Economics and Banking – Page 145 – Digital Finance Analytics (DFA) Blog

Westpac Revises Broker Remuneration Policy

Westpac Group has announced that it will remove the claim process for upfront commissions paid on post-settlement drawdowns on broker-originated home loans, via InvestorDaily.

For all subsequent upfront commissions payable from 1 January 2020, brokers and third-party introducers will automatically receive remuneration.

Westpac revealed that subsequent upfront commission will remain payable for each eligible home loan following the 12-month anniversary of the loan settlement.

“This change delivers on our commitment to continue to review and improve the broker commission model,” Westpac stated.

Westpac’s announcement comes amid calls from broking industry stakeholders for more equitable remuneration arrangements.

Last month, Connective director Mark Haron noted the impact of contrasting remuneration policies adopted by lenders off the back of the Combined Industry Forum’s move to limit the upfront commission paid to brokers to the amount drawn down by borrowers (net of offset).

Mr Haron said that some lenders had opted to withhold the payment of commission for additional funds arranged by a broker, which are utilised by a borrower after a pre-determined period post-settlement.

The Connective director added that the disparity in the application of the CIF reforms had increased risks of “lender choice conflicts”, which could hinder compliance with the newly proposed best interests duty.

Loan Market’s executive chairman Sam White, has also noted his concerns with existing net of offset arrangements.

Mr White called for an arrangement that better aligns with existing clawback provisions, which, under the federal government’s newly proposed bill, would limit the clawback period to two years.

“Our belief is that net of offset should mirror clawback provisions,” Mr White said.

“If it is good enough for banks to claw back the money over two years, it should also be good enough to increase the upfronts over that same time period.”

Like Mr Haron, Mr White revealed that Loan Market would also be lobbying for reform to existing net of offset arrangements as part of the consultation process for the government’s best interests duty bill.

The push for reforms to net of offset policies follow the release of the Mortgage & Finance Association of Australia’s Industry Intelligence Service report, which revealed that, over the six months to March 2019, the national average annual gross value of commissions collected per broker dropped by 3 per cent when compared to the previous corresponding period, falling to a historic low of $128,709.

The decline was driven by a 10.6 per cent fall in the average upfront commission received by a broker, down from $75,604 to $67,554 – offset by a 6.9 per cent increase in the average annual gross trail commission received per broker, from $57,189 to $61,155.

Reductions in commission revenue have also prompted calls from both industry associations and aggregators for “fair and equitable” clawback arrangements.

Mr Haron and the Australian Finance Group’s head of industry and partnerships Mark Hewitt, recently indicated that they would be lobbying for clawback reform during the consultation period for the federal government’s proposed best interests duty bill.

The Credit Impulse Hiccups In August 2019

Both the RBA and APRA released their respective credit aggregates to end August today. And its not running to script, despite the rate cuts, some stronger buying signs in some housing markets (but on low, low volumes), and increased competition for loans. Overall credit growth rates continue to decline.

The RBA data over the rolling 12 months showed that credit growth dropped to 2.9%, compared with 4.5% just one year ago. That is the slowest rate of growth since 2011. It peaked in 2015 at 6.6%.

Housing sector growth rose 3.1% over 12 months, compared with 5.4% a year back and from a high of 7.4% back in 2015. Within that owner occupied lending fell to 4.7%, compared with 9.1% back in 2016, and investment lending rose at just 0.1% over 12 months, compared with 10.8% back in May 2015.

Business credit growth eased back to 3.4% annualised, from 3.8% a year ago, and 7.4% back in 2016, reflecting weaker business confidence and concerns about the local and international economic outlook.

Annual personal credit is down 3.4%, compared with down 1.4% a year ago, and up 0.3% in 2015.

The more noisy one month series shows that owner occupied lending rose 0.3%, compared with 0.9% in 2015, investment lending fell 0.1%, compared with a rise of 0.9% in 2015, business credit rose 0.2%, way lower than peaks of more than 1% in 2015 and 2017, and personal credit fell 0.2% again.

Note the RBA makes seasonal adjustments to the data – though they do not disclose the basis of these adjustment, and this year has been far from typical.

They also say:

Historical levels and growth rates for the financial aggregates have been revised owing to the resubmission of data by some financial intermediaries, the re-estimation of seasonal factors and the incorporation of securitisation data. The RBA credit aggregates measure credit provided by financial institutions operating domestically. They do not capture cross-border or non-intermediated lending.

So more data noise. And talking of that the new APRA data is all over the shop. They started running a parallel series in March, and as we discussed last month, the proportion of investment loans in the stock data have risen.

Overall credit stock of housing loans for the ADI’s is running at 0.36% and appears to be rising since April. However, the swings between growth in investor and owner occupied loans are massive, (and in opposite directions). This is not a sign of good data collection in my view.

The overall portfolio market shares indicate that CBA remains the largest lender for owner occupied loans, with a 26.1% share, followed by Westpac 21%, and ANZ at 14.7%. In investment lending, Westpac remains a clear leader, with 28.6% of all lending, followed by CBA at 24% and NAB at 17.5%.

The monthly movements tells an interesting story, with CBA driving the largest growth in owner occupied loans (2.3 billion), while dropping investment loans by a small amount. Westpac extended its investment loans by $0.6 billion, and owner occupied loans by $1.3 billion. NAB and ANZ both lost investor share and ME Bank lost owner occupied and investor loans. Other lenders picked some of these up.

Finally, our analysis of the proportion of individual bank portfolios in investment loans (generally more risky in a down-turn), shows that 44.9% of Westpac’s portfolio is investment lending (worth $185 billion), compared with an ADI market average of 37.4%. NAB is at 43.4% and Macquarie at 43.7% and Bank of Queensland at 42.7%. On the other hand CBA is at 35.6% and ANZ at 35.3%.

Data from our surveys suggests weakening demand for credit, and if this eventuates, it is quite possible recent home prices will be confirmed as a bear trap. While some down traders and more affluent households are in the market, many other segments are sitting this one out.

Remember that falling credit growth will translate to falling home prices, the math is that simple. And more rate cuts won’t help much at all!

Liar Loans Not Gone Away

The latest UBS study, the fifth in their series looking at lending standards, and based on a survey of around 900 home loan applicants reveals that (perhaps surprisingly) there was a rise in “porkys” being told as part of the mortgage application, despite the Banking Royal Commission.

As a result, more than a third of Australian home loans could have ‘liar loans’ based on inaccurate information.

UBS Analyst Jonathan Mott said:

While asking detailed questions appears to be prudent, it does not appear to be effective as many factually inaccurate mortgages are still working their way through the process.

Of the borrowers who said their application was not completely factual in the past year, 20 per cent overstated their income, 23 per cent understated debts, 34 per cent understated their living costs, and 23 per cent misstated multiple categories.

Now, this is consistent with the DFA surveys where true incomes and costs are often higher than might be expected. And the extra granularity now required by the banks (many categories of costs, more detail on incomes etc) can create a false sense of accuracy – especially when many households are making best guesses to provide information to support their applications.

And financial intermediaries still appear to be part of the story, with a higher percentage of borrowers who misstated information on applications through a mortgage broker (40 per cent) than through the banks (27 per cent).

UBS said that a “large number” of survey respondents indicated their mortgage consultant advised them to misrepresent elements of their application.

At a time when the mortgage growth stops are being pulled, and lower rates are expected in a highly competitive market, this will simply create a bigger bust later.

And remember that on an international basis, we are right at the top of the international benchmarks in terms of household debt.

In fact according to the latest BIS data we lead in terms of debt servicing ratios.

And the falls in prices have created a significant gap which highlights the risks in the system.

You can watch our recent show where we look at household debt in more detail including the data above.

German Bank Stress Test Hit By Low Interest Rates

Moody says that on 23 September, German bank regulator Bundesanstalt fuer Finanzdienstleistungsaufsicht (BaFin) and the German central bank, the Deutsche Bundesbank, published the results of their biennial stress test applied to 1,412 small and midsize German banks that fall under BaFin’s direct oversight. The tested banks represent 38% of German banking system assets. The stress test scenario was designed well ahead of the recent decision of the European Central Bank (ECB) to lower the rate on its deposit facility to a negative 0.50%.

Instead, the scenario tests the banks for a severe economic downturn combined with rising interest rates and credit spreads. The capital buffers of the tested German banks remained robust under stress with a Common Equity Tier 1 ratio of 13.0% on average, down 3.5 percentage points from the year-end 2018 starting point of 16.5%. The drawback of this scenario is that it does not address the more plausible future environment of weakening economic growth combined with extended low interest rates.

A return on equity survey that accompanied the stress test, however, was more revealing. The survey required the banks to contrast their five-year base-case assumptions for return on equity evolution (from 2018 to 2023) with five defined interest-rate scenarios.

The closest interest rate scenario to current market expectations simulates the present ultra-low interest rates lasting throughout the five years. In terms of potential to impair the banks’ profitability, it is also the most severe. Based on the assumption of a static balance sheet,2 banks would see their profitability falling by more than 50%. The high probability of this interest rate scenario unfolding suggests that the banks need to materially increase their focus on cost management to protect their credit profiles.

Unchanged rate environment is the most severe scenario. The survey results show improved forecasts for base-case profitability at the end of the five-year horizon against the same survey two years ago (2016-21). In part, this reflects moderate progress in trimming high cost bases. The German regulators cautioned, however, that the improvement is substantially driven by the fact that about half of the participating banks (Group B) assumed a rise in interest rates over the five-year horizon from year-end 2018 levels.

They added that even the flat interest rate assumption employed by the other half (Group A) based on year-end 2018 interest rates has become an optimistic scenario. Exhibit 2 shows that long-term interest rates have in fact declined by around 100 basis points since the end of 2018, broadly in line with Scenario 4 (the most severe scenario), with an even more pronounced decline in longer-term rates.

The banks’ simulated results are better under the assumption of dynamic balance sheets. This is because active management intervention to counteract interest rate-driven income declines remains an important lever to reduce the profitability pressure on German banks. Close to half the bank managers surveyed indicated that under Scenario 4, an interest rate drop of 100 basis points, they would consider applying negative interest rates to the deposits of retail clients. Less than one third excluded this for retail and corporate clients under this scenario.

Managers of banks that participated in this year’s stress test expect a combination of weaker deposit margins and a reduced contribution from maturity transformation business to outweigh moderately improving lending margins. This was the case even in Scenario 1 (based on year-end 2018 institutions’ plans with a dynamic balance sheet). It illustrates that banks with lower dependence on maturity transformation results (i.e. with higher fees and commissions income) and with more flexible funding options are better positioned to defend their profitability during a period of extended low interest rates.

As in prior years, the stress test exercise excluded the 21 large German banking groups that are under the direct supervision of the ECB.

We believe that, on aggregate, these larger banks benefit from their access to more diversified funding sources.

The low interest rate environment has particularly compressed the net interest margin on newly originated loans if these new loans have been financed with retail deposits. This is because banks have so far felt unable to charge for retail deposits and these deposits have effectively been floored at 0% interest, even as lending rates have continued to fall.

In contrast, the use of secured or unsecured market funding sources (where costs have continued to fall) available to the larger banks, enables them to substantially offset the decline in interest rates earned on their newly originated loans. This is illustrated in Exhibit 3 using residential mortgage loans as an example. On the other hand, despite economies of scale, large banks’ cost efficiency materially lags the efficiency of smaller German banks – and in turn the efficiency of small German banks lags international peers.

Westpac tipped to cut dividend by 12%

Analysts believe the major banks will be forced to reduce dividend payments amid slower growth, margin squeeze and significant remediation costs, via InvestorDaily.

In a research note published on Wednesday (25 September), Morningstar analyst Nathan Zaia forecast Westpac’s 2020 dividend will be reduced by 12 per cent to $1.66 from $1.88.

The analyst believes that the bank may struggle to meet its January 2020 capital deadline.

“When Westpac reported first-half earnings in May, the bank appeared in good shape to meet APRA’s 10.5 per cent unquestionably strong target by January 2020,” Mr Zaia said.

“However, we estimate capital headwinds, new and previously known, will detract around 44 basis points from Westpac’s common equity Tier 1 ratio by December 2019.”

Morningstar believes that if Westpac maintains its final dividend of $0.94 a share, which is paid in December, its CET1 capital level will fall below 10.5 per cent. To offset this, the research house assumes that the major bank will partially underwrite the dividend reinvestment plan (DRP).

NAB used the same strategy in May when it partially underwrote $1 billion on top of the $800 million received through ordinary DRP participation by shareholders.

The capital headwinds are largely being driven by remediation programs among the big four banks. In July, APRA announced a $500 million operational risk overlay for the banks. This applied to all majors except CBA, which was asked to hold an additional $1 billion in capital. These capital burdens will remain in place until the banks have completed their remediation programs and strengthened risk management.

Last month UBS analyst Jonathan Mott warned that the majors will be forced to cut dividends as net interests margins become unsustainable.

Mr Mott explained that with interest rates entering ultra-low territory, the ability of the banks to generate a lending spread and return on equity (ROE) has become significantly challenged.

“If the housing market does not bounce back quickly this could put material pressure on the banks’ earning prospects over the medium term, implying that the dividend yields investors are relying upon come into question once again,” he said.

UBS now believes the majors will be forced to cut dividends in the next two years.

“We believe the significant revenue pressure the banks are facing as interest rates fall and NIMs decline will force the banks to review their dividend policies,” Mr Mott said.

UBS expects CBA, Westpac and Bendigo and Adelaide Bank to cut their dividends over the next two years if the RBA cuts the cash rate to 0.5 per cent or undertakes any alternative monetary policies like QE.

Yes, But What About Deposit Insurance?

Following on from our show on Deposit Bail-In, we discuss the Deposit Insurance arrangements in Australian and New Zealand.

What happens in a “gone” situation?

https://www.rba.gov.au/publications/bulletin/2011/dec/pdf/bu-1211-5.pdf

https://www.fcs.gov.au/are-your-savings-protected

https://www.moneysmart.gov.au/managing-your-money/banking

https://treasury.govt.nz/publications/resource/questions-and-answers-phase-2-review-reserve-bank-act-second-round-consultation

Has The Fed Lost Control?

We look at the latest in the “repo” drama.

Fed’s Repo Operations Grow

Fed’s Repo Operations Grow

The news from the New York Federal Reserve indicates that the “one-off” spike in repo rates is more structural than many thought – many pundits blamed the timing of tax payments and the like.

But the latest tranches of both the term and overnight operations are now at $60 billion and $100 billion respectively. All up this is now ~$250 billion in funding, and counting. And the target rate is still on the high side, and the offers over subscribed.

If this continues then the Fed’s balance sheet will be growing again, and fast (remember when they were planning to shrink?).

In essence, more of the US economy will be supported by a larger FED, a larger and market distorting Fed to boot.

But the underlying question, still open, is, are these measures signs of a deeper malaise, signalling banks are not trusting some of their counter-parties? Without constant liquidity support will the markets fall over? And in the light of events over the past week plus, do the remarks from the Fed pass muster? We think not. This is significantly more serious than they admit.