Category: Economics and Banking

Welcome to the Property Imperative weekly to 27^th October 2018, our digest of the latest finance and property news with a distinctively Australian flavour.

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

As we approach the end of October, which is often a volatile month, the markets are down and the outlook globally and in Australia to my mind looks increasingly uncertain. Property and Stocks, and other asset classes are looking distinctively wobbly, as does the banking sector.  I fear that money printing will become back on the agenda sooner than many are expecting to try to stop the rot, and “maintain” the wealth effect created as real money loses its true value.

We start with the markets which had one of the worst weeks this year. Let’s start in the US, before looking at the local Australian markets.  And later we will look at the latest property data too.

The Dow tumbled on Friday, shrugging off data showing ongoing U.S. economic growth as high-flying tech companies were punished in the wake of downbeat reports from Google and Amazon.

The Dow Jones Industrial Average fell about 1.19% to 24,688, though remember it hit 23,500 back in April. The S&P 500 fell 1.73% down to 2,659, while the Nasdaq Composite fell 2.07% ended at 7,167 on Friday. The three indexes are on track for their worst month in years. The narrower S&P 100 was down 1.82% to 1,189. Technical correction or not, these are significant falls, and we expect more volatility ahead. The fear index, or volatility index ended the week at 24.16, near its recent highs, but still below the February 18 spike.

The pair of downbeat reports overshadowed data showing the U.S. economy grew 3.5% in the third quarter, above economists’ estimates for a 3.3% increase, though analysts said a deeper look into the data revealed signs of a possible slowdown. In fact, it was buoyant consumer spending which helped to prop up the numbers.

Disappointing business investment suggested “the boost in capex from tax cuts and deregulation was likely front-loaded and fading quickly,” BNP Paribas said. “We continue to expect growth to slow from here as the sugar high in consumer spending turns into a sugar low.”

Investors grappled with wild swings on Wall Street amid growing concerns U.S. corporates were approaching peak profit growth after tech heavyweights Google and Amazon delivered underwhelming quarterly reports and signalled a softer patch of growth for the fourth quarter.

Alphabet fell 1.80% to 1,083 after it posted third-quarter revenue that fell short of expectations. Amazon shares, meanwhile, dropped 7.38% to 1,643 as its third-quarter revenue also fell short, while its weaker-than-expected guidance for the key holiday season exacerbated concerns.

On the other hand, Intel did better, up 3.11% to 45.69, despite some trade war concerns. The S&P 500 tech sector closed about 2% lower, while the communication services sector, which includes Netflix, Facebook, Alphabet and telecom companies sunk more than 2%.

More broadly you can list out some of the underlying concerns which are driving the market lower.

First, it’s the tightening policy of the Federal Reserve. Interest rates in the United States go up and the Fed let the market know that it will continue hiking rates next year. Higher interest rates mean that borrowing will become more expensive for US companies. Hence, the negative impact on stocks.

The trade tensions. So far, no end of the mutual tariff blows between the United States and China is in sight. This creates uncertainty and is bad for business.

Then the bumpy earnings season. Investors had high expectations for the financial reports of American companies. As well as result so far, concerns are now spreading about the fate of earnings in 2019. Interest rates rises would crimp consumers spending.

Then we cannot overlook the political tensions in America. The US midterm election will take place on November 6, and the pressure is rising. Will the Republicans retain power in the Congress?

Add to that more weak housing data as we discussed last week. There are worries that rising prices will hamper US economic growth.

And more broadly consensus is rising that global growth is heading south in 2019. This could hit China, Europe and other centres, Of course the quest for perpetual growth is unrealistic and stupid, but no-one is wanting to change tack, and drove towards a more sustainable path.

Banks are right in the middle of this, with the S&P 500 Financials down 1.39% on Friday to 419.21. Bitcoin slide a little, down 0.24% to 6,553, while Gold was up 0.51% to 1,235 and Oil was up 0.43% to 67.62.

The 3 Month yield was steady at 2.33, and the 10-year yield was down to 3.077, 15 basis points off its recent highs, though given the FED’s stance that may be temporary.

One International Bank to watch is Deutsche Bank, which has been taking a bath recently. Bank in January 2014 it was at around 30.00 Euros, but now its languishing at 8.51 and was down 3.56% on Friday.  The plunge in shares for the German lender comes after mixed quarterly figures were released this week which showed Deutsche Bank profits had dropped by 65 percent in the third quarter. Deutsche Bank revealed net profit of €229 million, a decline from the €649 million seen in the same period in 2017.   But despite the steep decline, Deutsche Bank officials declared they were still on track to swing to a profit this year, its first since 2014. The German lender has been restructuring under a new leadership as it struggles to rebound after three consecutive years of losses. Chief Executive Christian Sewing said: “We have our costs under control and sufficient capital to grow. “We are on track to be profitable in 2018, for the first time since 2014.” Revenue in the third quarter fell 9 percent, to €6.175 billion. Deutsche Bank is currently in the middle of a mass restricting, with 2,800 jobs already cut to bring headcount to 94,717. The aim is to drag this number to below 90,000 by the end of this year. The bank predicts a saving of €900 million by 2022 through restructuring, including the merging of the head office and infrastructure. But the bank has very large exposures to derivatives, especially interest rate related, and given the uncertainly around Brexit, the FED and other factors, its risk on at the moment.

So to the local markets.  Among the banks, most were up a little on Friday, having dropped the day before. CBA was up 0.83% to end at 65.81, NAB was up 0.69% to 24.70, Westpac was up 0.46% to  25.96 and ANZ was up 0.44% to 24.91.  The Regionals also bounced a little with Bendigo and Adelaide Bank up 1.42% to 9.90, Suncorp up 0.28% to 13.65 and the Bank of Queensland up 1.17% to 9.54, after it had dropped significantly the previous day thanks to going ex. Dividend. Macquarie was also high, up 0.94% to 111.17, but AMP continues to fall as it reported the loss of more customers, despite a fire sale. It ended down another 7.72% to 2.36. Frankly it’s hard to know that value remains there.

The ASX 200 Financials remains down, well down, though did rise by 0.35% yesterday to 5,554. The local volatility index was down 9.68% on Friday at 20.12, but is still elevated.  The Aussie ended at 70.92, at the lower end of its recent range and most commentators expect more falls ahead. Fitch, for example said “We are bearish on the Australian dollar over the near term due to a neutral RBA”, but suggested that may change later. They only expect a 25bps rate hike from the RBA by end-2019, in contrast with 100bps worth of hikes from the US Fed over the same period. The ASX 100 ended up just a little at 0.12% to 4,666, but we might expect more downward moves next week. At very least trading will remain choppy.

To understand why, its worth looking at the ABS data on The Australian Annual National Accounts which show that the size of the economy has reached over $1.8 trillion, reflecting a 2.8 per cent increase in 2017-18. This is up from the $1.2 trillion in 2007-08 in nominal terms.

But household consumption is a large part of the story, contributing 1.6 percentage points, though with incomes and the savings ratio falling, while investment in property is the standout. Households borrowed an additional $981 billion over the 10-year period from 2007-08, while the value of land and dwellings increased by $2,957 billion over the same period.  No wonder the regulators want to maintain the credit bubble. Household gross disposable income plus other changes in real net wealth decreased $634 billion, or 33.3%, in 2017-18, thanks mainly to falling property values.  Expect more falls ahead.  This shows that our economic settings are just plain wrong. Yet I suspect more of the same ahead.  And note this, The Annual National Accounts also include labour productivity by industry estimates, which are only available annually. Australia’s labour productivity rose by 0.2 per cent, recording the lowest rise since recording a fall in 2010-11. Agriculture, mining and utilities industries all recorded falls in labour productivity while services industries such as finance, professional, scientific and technical services as well as administrative support services were more productive.

So the property market. CoreLogic reported that last week, the weighted average clearance rate came in below 50 per cent for the 3rd consecutive week with 47 per cent of capital city homes selling.  There were 1,851 homes taken to auction, having increased on the 1,817 auctions held over the week prior when the clearance rate was 49.5 per cent.  One year ago, 67.1 per cent of capital city homes cleared at auction, when volumes were considerably higher (2,525).

Melbourne’s final auction clearance rate showed further softening last week, returning a 50.4 success rate, surpassing the previous week as the lowest recorded since December 2012 (50.6 per cent). Volumes across the city were relatively stable week on week, with 912 homes taken to auction; only 8 more than the prior week.  Clearance rates across the city are now down around 20 per cent on last year, when over the same week a higher 1,223 homes were taken to auction and 73.2 per cent cleared.

In Sydney, the final clearance rate fell last week, with 45.1 per cent of the 647 homes taken to auction selling, down from the 46.1 per cent over the week prior when 611 auctions were held. One year ago, a higher 928 Sydney homes were taken to auction with 63.3 per cent successful.

Across the smaller markets, Canberra came in with the highest clearance rate last week with 59.6 per cent of the 67 auctions held returning a successful result. Brisbane saw the highest number of homes auctioned, with 117 held, however only 28.6 per cent sold.

There are 2,009 capital city homes set to go under the hammer this week, increasing on last week’s 1,851 auctions held as at final figures, however, lower than the 2,519 auctions held over the same week last year. Melbourne will see 1,020 homes auctioned this week, rising from the 912 auctions held last week, and lower than the 1,251 homes taken to market one year ago. Activity is set to remain steady across Sydney this week, with a total of 640 properties scheduled for auction, down only 7 auctions from final figures last week. One year ago, 823 Sydney homes went to auction. Across the smaller markets, Adelaide will see the most notable increase in weekly volumes, with 124 scheduled auctions this week, increasing from the 72 held last week.  Canberra and Perth are also expected to see a higher volumes of auctions take place this week, while Brisbane and Tasmania will see fewer auctions held.

More are getting twitchy about the property sector, with both Mirvac and Stockland now selling off land sites in Sydney and Melbourne, to reduce risks, according to a report in the Australian.  Then there was the latest HIA-CoreLogic land report, which on one hand reported that there was a 15.5% annual increase in the median capital city lot price to an all-time high $336,124, despite a 22% slump in sales volumes and broader housing market weakness. Land supply is clearly an issue, but with demand weakening, these high prices may not be sustainable.  This was brought home in the latest from Ernst and Young, which warns that developers are in for a bumpy ride.  the combination of falling prices and tightening lending standards has had negative implications for not only developers but also builders and lenders, noting slowing project and land sales may affect the timing of cash flows and payments, leaving developers vulnerable in the medium-to-long term. Thus, declining land values may impact loan-to-value ratios and require developers to generate more or new equity to get new projects off the ground while declining sales and revenues from projects may not cover returns to equity and debt holders. This could lead to an increase in ‘fire sales’ which will re-set the market and cause further concern from a finance perspective.

Meantime both Domain and CoreLogic reported more price falls. CoreLogic said their weekly index has dropped 0.05%, across the main centres, but with Melbourne down 0.12%. We think Melbourne is at risk now. Domain released its State of the Market Report for the September quarter of 2018, which revealed that Sydney and Melbourne house prices fell, down 3.1% and 3.9% respectively over the quarter. Nationally house prices were down 2.6%. But of course there are variations by post code and property type. Averages tell you very little.  And remember it’s the “equity” being eroded, if you have an 80% Loan to value, last year, you could easily have lost half now. The banks benefits, home owners with a mortgage do not!

S&P’s latest SPIN index, the measure of defaults on Residential Backed Mortgage Securities for August was mixed. The read was 1.36% in August, down from 1.38% in July. Arrears have typically decrease month on month in August for the past five years. At 1.36%, however, arrears are noticeably higher than the August average for the past five years of around 1.13%, though they remain low overall. They say there has been an ongoing increase in home loans that are more than 90 days in arrears. Loans more than 90 days past due reached 0.74% in August, making up around 54% of total arrears. This is up from 42% five years ago. This is consistent with our mortgage stress data, more households getting into more financial difficulty.  Regional bank mortgage originators reported the highest percentage of loans more than 90 days in arrears in August, at 1.33%, followed by the major banks, at 0.99%. Some of the increase is due to geographic influences. This is most evident in the regional bank portfolios, which have a 35% exposure to Queensland, compared with 28% for the entire RMBS prime portfolio, and 18% exposure to Western Australia, compared with 11% for the entire portfolio. The downturn in the mining sector and an ongoing drought in agricultural areas are placing pressure on mortgage payments in Queensland and Western Australia.

They concluded “We expect falling house prices to put further pressure on mortgage arrears in coming months. Borrowers with higher loan-to-value (LTV) ratios are more likely to be affected by softening property prices because they have not had time to build up equity or accumulate mortgage buffers. This could tip some borrowers into a negative equity position, which would significantly impede their refinancing prospects in the current lending environment. Across all RMBS loan portfolios we expect borrowers with LTV ratios of 80% and higher to be most at risk. These loans account for around 13% of RMBS loan portfolios.

Negative Equity could become a big issue if prices do continue to fall. We ran some modelling for the AFR reported today, with 350,000 households at risk if prices fell peak to trough by 20% (which is not our worst case scenario).  They even created an interactive tool, using our data.  “Comparison site RateCity illustrates the impact of a 20 per cent fall during the two years to December 2019 depending on when a property was purchased. A median-priced Sydney house of $745,000 bought in 2013 with a 10 per cent deposit would have an estimated value of $836,000 in December 2019, a profit of nearly $44,000 and estimated loan to value ratio (LVR) of 71 per cent, according to RateCity. A median-priced house in Sydney worth $930,000 in December 2015 with the same deposit would by the end of next year be worth $836,000 –a loss of more than $154,000 if sold or a LVR of 93 per cent. The same property purchased for $1.05 million in December 2017 would on these numbers sell next December for a loss of $278,000. These estimates do not include interest paid, loan mortgage insurance, stamp duty, moving costs, marketing and legal expenses, which can add another 10 per cent to the cost of purchasing a property.

This week there was a silly report from the Master Builders, claiming to model the impact of Labor’s proposed changes to negative gearing. They claimed it would cause major falls in home prices, and rises in rents, and kill the construction sector, but failed to model in the “minor” fact that Labour would grandfather existing gearing arrangements, and still provide support for new developments. In fact, Macquarie debunked the modelling in short order, and concluded there would be but a small impact, following through to GDP. In fact, we think this is the ideal time to bring in such a reform, when property investors are on the side lines. In fact it might well stimulate new builds.

And more poor arguments, were abroad this week, as people tried to head off the Royal Commission outcomes before they are delivered. We made a submission on the interim report, and you can watch our Video on this.

But, amazingly, Treasury secretary Philip Gaetjens told a Senate estimates hearing in Canberra on Wednesday that a key risk to Australia’s strong economy is banks cutting their lending too much in response to the Royal Commission into financial services and tougher credit rules imposed by the prudential regulator. Amid complaints from small business and home buyers that they are finding it harder to attain finance, Mr Gaetjens said a tightening of credit conditions could constrain household consumption and business investment.     “There is also some evidence of a modest tightening in lending standards by banks which could be limiting access to credit for some borrowers who may previously been able to borrow,” he said.

And the RBA is at it too “The Reserve Bank of Australia and Treasury have privately cautioned the Morrison government that any regulatory response to the financial services Royal Commission must be careful to avoid putting the brakes on lending to home buyers and business.”

And in the minutes of its October meeting on monetary policy, the Reserve Bank notes that members discussed the release of the interim report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry. “The report contains many questions covering a broad range of issues, but at this stage provides relatively little indication of the recommendations that are likely to be made in the final report,” the minutes said  “Members observed that while the regulators had already overseen a tightening of lending standards, and a degree of tightening of lending standards had been implemented by banks in anticipation of the commission’s findings, it was possible that banks could tighten lending conditions further given the issues raised in the report. “Members noted that it would be important to monitor the future supply of credit to ensure that economic activity continued to be appropriately supported.”

Now let’s be clear, a decade of too lose lending has to be brought under control. The Royal Commission has done a great job in shining a light into the dark places, and it’s not pretty. And yes the banks are now tightening their lending criteria. Rightly. The last think we need is a reversion to this bad practice. Loans need to be suitable and fit for purpose, and affordable.

This does put pressure on the overall economy though, because this poor lending which drove household consumption and home prices plus construction, will ease, and we do not have a Plan B for economic success in an uncertain world. But reverting to Plan A, just ease lending restrictions is NOT the answer, and we hope the Royal Commission remains true to its focus on Community Expectations. We should demand more from Treasury and the RBA, but then they are caught in a trap of their own making.

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