast.

Employment growth had been stronger over recent months, so the forecasts for the labour market were starting from a stronger position. Forward-looking indicators suggested that the degree of spare capacity in the labour market would continue to decline gradually. Wage growth had remained low but was still expected to increase a little as conditions in the labour market improved. Members observed that recent strong employment growth would be likely to contribute to an increase in household disposable income, and therefore consumption growth, over the forecast period. However, ongoing low wage growth and the high level of debt on household balance sheets raised the possibility that consumption growth could be lower than forecast.

Members regarded conditions in the housing market and household balance sheets as continuing to warrant careful monitoring. Conditions in the housing market varied considerably around the country. While there were signs that conditions in the Sydney and Melbourne markets had eased somewhat, housing price growth in these two cities had remained relatively strong. In some other housing markets, prices had been declining. Borrowers investing in residential property had been facing higher interest rates and growth in credit to investors had eased, but overall housing credit growth had continued to outpace the relatively slow growth in household incomes.

Taking account of the available information and the need to balance the risks associated with high household debt in a low-inflation environment, the Board judged that holding the stance of monetary policy unchanged would be consistent with sustainable growth in the economy and achieving the inflation target over time.

The Decision

The Board decided to leave the cash rate unchanged at 1.5 per cent.

APRA To Ease New Banking Entrance Requirements

APRA is reviewing its licensing approach for authorised deposit-taking institutions (ADIs). They propose new entrants could gain an interim licence and operate on a conditional basis for a period before transitioning to a full licence, with a view to increasing competition in the banking sector.

The discussion paper seeks views on the proposed amendments to introduce a phased approach to authorisation, designed to make it easier for applicants to navigate the ADI licensing process.

The phased approach is intended to support increased competition in the banking sector by reducing barriers to new entrants being authorised to conduct banking business, including those with innovative or otherwise non-traditional business models or those leveraging greater use of technology. In particular, the purpose of the Restricted ADI licence is to allow applicants to obtain a licence to begin limited operations while still developing the full range of resources and capabilities necessary to meet the prudential framework.

An overview of the phased approach is depicted below.

In facilitating a phased approach, APRA still needs to ensure community confidence that deposits with all ADIs are adequately safeguarded, and that any new approach does not create competitive advantages for new entrants over incumbents, or compromise financial stability. Therefore, reflecting their relative infancy, Restricted ADIs will be strictly limited in their activity and would not be expected to be actively conducting banking business during the restricted period.

The Restricted ADI licence will be subject to certain eligibility requirements and a maximum period after which they are expected to transition to an ADI and fully comply with the prudential framework or exit the industry.

APRA invites written submissions from all interested parties on its proposals for the phased approach to licensing new entrants to the banking sector.

Submissions close on 30 November 2017.

Submissions are welcome on all aspects of the proposals. In addition, specific areas where feedback on the proposed direction would be of assistance to APRA in finalising its proposals are outlined below.

Introduction of phased approach for ADIs​ ​Should APRA establish a phased approach to licensing applicants in the banking industry?
​Balance of APRA‘s mandate ​Do the proposals strike an appropriate balance between financial safety and considerations such as those relating to efficiency, competition, contestability and competitive neutrality?
​Eligibility ​Are the proposed eligibility criteria appropriate for new entrants to the banking industry under a Restricted ADI licence?
Restricted ADI Licence phase​ ​Is two years an appropriate time for an ADI to be allowed to operate in a restricted fashion without fully meeting the prudential framework? Is two years a sufficient period of time for a Restricted ADI to demonstrate it fully meets the prudential framework?
Minimum requirements​ ​Are the proposed minimum requirements appropriate for potential new entrants to the banking industry? Are there alternative requirements APRA should consider?
​Licence restrictions ​Are the proposed licence restrictions appropriate for an ADI on a Restricted ADI licence? Are there alternative or other restrictions APRA should consider?
Financial Claims Scheme​ ​Are the proposals appropriate in the context of the last resort protection afforded to depositors under the Financial Claims Scheme?
Further refinement​ ​Are there other refinements to the licensing process APRA should consider?

During the consultation process APRA may also look to arrange discussions of these proposals with interested parties

Some Innovative Mortgage Data

RBA Assistant Governor (Financial Markets) Christopher Kent discussed data from their securitised mortgage data pool. Currently, the dataset covers about 280 ‘pools’ of securitised assets and has information on 1.6 million individual mortgages with a total value of around $400 billion. Currently, this accounts for about one-quarter of the total value of home loans outstanding in Australia.

It is worth noting that securitised loans may not accurately represent the entire market, as loan pools are selected carefully when they are rolled into a securitised structure – “the choice of assets in the collateral pool may be influenced by the way that credit ratings agencies assign ratings and by investor preferences”. That said, there is interesting data contained in the speech, below. Note the focus on household debt. But no data on loan to income (again!)

The Reserve Bank has always emphasised the value of using a wide range of data to better understand economic developments. One relatively new source of data for us is what we refer to as the Securitisation Dataset. Today, I’ll briefly describe this dataset and then I want to tell you a few of the interesting things we are learning from it.[1]

The Bank collects data on asset-backed securities. Currently, the dataset covers about 280 ‘pools’ of securitised assets. We require these data to ensure that the securities are of sufficient quality to be eligible as collateral in our domestic market operations. The vast bulk of the assets underlying these securities are residential mortgages (other assets, such as commercial property mortgages and car loans, constitute only about 2 per cent of the pools). Some of these are ‘marketed securities’ that have been sold to external investors. There are also securities that banks have ‘self-securitised’.[2]

Self-securitisations are primarily used by participating banks for the Committed Liquidity Facility (CLF) in order to meet their regulatory requirements.[3] The size of the CLF across the banking system is currently $217 billion. Self-securitisations are also used to cover payment settlements that occur outside business hours via ‘open repo’ transactions with the RBA.

The Bank has required the securitisation data to be made available to permitted data users (such as those who intend to use the data for investment, professional or academic research). This has helped to enhance the transparency of the market. Much of that has been achieved by requiring data that is comparable across different pools of securities.

Another benefit of the Securitisation Dataset is that it provides a useful source of information to help us better understand developments in the market for housing loans. The dataset covers information on 1.6 million individual mortgages with a total value of around $400 billion. Currently, this accounts for about one-quarter of the total value of home loans outstanding in Australia.

Nature of the data

Let me make a few brief remarks about the nature of the data.

For each housing loan, we collect (de-identified) data on around 100 fields including:

  • loan characteristics, such as balances, interest rates, loan type (e.g. principal-and-interest (P&I), interest-only), loan purpose (e.g. owner-occupier, investor) and arrears status;
  • borrower characteristics, such as income and the type of employment (e.g. pay as you go (PAYG), self-employed);
  • details on the collateral underpinning the mortgage, such as the type of property (e.g. house or apartment), its location (postcode) and its valuation.[4]

The dataset is updated each month with a lag of just one month. The frequency and timeliness of the data allow us to observe changes in interest rates, progress on repayments (i.e. the current loan balance) and the extent of any redraw or offset balances (just to name a few) without much delay.

I should note that, while the dataset covers a significant share of the market for housing loans, it may not be entirely representative across all its dimensions. In particular, the choice of assets in the collateral pool may be influenced by the way that credit ratings agencies assign ratings and by investor preferences. Also, in practice it may take quite a while until new loans enter a securitised pool. I’ll mention one important example of this later.

Now let’s look at some interesting things we have learnt from this dataset.

1. Interest Rates

In the years prior to 2015, banks would generally advertise only one standard variable reference rate for housing loans.[5] There was no distinction, at least in advertised rates, between investors and owner-occupiers, or between principal-and-interest and interest-only loans. That changed when the banks responded to requirements by the Australian Prudential Regulation Authority (APRA) to tighten lending standards, with a particular focus on investor loans. Then, earlier this year, APRA and the Australian Securities and Investments Commission (ASIC) further tightened lending standards: this time the focus was on interest-only lending. A key concern has been that interest-only loans are potentially more risky than principal-and-interest loans. This is because with a principal-and-interest loan the borrower is required to regularly pay down the loan and build up equity. Also, interest-only borrowers can face a marked step-up in their required repayments once they come off the interest-only period (after the first few years of the loan term).

Among other things, the banks have responded to these regulatory actions by increasing interest rates on investor and interest-only loans. There are now four different advertised reference rates, one for each of the key types of loans (Graph 1). While the data in Graph 1 provide a useful guide to interest rate developments, they only cover advertised or reference rates for variable loans applicable to the major banks. Actual rates paid on outstanding loans differ from these for a few reasons. Borrowers are typically offered discounts on reference rates, which can vary according to the characteristics of the borrower and the loan. Discounts offered may vary across institutions, reflecting factors such as funding costs and market segmentation. (For example, non-bank lenders typically compete for different borrowers than the major banks.) The level of the discounts has also varied over time. Furthermore, there are fixed-rate loans, for which rates depend on the vintage of the loan.

Graph 1
Graph 1: Variable Reference Interest Rates

 

The Securitisation Dataset provides us with a timely and detailed source of information on the actual interest rates paid by households on their outstanding loans. Graph 2 shows rates paid on specific types of loans and by different types of borrowers.[6]

Graph 2
Graph 2: Outstanding Variable Interest Rates

 

The first thing to note is that rates on owner-occupier loans and investor loans used to be similar, but investor loans became relatively more expensive from the latter part of 2015. Again, this followed regulatory measures to impose a ‘benchmark’ on the pace of growth of investor credit, which had picked up noticeably.

The second development I’d draw your attention to is the variation in housing loan interest rates over time. There were declines in 2016 following the reduction in the cash rate when the Reserve Bank eased monetary policy in May and then August. More recently, rates have increased for investor loans and interest-only loans, with a premium built into the latter as lenders have responded to the tightening in prudential guidance earlier this year. As part of that guidance, lenders will be required to limit the share of new mortgages that are interest-only to 30 per cent. Meanwhile, interest rates on principal-and-interest loans to owner-occupiers are little changed and remain at very low levels. Pulling this all together, the average interest rate paid on all outstanding loans has increased since late last year, but only by about 10 basis points.

A third and subtle point relates to the differences in the level of interest rates actually paid on different loan products (Graph 2) when compared with reference rates (Graph 1). The reference rates suggest that any given borrower would expect to pay a higher rate on an interest-only loan than on a principal-and-interest loan. That makes sense for two reasons. First, because the principal is paid down in the case of principal-and-interest loans, those loans are likely to be less risky for the banks; other things equal, you would expect them to attract a lower interest rate. Second, the banks have added a premium to interest-only loans of late to encourage customers to take on principal-and-interest loans and constrain the growth of interest-only lending.

But Graph 2 (based on securitised loans) suggests that, up until most recently, actual rates paid on interest-only loans have been lower than those on principal-and-interest loans. This doesn’t necessarily imply a mispricing of risk. Rather, it appears to reflect differences in the nature of loans and borrowers across the two types of loan products. In particular, borrowers with an interest-only loan tend to have larger loan balances (of around $85 000–100 000) and higher incomes (of about $30 000–40 000 per annum).[7]

We can control for some of these differences between loan characteristics (such as loan size, loan-to-valuation ratio (LVR) and documentation type). When we do that, we find that rates have been much more similar across the two loan types in the past; although, a wedge has opened up more recently as we’d expect (Graph 3).

Graph 3
Graph 3: Outstanding Variable Interest Rates - selected loans

 

This highlights the value of examining loan-level data. We find that interest rates are lower for borrowers that are likely to pose less risk (as indicated, for example, by lower loan-to-value ratios and full documentation). Borrowers with larger loans – who typically have higher income levels – also tend to attract lower interest rates. In relation to loan size, this suggests that borrowers with larger loans may have somewhat greater bargaining power.

2. Loan-to-Valuation Ratios and Offset Balances

The Securitisation Dataset provides us with a measure of the LVR, based on the current loan balance.[8] We refer to this here as the ‘current LVR’. This is one indicator of the riskiness of a loan. Other things equal, higher LVRs tend to be associated with a greater risk of default (and greater loss for the lender in the case of default).[9]

Graph 4 shows current LVRs for owner-occupiers and investor loans, split into interest-only and principal-and-interest loans. I should emphasise again that the Securitisation Dataset may not be entirely representative of the set of all mortgages, particularly when it comes to LVRs. That is because high LVR loans may be less likely to be added to a pool of securitised assets in order to ensure that the securitisation achieves a sufficiently high credit rating.[10]

With that caveat in mind, we see that there is a large share of both owner-occupier and investor loans with current LVRs between 75 and 80 per cent. That is consistent with banks limiting the share of loans with LVRs (at origination) above 80 per cent. Also, borrowers have an incentive to avoid the cost of mortgage insurance, which is typically required for loans with LVRs (at origination) above 80 per cent.

Graph 4
Graph 4: Loan-to-Valuation Ratios - current

 

Comparing investor loans with owner-occupier loans, we can see that investors have a larger share of outstanding loans with current LVRs of 75 per cent or higher.[11] That’s most obvious in the case of interest-only loans, but is also true for principal-and-interest loans. This reflects the investor’s financial incentive to maximise the amount of funds borrowed (without breaching the banks’ threshold above which they require lenders mortgage insurance). That can be more easily achieved with an interest-only loan. And, even in the case of principal-and-interest loans, investors don’t have the same incentives as owner-occupiers to get ahead of their scheduled repayments.

But what I’ve just shown doesn’t account for offset accounts. These have grown rapidly over recent years and are now an important feature of the Australian mortgage market (Graph 5). Funds held in these accounts are ‘offset’ against the loan balance, reducing the interest payable on the loan. In that way they are similar to a principal repayment. But, unlike the scheduled principal repayment, offset (and redraw) balances can be moved in and out freely by the borrower.

Graph 5
Graph 5: Interest-Only and Offset Account Balances

 

Part of the strong growth in offset balances up to 2015 appears to have been related to the rise in the share of interest-only loans, with the two being offered as a package. Interestingly, we saw a significant slowing in growth in offset balances around the same time as growth in interest-only housing loans started to decline.

Graph 6 highlights how the distribution of current LVRs is altered if we deduct funds held in offset accounts from the balance owing. This suggests that for owner-occupier loans, interest-only borrowers are behaving somewhat like those with principal-and-interest loans. That is, many of those borrowers have built up significant balances in offset accounts. If needed in times of financial stress – such as a period of unemployment – borrowers could use those balances to service their mortgages.

Graph 6
Graph 6: Loan-to-Valuation Ratios

 

However, I would caution against any suggestion that this similarity regarding the build-up of financial buffers means that the tightening of lending standards for interest-only loans was not warranted – far from it. What matters when it comes to financial stability is not what the average borrowers are doing, but what the more marginal borrowers are doing. There are two important points to make on this issue.

First, for investor loans, even after accounting for offset balances, there is still a noticeable share of loans with current LVRs of between 75 and 80 per cent. And for both investor and owner-occupier loans, adjusting for offset balances leads to only a small change in the share of loans with current LVRs greater than 80 per cent. This suggests that borrowers with high current LVRs have limited repayment buffers.

The second point is that more marginal borrowers are now more likely to take on a principal-and-interest loan than in the past. One reason is that there is a premium on the interest rates charged on an interest-only loan (for any given borrower, compared with an owner-occupier loan). Another reason is that banks, at APRA’s direction, have also tightened their lending standards for interest-only loans, most notably by reducing the share of new interest-only loans with high LVRs at origination.[12]

3. Arrears by region

Banks’ non-performing housing loans have increased a little over recent years (Graph 7). However, at around ¾ of one per cent as a share of all housing loans, non-performing loans remain low and below the levels reached following the global financial crisis.

Graph 7
Graph 7: Banks' Non-performing Housing Loans

 

Using the Securitisation Dataset we can assess how loans are performing across different parts of the country by examining arrears rates. Like non-performing loans, the arrears rates have increased a little but remain low.[13] Arrears have risen more in regions experiencing weak economic conditions over recent years. In particular, there has been a more noticeable pick-up in arrears rates in Western Australia, South Australia and Queensland since late 2015 (Graph 8).

Graph 8
Graph 8: Mortgage Arrears Rates

 

The Securitisation Dataset allows us to drill down even further to examine some relationships between arears and other factors. A key factor contributing to a borrower entering into arrears is a reduction in income, most obviously via a period of unemployment. We find that there is a positive relationship between arrears rates and the unemployment rate across regions (Graph 9).[14] However, the relationship is not especially strong, which suggests that other factors are at play. For example, arrears rates are higher in mining-exposed regions, which have generally experienced a sharp fall in demand following the end of the mining investment boom. One indicator of that has been the pronounced fall in the demand for housing in those parts of the country as indicated by a decline in housing prices (Graph 10).

Graph 9
Graph 9: 90+ Days Arrears Rate by Region
Graph 10
Graph 10: Mining Regions' Median House Prices

Conclusion

The Securitisation Dataset plays a crucial role in allowing the Reserve Bank to accept asset-backed securities as collateral in our domestic market operations. The development of this database and its availability to investors has also helped to enhance the transparency of the securitisation market.

A useful additional benefit of this database is that it provides us with a range of timely insights into the market for housing loans. I’ve discussed how things like actual interest rates paid, loan balances and arrears vary over time and across different types of mortgages and borrowers. Although variable interest rates for investor loans and interest-only loans have risen noticeably over recent months, the average interest rate paid on all outstanding loans has increased by only about 10 basis points since late last year. Also, many borrowers on interest-only loans have built up sizeable offset balances. But even after taking those into account, it appears that current loan-to-valuation ratios still tend to be larger than in the case of principal-and-interest loans. Finally, while mortgage arrears rates have increased slightly over recent years, they have increased more noticeably in regions exposed to the downturn in commodity prices and mining investment.

Endnotes

I thank Michael Tran and Michelle Bergmann for invaluable assistance in preparing these remarks. [*]

For more detail, see Aylmer C (2016), ‘Towards a More Transparent Securitisation Market’, Address to Australian Securitisation Conference, Sydney, 22 November. [1]

I use the term banks here to refer to all authorised deposit-taking institutions (ADIs), namely banks, building societies and credit unions. [2]

The RBA provides a Committed Liquidity Facility (CLF) to participating ADIs required by APRA to maintain a liquidity coverage ratio (LCR) at or above 100 per cent. [3]

For more details, see reporting templates on the Securitisations Industry Forum website. The valuation is typically from the time of origination. [4]

An exception was a period during the 1990s, when banks advertised distinct rates for owner-occupier and investor loans. [5]

Modernised reporting forms that are collected by APRA on behalf of the RBA and the Australian Bureau of Statistics will significantly improve the aggregate and institution-level data that are currently collected from ADIs and registered financial corporations (RFCs). While the new data will have less granularity than the Securitisation Dataset, they will have much greater coverage. [6]

The figure for income is the average of all borrowers for each loan. That is, a given loan may be in the name of more than one borrower; on average, there are 1.7 borrowers per loan. [7]

The balance of a loan is reduced via scheduled repayments of the principal and by any repayments ahead of schedule. The latter may be accessible through a redraw facility. [8]

Read, Stewart and La Cava (2014), ‘Mortgage-related Financial Difficulties: Evidence from Australian Micro-level Data’, RBA Research Discussion Paper No 2014-13. [9]

Some analysis we have conducted on the representativeness of the Securitisation Dataset suggests that it has fewer high LVR loans than the broader population of loans. There is also a tendency to include loans in securitisation pools only after they have aged somewhat (i.e. become more ‘seasoned’). [10]

The share of new investor loans with very high LVRs (above 90 per cent) at the time of origination has been declining for a few years and is below that for owner-occupier loans (Reserve Bank of Australia (2017), Financial Stability Review, April). This feature is not apparent in the data I’ve shown here, which is based on the current LVR for the stock of outstanding securitised loans, including those that are well advanced in age. [11]

APRA have instructed lenders to implement stricter underwriting standards for interest-only loans with LVRs greater than 80 per cent (see: <http://www.apra.gov.au/MediaReleases/Pages/17_11.aspx>). [12]

The 90+ days arrears rate refers to the share of loans that have been behind the required payment schedule or missed payments for 90 days or more but not yet foreclosed. [13]

These regions are defined in terms of the ABS’s Statistical Areas Level 4 (SA4s), which are geographic boundaries defined for the Labour Force Survey. The boundaries for most SA4s cover at least 100 000 persons. The Securitisation Dataset identifies loans according to the location of the mortgaged property.

 

Bendigo and Adelaide Bank FY17 Results

Bendigo and Adelaide Bank released their FY17 results today. It was perhaps stronger than expected and they have a good retail franchise. But they benefited from on-off mortgage loans repricing which helped margin and are now seeing lower mortgage volumes following the APRA guidance, so there remains much to do.

They reported an after tax statutory profit of $429.6m for the 12 months to 30 June 2017. The full year dividend was maintained at 68 cents fully franked.

Underlying cash earnings was $418.3 million, up 4.2% on the prior year.

They reported mortgage growth of 7.7%, with a strong NIM improvement of 8 basis points in the second half despite a 1 basis point fall across the year, achieving 2.26% half on half. They gave away deposit margin to grow their funding base.

Their exit margin was 2.34%. Keystart’s NII contribution was $11.3m.

Funding includes 80. 2 percent from deposits, with retail deposits up 4.7 per cent. The mix of call to term deposits swung a little to call (term down 1.1% and call up 2%).

Home lending showed a fall in approvals IH17 $8,711m approved compared with $5,419m in the 2H17.

They were impacted by APRA’s lending caps as shown by interest only flows

… and investor credit growth.

Settlements are sitting at ~$1bn per month. They say 45% of customers are ahead of minimum repayments, and 29% three or more repayments ahead.

Home loan 90+ days past due shows a persistent rise in WA (Keystart included from Jun-17 and is below the WA average). QLD was also higher.

Homesafe contributed $90.4m

Homesafe overlay reflects an assumed 3% increase in property prices for the next 18 months, before returning to a long term growth rate of 6%

Retail mortgage provisions are 0.02% in FY17, down from 0.03% at Jun-16.  Business arrears were lower, and there was a small rise in credit card arrears, to above 1.5% in Jun-17.  The specific provisions balance was $89.5m, reflecting 0.15% of gross loans compared with 0.22% a year ago.

The cost income ratio fell 2% to 56.1 per cent, on nearly flat expenses. They had 118 less FTE in FY17 and included redundancies of $4.2m.

They continued to invest in, and capitalise software.

The CET1 ratio is 8.27%, up 30 basis points from December 2016, and they say the “unquestionably strong” target will be achieved – but no details.

They continue progress towards advanced accreditation, and the investment has improved their risk management capability, whether or not they decide to switch (given APRA’s moving target!). Again, no details. Our own view is that the benefit of advanced has been significantly eroded by APRA.

 

When Will Rates Rise? – The Property Imperative Weekly 12 Aug 2017

Demand for housing credit remains firm, which explains the ongoing high auction clearance rates. So has the property market further to run and what is the RBA likely to do?

Welcome to the Property Imperative weekly to 12th August 2017, our weekly digest of the latest finance and property news.

Company results released this week included the full-year outcomes from the CBA,  half year from AMP, and 3rd Quarter results from NAB. There was a common theme through them all. Mortgage loan growth has continued, and thanks to loan and deposit repricing, net interest margins have improved in recent months. This was also helped by more benign conditions in the international capital markets. In addition, overall provisions for bad loans were reduced, despite higher delinquency rates in the troubled Western Australia market.  We think the banks, overall, will continue to churn out larger profits as they use repricing to cover the extra regulatory costs and bank taxes.  In fact savers are taking a lot of the pain, especially on term deposits, as rates fall even lower, this gets less focus compared with all the commentary is on mortgage interest rates.

Mortgage Brokers were in the news again, this week, with NAB suggesting that changes do need to be made to “improve the trust and confidence that consumers can have in brokers”.  UBS put out a research note suggesting that broker commissions will be trimmed soon, whilst CBA reported a fall in the volume of new mortgages sourced via brokers, compared with their branch channels. We are beginning to see significantly differentiated distribution strategies, with some suggesting a migration to digital will reduce the importance of the branch, whilst other lenders, like CBA are investing in new, smaller, outlets with the expectation of driving more business generation through them.   On the other hand, CBA, as a result of John Symond exercising his put option, is also buying the remaining 20% interest rest of Aussie Home Loans. Interesting timing!

RBA Governor Philip Lowe’s Opening Statement to the House of Representatives Standing Committee on Economics today contained a few gems.

Globally monetary policy stimulus may be reducing, whilst low wage growth is linked to a complex range of global factors, from technology, competition and lack of security. Locally, business investment is still sluggish, and the RBA says, household are adjusting to lower wage growth plus rising power prices and the burden of household debt.  They still back 3% growth in the years ahead. The next move in the cash rate will be up, but not for some time yet.

Ten years ago this week, French bank BNP Paribas wrote a warning of the risks in the US securitised mortgage system. Later, UK lender Northern Rock saw customers queuing to get their money from the bank, a reminder of what happens when confidence fails.  Later still, Lehmann Brothers crashed. In the ensuing mayhem, as banks fell from grace and were either left to die, or were bailed out – mostly with public funds – and as mortgage arrears rocketed away in many northern hemisphere centres.

Whilst much has changed, and banks now hold more capital, we still think there are risks in the financial system. In fact, if the RBA does raise rates here, there is a risk we could have our own version of the GFC. It was the sharp move up in mortgage rates which finally triggered the crash a decade ago. We have very high household debt, high home prices, flat income, rising living costs and ultra-low, but rising mortgage rates. We also have a construction boom, with a large supply of new (speculative) property, and banks that have around 60% of their assets in residential property. Arguably lending standards are still too lose despite recent tightening (which note, had to be imposed on the lenders by the regulators!). So the RBA will need to lift rates carefully to avoid a crash.

Lending data from the ABS showed owner occupied housing lending rose 0.5% in trend terms in the past month – or around 6% annually, well ahead of inflation.  Lending for new construction rose. But lending for investment housing fell 0.85% month on month, despite ongoing strong demand from investors in Sydney and Melbourne. First time buyers were more active in June, they made up 15.0% of transactions, compared with 14.0% in May. Property demand is actually stronger than a couple of months ago as confirmed by the still strong auction clearance rates. Other personal finance fell 1.8%.

The trend series for the value of commercial finance commitments rose 1.8%. Non housing fixed lending rose 3% and revolving credit rose 1.8%. So, perhaps, finally, we see lending by business beginning to gain momentum! This is needed for sustainable growth. The ANZ Job ads were also stronger in July, and the NAB business confidence indicators were also higher. All pointing to strong business investment, perhaps.

On the other hand, the July DFA household finance confidence index was lower with the average score at 99.3, down from 99.8 last month and below the neutral setting. However, the average score masks significant differences across the dimensions of the survey results. For example, younger households are considerably more negative, compared with older groups. This is strongly linked with property owning status, with those renting well below the neutral setting (and more younger households rent these days), whilst owner occupied home owners are significantly more positive. We also see a fall in the confidence of property investors, relative to owner occupied owners. Across the states, we see a small decline in confidence in NSW from a strong starting point, whilst VIC households were more confident in July.

The driver scorecard shows little change in job security expectations, but lower interest rates on deposits continue to hit savings. Households are more concerned about the level of debt held, as interest rate rises bite home. The impact of flat or falling incomes registers strongly, with more households saying, in real terms they are worse off. Costs of living are rising fast, with the changes in energy prices, child care costs and council rates all hitting hard. That said, the continued rises in home prices, especially in the eastern states meant that net worth for households in these states rose again, which was not the case in WA, NT or SA.

Sentiment in the property sector is clearly a major influence on how households are feeling about their finances, but the real dampening force is falling real incomes and rising costs. As a result, we still expect to see the index fall further as we move into spring, as more price hikes come through. In addition, the raft of investor mortgage rate repricing will hit, whilst rental returns remain muted.

So, overall, we see a mixed and complex picture, with demand for property remaining firm, lending still rising, incomes still under pressure and lenders able to buttress their profits thanks to lifting margins. This puts pressure on the RBA, who continues to warn of the risks to households but then cannot lift rates very far. This tension will all play out, not just in the next few months, but over the next two or three years.

And that’s the Property Imperative to 12th August 2017. If you found this useful, do subscribe to get future updates, and check back for the latest installment.