ABA Responds To Independent Retail Banking Commission Review

The ABA, in a media release has responded to the paper which has been released, and which questioned whether good customer outcomes and product commission payments were possible. It warned that the use of upfront and trailing commissions and their effect on incentivising sales may potentially lead to poor customer outcomes.

The Australian Bankers’ Association has today welcomed the release of Mr Stephen Sedgwick’s issues paper from his independent review into commissions and payments made to bank staff and third parties.

“Banks want to ensure that they pay their staff to do the right thing by customers, and we will work on any areas that need improving,” ABA Executive Director – Retail Policy Diane Tate said.

“This review is part of an industry-wide look at some of the influences on culture in banks, such as leadership and people and performance management.

“In recent years banks have made changes to remuneration practices to place more of an emphasis on good behaviour rather than sales targets, in light of changing community expectations and regulatory requirements; however there is more to do.

“It is important that banks get the balance right between rewarding employees and getting the best results for customers.

“Banks have committed to changing or removing payments that could lead to poor customer outcomes,” she said.

“Importantly, the issues paper has not identified systemic issues warranting the outright banning of product based payments. However, the paper does highlight the importance of culture, good governance, performance management systems, compliance checking, and communications across the organisation and by management, as all related to remuneration.

“The ABA looks forward to providing another submission to Mr Sedgwick to help complete his review. This is a complex area with mixed views so we encourage interested parties to have their say,” Ms Tate said.

In addition to reviewing payments for the selling of retail banking products like deposit accounts and mortgages, the Sedgwick Review will also comment on overarching principles on how banks pay and incentivise all executives and employees.

More information on the Sedgwick Review is available at retailbankingremreview.com.au.

As I recall the ABA were central to the establishment of the review in the first place, (mitigating the pressure for an independent financial services review) and perhaps they are surprised that the independent review is questioning commissions! We shall see.

 

Risk of commission-related incentivisation “not insignificant”

From Australian Broker.

A new report on the retail banking remuneration review has warned that the use of upfront and trailing commissions and their effect on incentivising sales may potentially lead to poor customer outcomes.

In the Issues Paper on Remuneration in Retail Banking released yesterday (17 January), independent reviewer Stephen Sedgwick AO said industry risks were “amplified” through the use of accelerators such as larger commissions for greater volumes of sales through the broker channel.

The review which was commissioned by the Australian Bankers’ Association said that the banks’ reluctance to move away from commission-based arrangements suggested that “the risk of commission-related mis-selling was not insignificant”.

“Indeed, data was presented to the review that suggested that third-party mortgages are likely to be larger, paid off more slowly, and more likely to be interest-only loans than those provided to equivalent customers who dealt directly with bank staff.”

However, he added that this data was “suggestive rather than conclusive” given the fact that mortgages need to satisfy a bank’s credit assessment and responsible lending requirements at all times.

With the growth of the third party market segment, Sedgwick said that brokers provide a service valued by mortgage holders. Thus, any move to eliminate or reduce commissions in Australia would need to maintain a competitive balance.

Another area of risk was that while banks implemented risk mitigation devices to protect against mis-selling within (including compliance checks and performance management), they were not employers of third party channels and thus may not have as many options available to combat improper behaviour, he said.

“Usually banks use contractual terms to enforce appropriate behavioural norms, which in practice may be enforced more readily in a franchise or profit-sharing model than otherwise.”

With ASIC currently reviewing the mortgage broking industry, he said the retail banking review would examine ASIC’s report once it was published to gain further insights on the matter.

Sedgwick called for further information on a number of areas relating to third party channels and asked for submissions on the following questions:

  1. Is there sufficient evidence to support a case for banks to discontinue the practice of paying volume-based commissions to third parties in respect of new and increased mortgages?
  2. If a move away from commissions cannot be justified, should banks desist from paying on the basis of accelerator-like arrangements (including bonus commissions)?
  3. Is there evidence that the contractually-based risk mitigation devices available to banks in respect of third parties are deficient in avoiding poor customer outcomes?

Submissions can be sent to submissions@retailbankingremunerationreview.com.au.

One in five homeowners will struggle with rate rise of less than 0.5%

From News.com.au

ONE in five Australians are walking such a fine mortgage tightrope that they could lose their homes if interest rates rise by even 0.5 per cent.

Our love affair with property has pushed Australia’s residential housing market to an eye-watering value of $6.2 trillion.

But as we scramble over each other to snap up property while interest rates are at historic lows, we have gotten ourselves into a bit of a pickle. We might not actually be able to afford funding our affair.

An analysis, based on extensive surveys of 26,000 Australian households, compiled by Digital Finance Analytics, examined how much headroom households have to rising rates, taking account of their income, size of mortgage, whether they have paid ahead, and other financial commitments. And the results are distressing.

It showed that around 20 per cent — that’s one in five homeowners — would find themselves in mortgage difficulty if interest rates rose by 0.5 per cent or less. An additional 4 per cent would be troubled by a rise between 0.5 per cent and one per cent.

Almost half of homeowners (42 per cent) would find themselves under financial pressure if home loan interest rates were to increase from their average of 4.5 per cent today to the long term average of 7 per cent.

“This is important because we now expect mortgage rates to rise over the next few months, as higher funding costs and competitive dynamics come into pay, and as regulators bear down on lending standards,” Digital Finance Analytics wrote.

The major banks have already started increasing their home loan rates this year, despite the market broadly expecting the Reserve Bank to keep the cash rate steady at 1.5 per cent this year.

Just this week NAB upped a number of its owner-occupied and investment fixed rate loans.

“There are a range of factors that influence the funding that NAB — and all Australian banks — source, so we can provide home loans to our customers,” NAB Chief Operating Officer, Antony Cahill, said of the announcement.

“The cost of providing our fixed rate home loans has increased over recent months.”

So as interest rates rise and leave mortgage holders in its dust, it leaves a huge section of society, and our economy, exposed and at risk.

NOT TERRIBLY SURPRISING

Martin North, Principal of Digital Finance Analytics, said the results are concerning, albeit not surprising.

“If you look at what people have been doing, people have been buying into property because they really believe that it is the best investment. Property prices are rising and interest rates are very low, which means they are prepared to stretch as far as they can to get into the market,” Mr North told news.com.au.

But the widespread assumption that interest rates will remain at historic lows is a disaster waiting to happen, especially in an environment where wage growth is stagnant.

“If you go back to 2005, before the GFC, people got out of jail because their incomes grew a lot faster than house prices, and therefore mortgage costs. But the trouble is that this time around we are not seeing any evidence of real momentum in income growth,” Mr North said.

“My concern is a lot of households are quite close to the edge now — they are not going to get out of jail because their incomes are going to rise. We are in a situation where interest rates are likely to rise irrespective of what the RBA does … There has already been movement up.”

Australia’s wages grew at the slowest pace on record in the three months to September 2016, according to the latest Wage Price Index released by the Australian Bureau of Statistics (ABS).

And as a result Australia’s debt-to-income ratio is astronomical. The ratio of household debt to disposable income has almost tripled since 1988, from 64 per cent to 185 per cent, according to the latest AMP. NATSEM Income and Wealth report.

What this means is that many Australian households are highly indebted, thanks in large part to the property market, without the income growth to pay it down.

“The ratio of debt to income is as high as it’s ever been in Australia and there are some households that are very, very exposed,” Mr North said.

THE YOUNG AND RICH MOST AT RISK

This finding will come as a surprise: young affluent homeowners are the most at risk — it is not just a problem with struggling families on the urban fringe. When it comes to this segment of the market, around 70 per cent would be in difficulty with a 0.5 per cent or less rise. If rates were to hike 3 per cent, bringing them to around the long term average of 7 per cent, nine in ten young affluent homeowners would feel the pressure.

“It is not necessarily the ones you think would be caught. And that’s because they are actually more able to get the bigger mortgage because they’ve got the bigger income to support it.

“They have actually extended themselves very significantly to get that mortgage — they have bought in an area where the property prices are high, they have got a bigger mortgage, they have got a higher LVR [loan-to-valuation ratio] mortgage and they have also got lot of other commitments. They are usually the ones with high credit card debts and a lifestyle that is relatively affluent. They are not used to handling tight budgets and watching every dollar.”

And while the younger wealthy segment of the market being most at risk might not be of that much importance compared to other segments, Mr North said what is concerning is the intense focus on this market.

“Any household group that is under pressure is a problem for the broader economy because if these people are under pressure they are not going to be spending money on retail and the broader economy,” Mr North told news.com.au.

“The banks tend to focus in on what they feel are the lower risk segments and the young affluent sector has actually been quite a target for the lending community in the last 18 months. Be that investment properties or first time owner-occupied properties, my point is there is more risk in that particular sector than perhaps the industry recognises.”

TOUGHER HOME LOAN RESTRICTIONS NEEDED

Now an argument is mounting that Australian banks need to toughen up their approach to home lending.

“I think we have got a situation where the information that is being captured by the lenders is still not robust enough. I am seeing quite often lenders willing to lend what I would regard as relatively sporty bets … I’m questioning whether the underwriting standards are tight enough,” Mr North said.

This includes accepting financial help from relatives for a deposit, a growing trend among first home buyers.

“The other thing that I have discovered in my default analysis is that those who have got help from the ‘Bank of Mum and Dad’ to buy their first property are nearly twice as likely to end up in difficulty … It potentially opens them to more risk later because they haven’t had the discipline of saving.”

News.com.au contacted several banks for comment on whether they think a rethink of their underwriting standards is needed. Only one lender, Commonwealth Bank, agreed to comment, but remained vague on the topic.

“In line with our responsible lending commitments, we constantly review and monitor our loan portfolio to ensure we are maintaining our prudent lending standards and meeting our customers’ financial needs. Buffers and minimum floor rates are used when assessing loan serviceability so it is affordable for customers,” a CBA spokesman said in an emailed statement.

But Mr North said something needs to be done before we find ourselves in a property and economic downturn.

“I’m assuming that with the capital growth we have seen in the property market, it will allow people who get into significant difficulty to be able to get out, however, it’s the feedback concern that I’ve got.

“If you have got a lot of people in the one area struggling with the same situation, you might see property prices begin to slip. If we get the property price slip, and we get unemployment rising and interest rates rising at the same time, we have that perfect storm which would create quite a significant wave of difficulty.

“We need to be thinking now about how to deal with higher interest rates down the track. We can’t just say it will be fine because it won’t be,” he told news.com.au.

Home loan rates heading higher as funding costs rise, competition eases

From The Australian Financial Review.

Mortgage rates are set to rise for both fixed and variable rate borrowers this year as global interest rates shoot higher, competition eases and capital rules begin to bite.

“Borrowers should assume we are at the bottom of the interest rate cycle – in fact we are probably already past it,” housing finance expert Martin North of Digital Finance Analytics told The Australian Financial Review.

Australia’s banks have cited higher funding costs as a reason for increasing fixed-rate home loans. On Monday National Australia Bank became the last of the big four banks to lift fixed-rate loans in recent months, citing higher funding costs as it raised rates on two, three and four-year mortgages.

The main cause of these higher funding costs for fixed-rate loans was a sharp rise in Australian medium-term bond rates from September to December as rising commodity prices, rising inflation and a shift in global monetary policy rhetoric forced traders to question the thesis that rates would stay low indefinitely.

Bond rates kicked up again following the election of Donald Trump in the US, forcing the three-year Australian swap rate to 2.35 per cent from an all-time low of 1.75 per cent in September. Australian interest rates rates tend to closely track movements in global bond rates and are expected to rise further this year, which will force costs higher for prospective borrowers seeking a fixed interest rate.

“Capital markets have seen a price hike since Trump, and as a result banks are having to pay more for wholesale funding – a critical element in bank funding,” Mr North said.

While rates on standard variable mortgage loans are not impacted by medium-term moves in the bond market, they too could edge higher this year if traders’ bets that the Reserve Bank is more likely to hike than lower interest rates prove correct.

For most of last year bond markets had priced in cuts for this year, but as global bond rates have shot higher rate cuts have all been but priced out – with markets prescribing just a one in 13 chance that the cash rate will fall this year. Meanwhile, traders are attaching a one in three probability that the Reserve Bank will raise the cash rate to 1.75 per cent before the end of the year.

Mr North said the global outlook and initial indications of the policy stance of new Reserve Bank governor Phil Lowe mean rate reductions appear unlikely.

“It depends on the Reserve Bank’s view on inflation versus property [risks from lower rates],” Mr North said. “Investment loans are hot, so I think it’s an even bet as to whether they raise rates.”

Australian Bureau of Statistics figures released on Tuesday showed mortgage lending to investors, which has concerned regulators, jumped by 4.9 per cent in November, up from 1.5 per cent in October – to the highest level since July 2015.

While base interest rates are likely to have the largest bearing on borrowing costs, other factors such as wholesale and deposit funding costs and capital requirements, and the level and intensity of competition among the banks for new loans will influence mortgage rates too.

Mr North, however, said that the signs are that competition pressures are easing, which will remove the downward pressure on home loan rates evident last year.

“The banks have realised that the deep discounting we saw in 2016 was a race to the bottom, so the banks are going to be sassier from here and that means higher rates,” he said.

Another potential upward force is the chance of further increases in capital when the Basel committee on banking supervision finalises its Basel III capital framework.

Mr North said this year will be characterised by differentiated pricing between customers with low risk, ‘low loan to value’ borrowers, that is, those who have a higher deposit, receiving favourable rates while riskier ‘high loan to value’ borrowers will pay more.

“The thing about Basel is it’s translating more of the portfolio risks into capital calculations so different types of borrowers attract different charges,” he said.

One positive for borrowers is that two important components of bank funding costs have moderated.

Concerns have been raised that banking rules that come into effect in early 2018 and prioritise retail deposits over other forms of funding will increase competition for savings, forcing up deposit costs. From January next year Australia’s banks will have to meet a prescribed ‘net stable funding ratio’ aimed at limiting the risk of a bank run by funding their loans with stable sources such as deposits.

So far, however, the evidence is that banks are not competing aggressively for savings, by increasing term deposit rates, as they were six months ago.

Analysis compiled by Deutsche Bank this week shows that deposit margins, measured as a spread over the bank bill rate, had declined significantly from August, when they rose to about 0.40 percentage points over the bank rate to below 0.20 percentage points. Online saving rates have also declined in recent weeks.

“While deposits remain a headwind to margins, these trends illustrate the continuing easing of deposit spread pressures,” Deutsche analyst Andrew Triggs wrote.

Wholesale bank funding costs, as measured by credit spreads, also appear to have moderated despite significant market uncertainty.

The cost of insuring against the default of a major Australian bank’s debt for five years is now around 64 basis points, its lowest level for 18 months, and well below the 10-year average of 100 basis points. Australian bank credit default swaps are a proxy for wholesale funding costs.

Fitch puts Australian banks on negative watch

From Business Insider.

Fitch Ratings has revised its outlook on Australia’s banking for 2017 to negative from stable.

In its 2017 outlook report, the agency says the change reflects an increase in macroeconomic risks and pressure on profit growth.

The change follows Moody’s which in August last year changed the outlook for the banking system in Australia to negative from stable.

Profits at Australia’s banks are under pressure. The combined cash profits of the big four banks didn’t make last year’s record $30 billion.

Fitch now says Australia’s household debt is high and rising relative to disposable incomes, making borrowers sensitive to changes in the labour market and interest rates.

“Profit growth is likely to continue to slow in 2017, reflecting low interest rates, slow asset growth, competition for assets and deposits, higher funding costs, and a rise in loan-impairment charges,” Fitch says.

Fitch expects improvements in cost management to be offset by increased investment in technology.

The agency says the ongoing rise in household debt and house-price growth heightens the banking system’s sensitivities to a sharp correction if labour market conditions and interest rates changed.

“In addition, a worse-than-expected slowdown in China’s growth would negatively impact Australia’s economy given the countries’ strong economic ties,” the agency says.

“These scenarios — although not our base case — could jeopardise the banks’ strong asset quality and profitability, and weaken capitalisation.

“A prolonged global funding market disruption could place significant pressure on the banks’ balance sheets despite the improvements in liquidity.”

Standard and Poor’s in July last last year placed Australia’s sovereign rating on credit watch negative from its previously stable outlook.

APRA On The Countercyclical Capital Buffer

APRA released a brief update to support their zero Countercylical Capital Buffer setting. As they say “the countercyclical capital buffer is designed to be used to raise banking sector capital requirements in periods where excess credit growth is judged to be associated with the build-up of systemic risk. This additional buffer can then be reduced or removed during subsequent periods of stress, to reduce the risk of the supply of credit being impacted by regulatory capital requirements”.

APRA may set a countercyclical capital buffer within a range of 0 to 2.5 per cent of risk weighted assets. On 17 December 2015, APRA announced that the countercyclical capital buffer applying to the Australian exposures of authorised deposit-taking institutions (ADIs) from 1 January 2016 would be set at zero per cent. An announcement to increase the buffer may have up to 12 months’ notice before the new buffer comes into effect; a decision to reduce the buffer will generally be effective immediately.

APRA reviews the level of the countercyclical capital buffer on a quarterly basis, based on forward looking judgements around credit growth, asset price growth, and lending conditions, as well as evidence of financial stress. APRA takes into consideration the levels of a set of core financial indicators, prudential measures in place, and a range of other supplementary metrics and information, including findings from its supervisory activities. APRA also seeks input on the level of the buffer from other agencies on the Council of Financial Regulators.

A range of core indicators are used to justify their position. Here are their main data-points.

Credit growth

Credit-to-GDP ratio (level, trend and gap)

The credit-to-GDP gap is defined as the difference between the credit-to-GDP ratio and its long-run trend. The long-run trend is calculated using a one sided Hodrick-Prescott filter, a tool used in macroeconomics to establish the trend of a variable over time. The credit-to-GDP gap for Australia is currently negative at -3.9. The Basel Committee suggests that a gap level between 2 and 10 percentage points could equate to a countercyclical capital buffer of between 0 and 2.5 percent of risk-weighted assets.

Housing credit growth

The pace of housing credit growth has slowed this year, growing at 6.4 per cent year on year as at September 2016, down from 7.5 per cent at the time the buffer was initially set. Investor housing credit growth fell from 10 per cent to 4.9 per cent over the same period, however the pace of growth has been increasing again more recently. APRA has identified strong growth in lending to property investors (portfolio growth above a threshold of 10 per cent) as an important risk indicator for APRA supervisors.

Business credit growth

Business credit growth increased marginally in the first half of 2016. However, business credit growth has fallen over recent quarters; annual growth in business credit was 4.8 per cent over the year to end September 2016, down from 6.3 per cent as at September 2015. Notwithstanding the lower overall rate of growth, commercial property lending growth (not shown) has remained strong, growing 10.5 per cent year on year as at September 2016.

Asset Prices

National housing price growth remains strong, but has slowed relative to 2015 peaks, growing nationally at around 3.5 per cent over the 12 months to September 2016. However, over a shorter horizon, prices have been reaccelerating recently with six month-ended annualised price growth of 7.2 per cent nationally as at September 2016 (albeit still a slower pace than 2015 peaks). Conversely, rental growth and household income growth have been relatively weak. Looking beyond the national averages, conditions vary significantly across individual cities and regions. In particular, housing price growth has strengthened in Sydney and Melbourne over recent months with six month-ended annualised growth rates of 11.4 per cent and 9.0 per cent respectively.

Non-residential commercial property has also been exhibiting strong price growth, though this has moderated somewhat in recent months (not shown).

Lending indicators

APRA monitors a range of data and qualitative information on lending standards. For residential mortgages, the proportion of higher-risk lending is a key metric. Over the past few years, APRA has heightened its regulatory focus on the mortgage lending practices of ADIs in order to reinforce sound lending practices. This has included, but not been limited to, the introduction of benchmarks on loan serviceability and investor lending growth, and the issuance of a prudential practice guide on sound risk management practices for residential mortgage lending.

In general, higher-risk mortgage lending has been falling recently with the share of new lending at loan-to-valuation ratios greater than 90 per cent falling from 9.5 per cent to 8.1 per cent over the year to September 2016. Other forms of higher-risk mortgage lending including high loan-to-income and interest-only lending (not shown) have also moderated from 2015 peaks, although there has been some pick-up in the share of interest-only lending recently.

In business lending, banks have showed some evidence of tightening lending standards more recently, in particular for commercial property lending, with the lowering of loan-to-valuation and loan-to-cost ratios on certain development transactions (not shown).

Lending rates had been steadily falling for both housing and business lending to historical lows. More recently however, lending rates have fallen by less than the cash rate, with banks passing on around half of the August cash rate reduction. Lending rates have also risen in recent weeks in response to higher costs in wholesale funding markets. In particular, a number of ADIs have recently announced increases to their mortgage lending rates with some ADIs specifically targeting investor and interest-only loans.

APRA’s confidential quarterly survey of credit conditions and lending standards provides qualitative information on whether conditions are tightening or loosening in the industry.

Financial Stress

Indicators of financial stress are used in informing decisions to release any countercyclical capital buffer. While a wide range of indicators could signify a deterioration in conditions, APRA has identified non-performing loans as its core indicator of financial stress.

The share of non-performing loans remains low, though it has increased moderately over 2016, to 0.93 per cent as at September 2016, largely driven by increases in regions and sectors with exposures to mining.

So, everything is looking rosy, in their view. However, the high household debt to income ratio and the fact that debt servicing is supported by ultra low interest rates is not included adequately in their assessment – seems myopic in my view, but then this continues the regulatory group-think.  In addition the use of “confidential quarterly survey data” highlights the lack of industry disclosure.

NAB Re-balances Mortgage Rates

NAB today has announced changes to its home loan fixed rates.

From today, NAB will decrease its 1 year Package Fixed Rate for Home Loans to a highly competitive rate of 3.89% per annum for owner occupiers. NAB will also decrease its 1 year Package Fixed Rate for Residential Investment Home Loans to 3.99% per annum.

Meanwhile, NAB’s 2, 3 and 4 year Package Fixed Rate for Home Loans will increase effective today, to 3.98%, 4.09%, and 4.59% per annum respectively; and 2, 3, 4 and 5 year Package Fixed Rate for Residential Investment Home Loans will change to 4.19%, 4.29%, 4.79%, and 4.79% per annum respectively.

“There are a range of factors that influence the funding that NAB – and all Australian banks – source, so we can provide home loans to our customers,” NAB Chief Operating Officer, Antony Cahill, said.

“The cost of providing our fixed rate home loans has increased over recent months.”

“We continue to watch market and economic conditions to ensure we continue to lend and manage our business responsibly, so we remain strong and stable for the benefit of our customers, shareholders, and the broader economy,” Mr Cahill said.

Today’s decision applies to new fixed rate home loans only. NAB continues to closely monitor the various factors that influence its Variable Rate for Home Loans (Standard Variable Rate) for owner occupier customers, which remains at 5.25% per annum at this time.

Mr Cahill said NAB’s fixed rate home loans remain highly competitive – especially with today’s new one year rates.

“We know that fixed rate home loans have become increasingly popular with our customers. We saw these applications more than double as a share of total applications in December, compared to in September last year,” Mr Cahill said.

Customers who want to have certainty about their monthly repayments should speak with their banker or broker to find out more about what’s available, and if a fixed rate home loan might be right for their circumstances. Conditions, fees and eligibility criteria apply to NAB’s products.

NAB will also change NAB Homeplus Fixed Indicator Rates, available through NAB Broker, as stated above.

 

Advertised Fixed Rates for NAB Tailored Home Loan (Choice Package)

Principal and Interest Interest Only
New Rate Old Rate New Rate Old Rate
1 year 3.89% p.a. 3.99% p.a. 3.89% p.a. 4.09% p.a.
2 years 3.98% p.a. 3.75% p.a. 3.98% p.a. 3.85% p.a.
3 years 4.09% p.a. 3.89% p.a. 4.09% p.a. 3.89% p.a.
4 years 4.59% p.a. 3.99% p.a. 4.59% p.a. 3.99% p.a.
5 years 4.59% p.a. 4.59% p.a. 4.59% p.a. 4.69% p.a.

 

Advertised Fixed Rates for NAB Tailored Home Loan (Choice Package) – Residential Investment

Principal and Interest Interest Only
New Rate Old Rate New Rate Old Rate
1 year 3.99% p.a. 4.14% p.a. 3.99% p.a. 4.24% p.a.
2 years 4.19% p.a. 3.90% p.a. 4.19% p.a. 4.00% p.a.
3 years 4.29% p.a. 3.89% p.a. 4.29% p.a. 3.89% p.a.
4 years 4.79% p.a. 3.99% p.a. 4.79% p.a. 3.99% p.a.
5 years 4.79% p.a.

 

The Definitive Guide To Our Latest Mortgage Stress Research

We have had an avalanche of requests for further information on our recent research which was published as a series of blog posts over the past couple of weeks. Here is a summary of the findings.

In addition, here is a list of links to each segment, which together provides a comprehensive view of the work. This will all be rolled up into our next Property Imperative Report, to be published in a couple  of months.

Note that a number of people went to our 2015 report – The Stressed Household Finance Landscape, which looks at households and their use of small amount credit contracts, a.k.a. payday lending. This is a separate stream of work.

So here are all the links to each element of the mortgage stress and probability of default analysis, with a short summary and publication date.

So Where Will The Property Market Go In 2017?

Having looked at events in the Property Market in 2016, we now turn to our expectations for 2017. There are many uncertainties which may impact the market, but using our surveys and modelling as a guide, we can make some educated guesses. First, mortgage rates will be higher by the end of 2017 than they …

Posted on December 12, 2016

Mortgage Stress And Probability Of Default Is Rising

We have just finished the December update of our mortgage stress and probability of default modelling for the Australian mortgage market. Our model has been updated to take account of the latest employment, wage, interest rate and growth data, and we look are the current distribution of mortgage stress (can households settle their mortgage repayments, …

Posted on December 17, 2016

Mortgage Stress Covers 18.5% Of Book Value

Containing our latest series on mortgage stress and probability of default, we look further at the distribution of mortgage stress and potential defaults, using data from our household surveys, which includes results up to the middle of December 2016. Building on the data we discussed yesterday, it is worth remembering that the bulk of mortgages …

Posted on December 18, 2016

A Segmented View Of Mortgage Stress and Default

As we continue our series on mortgage stress, using the latest data from our surveys, we look at how stress aligns with our core household and property owning segments. To set the context for this, here are a couple of charts showing the mortgage distribution by income and age bands. The majority of mortgages are

Posted on December 19, 2016

Top 20 Postcodes For Mortgage Stress Across Australia

Now we get to the pointy end of our mortgage stress and default analysis. Today we list the top 20 post codes across Australia where the highest number of households currently in mortgage stress reside. We also reveal our estimate for the number of defaults which we expect to occur in the coming months. It …

Posted on December 20, 2016

New DFA Video Blog – Household Mortgage Stress and Defaults

Using data from our household surveys in this new video blog we discuss the findings from our latest modelling. More than 22% of households are currently in mortgage stress, and 1.9% of households are likely to default. Both are likely to rise next year.

Posted on December 20, 2016

The Full 100 Mortgage Stress Listing

To complete our series on mortgage stress, based on our household surveys, here is the complete list of the top 100 most stressed suburbs, and their relative position on the default list, as at December 2016. Victoria has the highest number of suburbs in the listing. As we discussed yesterday, this is based on the …

December 21, 2016

Mortgage Default Heat Map Predictions

In our last post for 2016 we have geo-mapped the probability of mortgage default by post code across the main urban centres through 2017. You can read about our approach to the analysis here. We start with Sydney, which is looking pretty comfortable. Melbourne is also looking reasonable, though with a few hot spots. Brisbane …

Posted on December 31, 2016

Channel Nine News Does House Prices and Mortgage Defaults

A segment today from Channel Nine featured the latest data on Sydney residential property, and featured data from the Digital Finance Analytics mortgage default heat mapping, as well as the latest from CoreLogic on Home Prices.

Posted on January 3, 2017

Affluent suburbs feel heat from rising property costs

The Australian Financial Review featured the Digital Finance Analytics probability of default modelling today. We discussed our analysis on the blog recently. Property buyers in some of the nation’s swankiest suburbs are among those under most stress keeping up mortgage repayments, according to an analysis by postcode of income and debt levels. The young affluent in plush …

Posted on January 9, 2017

ABC News 24 Does Affluent Mortgage Stress

Here is a segment in which we discuss our latest research into the probability of default modelling in a rising interest rate environment.  We highlight the rise of the “Affluent Stressed” households.

Posted on January 9, 2017

A Cumulative View Of Mortgage Rate Sensitivity

We had significant interest in our recent posts on mortgage rate sensitivity in a rising market. One recurring request was for a cumulative view of rate sensitivity. So today we post these views on a segmented basis, using our master household segmentation.

Posted on January 12, 2017

One in five homeowners will struggle with rate rise of less than 0.5%

From News.com.au. ONE in five Australians are walking such a fine mortgage tightrope that they could lose their homes if interest rates rise by even 0.5 per cent. Our love affair with property has pushed Australia’s residential housing market to an eye-watering value of $6.2 trillion.

Posted on January 18, 2017

 

 

 

 

 

Mortgage Rates Go Higher

From Australian Broker.

The number of fixed rate mortgages offering rates of less than 4% is trending downwards thanks to recent rate hikes by a large number of major and non-major banks.

The recent Rates of the Nation report by RateCity.com.au found there were now 525 fixed home loan products offering an interest rate of less than 4%. This was down by 98 throughout the December quarter.

“The ‘Under 4 Club’ for fixed rates contracted by 15% over the quarter; that’s around 100 fewer sub-4 per cent fixed rates on offer now compared to three months ago,” Peter Arnold, data insights director for RateCity.com.au, said.

This shift saw an increase in the demand for fixed mortgages by close to 30% at the end of 2016, he added.

This means that for brokers, conversations with borrowers around fixed rates will be quite different, Arnold told Australian Broker.

“Now there’s a higher chance than at any point in the last five years that the great rate that you’ve got will disappear before the loan gets funded so managing borrower expectations around that and considering rate locks is appropriate.”

He also suggested reassuring borrowers that although rates have increased by 10 or 20 basis points, levels still are at historic lows.

“If you look at the changes, we hope that won’t be enough to change whether someone will actually get a loan. Most brokers will probably be pretty comfortable with that but for a lot of borrowers that’s probably a big factor on their mind.”

At present, the majority of fixed rates lie between 3.8% and 4.6% while for variables, this is slightly higher between 3.8% and 4.8%.

The average rates for longer-term fixed mortgages are now higher than variable rates. This shows that the banks expect further rate rises in the foreseeable future.

For owner-occupiers, the gap between the average home loan rate and the lowest home loan rate has remained steady at 0.98% since September last year.

This was one of the more surprising results of the report, Arnold told Australian Broker, given the level of activity in the second half of last quarter.

“From mid-November onwards, out of the 105 lenders that we track, we’ve seen at least two thirds of those lenders increase at least some of those fixed rates.”

While it was unusual to see this much movement without an RBA cash rate change, Arnold said that the current state of play was a massive decoupling of home loan rates and the RBA.

“We’re seeing lenders raise and also decrease their offers whenever they see fit from a competitive or funding point of view, and we’re seeing a lot of good deals released daily and ending daily as well.”

For investors, the gap between average and lowest rates increased from 0.88% to 0.91% from September 2016 to January 2017.

LVR pricing has also shifted over the past 24 months. The largest movement was for loans available to borrowers with a 5% deposit which dropped from 61% of all mortgage products to 50%.

Looking ahead to the rest of the year, Arnold said consumers should expect even more rate rises on the horizon.

“It’s unlikely that we’ll see rates return to the long term average of around 7% just yet, but competition at the low-rate end of the market is slowing.”

He also predicted that lenders will undergo a full repricing to bring fixed rates more in line with variables. One reason behind this was since fixed rates have been significantly below variable rates for a while.

“I’d expect it would be more of a levelling out of fixed and variable rather than the shorter-term fixed ones sitting much higher than variables.”

 

Analysis of Mortgage Risk Under Basel

The Bank of England just published a staff working paper “Specialisation in mortgage risk under Basel II“.  Lenders using the less sophisticated risk models (generally smaller banks) are found to have a higher concentration of higher-risk mortgages than those using the advanced models.

They looked at the two models which were introduced under Basel II, lenders’ internal models (IRB) and the less risk-sensitive standardised approach (SA) by using a dataset covering 7 million UK mortgages from 2005-15. The switch to Basel II gave lenders using IRB models a comparative advantage in capital requirements (compared to lenders using the SA approach), particularly at low loan-to-value (LTV) ratios, and this was reflected in prices and quantities. They concluded:

First, mortgage risk is concentrated in lenders using the SA approach, which is typically used by smaller lenders, suggesting a potential higher failure rate than among IRB banks.

Second, macroprudential tools may affect the strength of the specialisation mechanism. This should be accounted for in calibrating such tools.

Third, they validate the view from competition authorities who have identified the cost of adopting IRB as a potential barrier to entry and expansion. IRB provides a competitive advantage in low LTV ratio mortgages.

Finally, the effect, is not specific to the mortgage market and this needs  further research.

IRB risk weights increase with the LTV ratio, the main indicator for credit risk used by UK mortgage lenders. In contrast, SA risk weights are fixed at 35% for LTV ratios up to 80%, and are then 75% on incremental balances above the 80%

LTV threshold. IRB risk weights tend to be lower than SA risk weights across most LTV ratios, but the gap is larger for lower LTV ratios. In 2015, the gap between the average IRB risk weight and the SA risk weight was about 30 percentage points for LTV ratios below 50%, compared to less than 15 percentage points for LTV ratios above 80%. The scale of variation in risk weights between IRB lenders is smaller than the gap between the IRB average and SA risk weights, at least at lower LTV ratios.

IRB lenders gain a comparative advantage in capital requirements compared to SA lenders, particularly at low loan-to-value (LTV) ratios. This comparative advantage is reflected in prices and quantities.

We expect all lenders to price lower for lower LTV mortgages. But under Basel II versus I, IRB lenders did so by 31 basis points (bp) more, and increased the relative share of low-LTV lending in their portfolios by 11 percentage points (pp) more, than SA lenders. Such specialisation leads to systemic concentration of high risk (high LTV) mortgages in lenders who tend to have less sophisticated risk management.

With an average 30 percentage point gap between IRB and SA risk weights for LTV ratios below 50%, this corresponds to an economically significant price advantage of 30bp. From the perspective of a typical borrower at this LTV level, with a 50% LTV mortgage against a $200,000 property, repayable over a remaining 15 year term, 30bp translates to around $170 per year or 0.7% of median household disposable income. From the lender’s perspective, a 30bp disadvantage translates to several places in `best buy’ tables, and thus likely material loss of market share.

If instead of risk weights we consider directly the variation in capital requirements, which is driven by both risk weights and lender-specific capital ratio requirements, a 1pp reduction in capital requirements causes a 6bp decrease in interest rates. These latter results can also be interpreted as `pass-through’ rates from lender-specific changes in risk weights or capital requirements to prices, subject to limits on external validity due to the Lucas critique.

Finally, we find that the pass-through from capital requirements to prices is significant only when lenders have low capital buffers (the surplus of capital resources over all regulatory requirements). Lenders with a buffer below 6pp of risk-weighted assets increase prices by 1.7bp basis point for a 1pp increase in risk weights.

Note: Staff Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. Any views expressed are solely those of the author(s) and so cannot be taken to represent those of the Bank of England or to state Bank of England policy. This paper should therefore not be reported as representing the views of the Bank of England or members of the Monetary Policy Committee, Financial Policy Committee or Prudential Regulation Authority Board.