Household Spending Patterns

Today the ABS published the latest selected costs of living indexes. One interesting data point is the relative movement in mortgage and consumer credit costs being paid by households. We mapped these back to the findings for our recent household surveys, and compared households and their spending patterns.

So first, here is the data on the index of mortgage and consumer credit charges:

Household-Costs1This is an index series, but note how different the shape of the curves are for mortgage debt and consumer credit debt repayments. As you would expect, with rates being so low, mortgage repayments reduced, though this is offset by the average mortgage being twice as large as in 2005, so in absolute terms, repayments are still pretty large. Certainly runs counter the claims from some that it is an all-time low, or even lower than trend! But also look at the consumer credit trends, there repayments are as high as ever, thanks to several factors. First, consumer interest rates have not fallen as far or as fast as the banks benchmark rate, second some households are paying down debt, and third, others are taking much more debt on. My recent post highlighted this.

We then went back to our surveys, and compared spending across first time buyers and other households.

Household-Costs4As expected first time buyers are spending a greater proportion on housing, insurance and financial services (using the ABS breakdown). Their overall spend is lower than other households, because they are spending less of food, and other categories, thought more on education and communications.

We can also compare the relative distribution – for all households but first time buyers, 27% is going on housing and financial services related spend.

Household-Costs2… and first time buyers:

Household-Costs3Nearing half of their spending is going on housing and financial services related spend. In addition, we already know they are borrowing more on cards and other consumer credit to fill the gap between income and spend – and this at a time of very low interest rates. No wonder many potential first time buyers are on the sidelines!

With the next rise in interest rates likely to be up, and first time buyers from 2009 in higher mortgage stress than average, things look very tight for many households in 2014. Especially in rates were to rise.

We are running our household mortgage stress models, and we will post updated findings later in the week, it may not be pretty!


A Segmentation Cookbook

DFA uses customer segmentation to analyse our surveys to create actionable and differentiated segments. We also apply the same techniques with our client’s data. We often get asked how we arrive at the segments we use, so today I will provide some further insights into our method, which is described at a high level on our web site here. Our overall approach is summarised in the diagram below.

Segment-7One of the essential aspects of segmentation is to determine the right number of segments, and their definition to ensure adequate separation and differention. Often we find clients segment without any clear end-game in mind, so whilst it might be interesting from an analytic stand-point, it does not assist in better business decisions. We always start by asking what they want to achieve from the segmentation in the first place!

There is no one single perfect segment approach, each case requires appropriate selection from the more 60 data elements which might be used. We look for correlations between the input data-sets and the output segmentation which should be aligned to specific goals. We use a proprietary tool for this assessment. To illustrate the point, we will post a few examples.

In the first example the output shows there is no correlation between the input data and output, so we see no clustering, no segmentation. This is the normal starting point.

Segment-2We then start running a series of correlations between the data elements looking for degrees of separation and alignment. In the example we are using, we settled on eight segments as being the best fit. As we tune the correlations, we start to see the data cluster together around the segments.

Segment-4We continue to refine the analysis to get ever better alignment, until we see separate clusters with adequate differentiation. In the case below, which is the one we used for our household segmentation, we were able to define parameters which gave clear and discrete segments. For example, first time buyers, were quite different to down traders. You can read more about our household segmentation here.

Segment-5If the analysis is pushed too hard, it is possible to end up with segments which are too small, leaving gaps. Here is an example from a client, who had spent big on developing selected a segment approach which simply could never work:

Segment-1We suggested an alternative, which has proved to be more useable, and stable. Our tool is capable of assessing different segmentation approaches, and selecting the best.

DFA is sometimes asked to remap our segmental analysis to existing segmentation within our clients. This approach can provide richer and deeper insights to our clients whilst retaining their already familiar segments.  Other clients have chosen to adopt DFA segments in total or in part. Either way, superior segmentation delivers superior results – consistently

 

 

DFA International House Price Comparison Index

DFA has published its first International House Price Comparison Index. Whilst many reports include international comparisons of property prices, using data from various sources, when you dig into them, often they do not show what you think they might, because the relative scales, and start points are often out of synch, or the data is not reported on the same basis. DFA has gone back to primary sources, including Corelogic and Federal Housing Finance Agency for the US, the Reserve Bank of New Zealand, the Office of National Statistics for the UK, and the Australian Bureau of Statistics to establish a house price index on a comparable basis.

We used data from 2000 as a baseline, and produced a relative movement index from then to the end of 2013, tracking relative movements in house prices over time. The results are in looking at data from the major centres in each country but we also include Sydney as a separate data point because of discussion about the momentum there.

Price-TrendUntil 2004, prices were moving up around average inflation rates, but then we see the US, running up to a peak, prior to the GFC, as markets ran hot, then falling significantly, and is now in recovery. The UK took a hit post the GFC, did not fall as fast, and is recovering now. New Zealand reveals high growth, some correction post GFC, but wins the growth prize relatively speaking, out-performing Australia – one reason why the Reserve Bank of NZ moved to limit credit last year.

Turning to Australia, we see the capital city markets growing relatively consistently, albeit with a GFC induced wobble. We also find the relative growth outside Sydney is higher than in Sydney, because the 2000 baseline there was higher. For example, the median price in Sydney was $310k in 2000, and is now $605k, wheres in Adelaide it was $141k (2000) and is now $395k. Hobart was $104k (2000) and is now $345k and Darwin was $161k (2000) and is now $565k. We can also look at the relative annualised growth rates over the trend period. Darwin is the winner, followed by Hobart and Perth.

Price-Trend1

So, two observations, first, by international standards, property price growth in Australia is at the high end as I discussed recently, and second, the relative growth has been a lot stronger away from Sydney, yet much of the recent talk has been about a bubble IN Sydney! We see again the impact of the structurally high property prices thanks to poor policy, easy credit and lack of supply. We have a national property problem, not a local Sydney one!

We plan to update our index regularly as new data is published.

Comprehensive Credit Reporting – Friend or Foe?

Australia’s current credit reporting regime is over twenty years old and permits the collection of only “negative” data. However in March 2014 the credit assessment of potential borrowers is set to change as a result of legislation passed in 2012. Behind the scenes, players are making changes to their systems and processes to meet the deadline, from when additional data about people will be used as part of a more comprehensive “positive” credit assessment scoring. This change has largely passed under the radar so far, but we discuss today some of the implications and issues arising, and potential consequences of the reforms.

By way of background, Australia has lagged behind many other western countries by only using  “negative” credit data. Essentially, this means that default events like missed payments appear on the credit registers and credit scores maintained by the credit reference agencies, like Veda, Experian or Dunn and Bradstreet. In addition some of the large banks hold private data on their customers, but this is not shared.

The international situation is summarised below.

Credit1The USA has some of the most comprehensive credit reporting. According to the  Australian Law Reform Commissions (ALRC)

In the US, credit reporting is regulated under the Fair Credit Reporting Act 1970 (US) (FCRA) by the Federal Trade Commission. The FCRA does not limit the permissible content of credit information files held by credit reporting agencies or the content of credit reports.Major credit reporting agencies in the US hold and report detailed information about individuals’ credit accounts including, but not limited to, current balances, credit limits, amounts past due, payment performance and payment status pattern and account descriptions.Credit reporting agencies receive information from credit providers and others, generally every month, and update their credit files within one to seven days of receiving new information.

In Australia, data is already collated from multiple sources according to Veda.

Credit3The public record element includes:

Credit2The Privacy (Enabling Privacy Protection) Bill 2012 enacted positive credit. The timetable is:

  • November 2012: Comprehensive Credit Reporting passes Parliament
  • December 2012: Royal Assent with the signature of the Governor General
  • April 2013: Draft Credit reporting code is available for public consultation
  • June 2013: Regulations are passed
  • July 2013: Draft Credit reporting code is lodged with the OAIC: Office of the Australian Information Commissioner
  • September 2013: OAIC public consultation on Credit reporting code
  • December 2013: OAIC approves credit reporting code
  • March 2014: New Credit reporting & Privacy Laws start

The rationale for more comprehensive credit reporting is to address the so called information asymmetry between a potential borrower and a potential lender which means the lender is not able to make an accurate  assessment of the risk of a particular customer at a point in time. As a result people with good histories may be disadvantaged in terms of price, and people with poor histories may get facilities they should probably not. In addition, people with minor dents in their behaviour, for example not paying a mobile phone bill some years back, might be disadvantaged or refused credit, when they have reformed. This leads to single pricing – one size fits all.  Today most lending is done on this basis in Australia. The ALRC says:

Due to problems in assessing the risk presented by individual borrowers, credit providers may charge borrowers an average interest rate that takes account of their experience of the pool of borrowers (good and bad) to whom they lend. This may cause adverse selection so that ‘some good borrowers … drop out of the credit market’, further increasing the average interest rate ‘to cover the cost of loans that are not repaid’

Positive credit assessment can therefore increase competition, and improve the relative pricing of some products for some people. People with “thin credit files” may be more able to obtain credit more easily. As a consequence of the enhanced data, default rates may be managed down, and the broader community may benefit from lower pricing due to lower loss rates. Some suggest that positive credit assessments lead to more responsible lending, though I must say, I do not think this is proven. Overseas evidence does suggest that default rates may fall after the introduction of positive assessment. What is true is that consumers will tend to be more aware of their rating, and in some cases make proactive decisions as a result.

On the down side, privacy has been traded away. More information about individuals will be captured, with all the potential issues of accuracy and security. Additional costs will be incurred in enhancing systems, and mechanisms need to be in place to deal with inaccuracies.

The new arrangements commence on the 12 March 2014, when the additional data stored from 2012 onwards will be available to authorised customers of the credit references agencies. The new additional information will include:

  • Date account opened
  • Current Limit of account
  • Nature of credit account
  • Date account closed
  • Account payment history (licensed credit providers)

It will be interesting to see if banks and other credit providers start to offer a range of risk based priced products, based on the enhanced credit score available, and whether net margins are reduced. There is a significant opportunity for players to use data better to segment and target selected customer, based on their credit score.

According to the Office of the Australian Information Commissioner, a credit reference bureau (CRB) or credit provider that holds credit-related personal information about an individual must, on request by an access-seeker (generally, the individual or a person authorised in writing who is assisting the individual), give the access-seeker access to the information.

So, I will be looking out for disclosure by which consumers can inspect, and if necessary correct data on their files. Today, you have to pay a fee in the order of $70 with Veda to examine and check your data for a year. Experian offers a 10 day turn around on an individuals current credit report. Experian in the UK offers a free 1 month trial, then charges after that, but you can also get a 2 pound statutory credit report there.

 

 

Is Lenders Mortgage Insurance A Good Thing?

The Australian Mortgage industry has a feature which is relatively unusual internationally speaking. Lenders Mortgage Insurance or LMI is an insurance scheme which protects a lender from default by the mortgage borrower. It is not the same as mortgage protection insurance, which is insurance a borrower can purchase to protect against events like illness or other adverse factors. About one quarter of borrowing households has LMI, so it is a substantial market. First time buyers are the most common type of borrower to use it. LMI is not mandated in Australia, but has become normal industry practice for loans above 80%, including investment loans.

Lender Mortgage Insurance is a policy which an insurer will write for a bank, to protect the value above 80% in case of default. Normally the premium, a one off fee on loan draw down, is paid by the borrowers directly, or added to the loan amount.  The premium varies by size of loan, and loan-to-value (LVR). Generally loans above 80% LVR require LMI, and loans up to 95% or more are covered. Loans over $1m, or 100% would require special quotations. The chart below shows a typical premium range for an existing borrower. First time buyers will be charged more. So, for example a loan of $600k, 95% LVR would incur a premium of $21,400 for an existing borrower (3.6%) whereas a first time borrower would be charged $23,800 (4%) for the same facility.

LMI1In our household survey we asked borrowers about their understanding of LMI. First time buyers, in particular, are not clear who benefits from LMI, whereas existing borrowers are slightly clearer that the insurance protects the bank. In the case of foreclosure, the bank would make a claim against the insurer, but it does not stop them also pursuing the borrowers to repay the debt!

LMI2LMI is either provided by captive insurers within the banks, or by the two major independent insurers, Genworth and QBE LMI. Genworth says:

“Most banks and financial institutions require you to contribute a deposit based on a percentage of the purchase price of your property. With Lenders Mortgage Insurance, lenders may allow you to borrow a higher portion of the purchase price, allowing you to purchase a property sooner and with a smaller deposit than would otherwise be required”.

This is the key benefit, people can borrow more, sooner, because the banks have higher levels of protection so are more willing to lend.  But as Aussie says:

“It’s really important to realise that only the lender is covered by this insurance. It offers no protection to you the borrower”.

Alternatives to LMI are to wait and save up the 20% deposit, or seek a guarantor. Our research indicates that a number of potential first time buyers are exploring these options, because one way or another, LMI costs.

There are a couple of issues we should highlight. LMI is a premium paid, or capitalised into the loan at inception. It is not portable though, so if you switch lenders, or buy a different property, the premium is foregone – unless you ask, and then only sometimes. ASIC’s Smart Money says you might get some of the premium back in the first year or so, but there is no guarantee. It is quite likely you will need to pay again. I have been advocating for truly portable LMI facilities for a few years now.

The other factor to consider is that the LMI Insurers have concentrated risks in their portfolios, so if there were a major downturn, and claims rocketed, they may have issues, just like the US had post 2007. The rating agencies are watching the insurers, and some were downgraded because of the risks implicit in the business. LMI Insurers also provide enhanced support to securitiation deals, which again enhances their exposure to risk. APRA, who regulates the LMI’s in Australia insists that the LMI business is structured as a monoline insurer, so that the systemic risks in LMI are not cross linked to broader insurance categories. With such potentially concentrated risks, will they be there if property prices fell significantly?

LMI’s may introduce additional credit cycle risks. The RBA Stability Review in September 2013 discussed the LMI industry.  They said:

“The use of mortgage insurance will not necessarily moderate the amplitude of the housing credit cycle, however. Lenders may respond by relaxing standards because they believe the LMI is assessing the risk – an unintended consequence of having a ‘second set of eyes’ – or because they believe that any loss is an LMI loss”

They also make the point that:

“Mortgage insurance is available in many jurisdictions but extensively used in only a small number, including Australia, Canada, Hong Kong, the Netherlands and the United States. The structure of the mortgage insurance industry across these and other countries varies considerably and is affected by the domestic regulatory landscape and the extent of government participation in each jurisdiction.”

So, overall, whilst LMI may allow some to access the property markets sooner, and protects the banks from risk of loss, borrowers are paying for this insurance, and if borrowing more than 80% they will have no choice as this has become industry practice.

There are systemic risks to LMI, and there is some consumer confusion about the role of LMI. The fact LMI is generally not portable is problematic.

In my view LMI is at least partly responsible for the lofty property prices in Australia, and it lifts the cost of entry into the market and if capitalised increases loan amounts on which interest is paid. It is a barrier to switching. Therefore the role of LMI should be reviewed as part of any wider property or banking inquiry.

Down Trader Motivations and Needs

Today we examine the motivations of Down Traders, a household segment which we identified in our household survey. They are people looking to sell their current property and buy smaller, so releasing capital to add to their savings. We have looked further at the data from our surveys, and can paint an interesting picture, which varies across the main urban centres which we feature in this post. More than half of these households are between 50 and 70 years. As some are planning to move interstate, we use their intended destination to define their location.

DownT5We asked about their plans in terms of what type of property they planned to buy. In Sydney and Perth for example, more were looking for an apartment, whereas in Hobart and Adelaide a smaller house was preferred. Some were undecided, others considering a retirement village or residential care.

DownT1Average price varied by location. In Sydney the planned median spend was in excess of $1m. Hobart was cheaper.

DownT2We asked about the factors which would influence their decision about where and what to buy. Households in different areas had different priorities. In Sydney, convenience and life style were important, in Hobart the community rated, whereas in Perth facilities were less important.

DownT3We unpacked the convenience driver. Sports facilities were most important in Melbourne, Access to public transport varied, with Melbourne rating lower, because they have better transport. Access to shops rated in Adelaide, but was less important in Perth. Availability of high speed internet was a factor in the decision matrix.

DownT4So, we find that within the Down Traders, there are considerable variations between locations, and accurate sub-segmentation is required to really pull out the insights. We see, for example, high demand in Sydney for convenient and well appointed apartments, close to public transport and shops, with good technology. There, Down Traders will be competing with property investors for similar properties. Elsewhere, they will be looking at property which would normally be attractive to first time buyers, who are being frozen out of the market. Planners and builders would do well to understand the variations, and focus on meeting the needs of Down Traders, an important and motivated group.

 

Mortgage Sector Competitive Dynamics

Information about mortgage industry market share data is hard to come by, especially amongst smaller banks and non-banks. So we welcome the arrival of the Australian Financial Group (AFG) Competition Index. AFG is a substantial player in the mortgage market, as an aggregator with than 1,800 brokers nationally, processing around $3 billion of mortgage finance every month, and managing more than $70 billion in mortgage finance. They fund some of their own book through securitisation.

They just released data for the 12 months of 2013, and it makes interesting reading, with a few caveats. The data only reports loan flows via AFG, so trends are probably more interesting than absolute numbers. It includes AFG funded loans also. They split out lenders into majors and non-majors, (which include smaller banks, non-banks and building societies). Although AFG has a national footprint, it is headquartered in Perth and so its business mix may not be representative of the national picture. Not all aggregators have the same lender panel mix. That said, here are some of the key findings:

Overall, according to AFG, the majors have lost relative share to the non-major lenders.

AFG1This is especially true for fixed loans, where there has been a 10% shift away from the majors.

AFG2First time buyers are also shifting slightly away from majors.

AFG3However, AFG writes a lot of business with Keystart, the WA owned state lender who offers up to 98% loans, does not require loan mortgage insurance and will consider joint housing association type ownership. We also know that first time volumes in some states are down significantly. The chart below shows the mix, and the yellow bar is Keystart with contributing up to 11% of AFG’s first time buyer business.

AFG4Turning to investor loans, we see players like Macquarie increasing their share, and ME Bank expanding later in the year. ING and AFG are a little down. Again a shift away from the majors is evident.

AFG5

My net conclusion is that there is significant competition for business at the moment, especially as demand is up, but not as much as house prices. Players are seeking to win share by offering special deals, and making changes to broker commissions. We see the presence of non-banks, like Liberty, Pepper, and AFG itself as funding options improve. As highlighted previously, there are data gaps in the national statistics relating to non-bank activity, which looks to be on the rise. We welcome the AFG data set as an additional contribution!

 

Blowing the Gaff on Housing Affordability

Through 2013, DFA has been highlighting the systematic long term deterioration in housing affordability in Australia. Not a bubble, but something much more structural, driven by easy credit AND artificial limitations on land supply. Demographia has just published their 10th global affordability survey. Australia features as one of the most expensive places around the world for residential property, based on Q3 2013 data.

The survey covers markets including Australia, Canada, Hong Kong, Ireland, Japan, New Zealand,  Singapore, United Kingdom and United States. It ranks 360 metropolitan markets. Their basic premise, is that if housing costs exceed three times annual household incomes, then there is institutional failure at the local level.

Their method is based on rating affordability using the “Median Multiple” of house prices and income, which is widely used to evaluate urban markets, and which has been recommended by the World Bank and the United Nations. They do not consider mortgage costs, because interest rates vary, whereas the price for a property is more stable. The benefits of applying a standard methodology over time are obvious, especially, when the long term averages are in the 2.0 –  3.0 range. Significant deterioration in affordability is noted wherever land supply has been restricted by policy intervention. They note that:

“virtually no government administering urban containment policy effectively monitors housing affordability. However, encouraging developments have been implemented at higher levels of government in New Zealand and Florida, and there are signs of potential reform elsewhere”.

They use the following ratings:

Afford1Severely unaffordable geographies included Australia (6.3), New Zealand (8.0), and Hong Kong (14.9). Sydney (9.0) was the fourth least affordable major market. Highly elevated Median Multiples were also recorded in Melbourne (8.4), Auckland (8.0) and London (7.3). Trends over time are interesting:

Afford2The range of affordability across cities shows significant variations:

Afford3In Australia, all urban markets in the study are rated as Severely Unaffordable.

Afford4

Each of Australia’s major markets has been severely unaffordable for all 10 years of the Survey (a distinction shared only with New Zealand, with its single major market, Auckland). Each of Australia’s major markets, with the exception of Sydney had housing affordability within the 3.0 Median Multiple norm during the 1980s, before the widespread adoption of urban containment policies, which is referred to as “urban consolidation” in Australia. The overall Median Multiple was 6.3 among the major metropolitan markets. Housing affordability deteriorated markedly in Sydney, from a Median Multiple of 8.3 to 9.0 in 2013. Melbourne also experienced a substantial loss in housing affordability, from a Median Multiple of 7.5 in 2012 to 8.4 in 2013. Adelaide (6.3), Perth (6.0) and Brisbane (5.8) were little changed from last year. Among all markets, Australia’s Median Multiple remained at a severely unaffordable 5.8. After major markets Sydney (9.0) and Melbourne (8.4). Port Macquarie (NSW) was third most unaffordable, at 8.1, followed by the Sunshine Coast (QLD), at 8.0 and the Gold Coast (QLD) at 7.7. None of Australia’s markets was rated either affordable or moderately unaffordable. The land rich Pilbara mining region of Western Australia was generally more affordable than the rest of Australia, but both markets were seriously unaffordable. Karratha had a Median Multiple of 4.1, Australia’s best, while Port Hedland had a Median Multiple of 5.0. Other seriously unaffordable markets included Gladstone (QLD) with a median multiple of 4.2, Townsville (QLD) and Mildura (VIC) with a Median Multiple of 4.5 and nine others.

Afford5Critics of the Demographia studies claims that the Australian data on household incomes or house prices are not correct, and that there are special circumstances in Australia, especially the urban concentration, which make it unique. However, my research, and even the RBA confirm affordability issues here.

My own view however is we need a deep and thorough review of housing policy in Australia, including land use and affordability, because unaffordable housing is already having poor social outcomes. Plot sizes are shrinking, and last week we highlighted the trade-offs made by first time buyers, if they can get into the market at all!  In the 2010 Demographia report, Dr. Tony Recsei, Save Our Suburbs, Sydney, said:

During the 18th century, especially after the industrial revolution, rural dwellers desperate to make a living streamed into the cities, converting many areas into overcrowded slums. However, as the new economic order began to generate wealth, standards of living improved, allowing an increase in personal living space. Unless we are vigilant, high-density zealots will do their best to reverse centuries of gains and drive us back towards a Dickensian gloom.

I would make a less poetic point, high housing costs, costs the economy because it blots up spending power, and distorts economic outcomes. It forces lending into uneconomic and unproductive avenues, and can force poor policy. Time for a rethink!

Mortgage Brokers Day In The Sun

We just updated our mortgage broker models, to take into account recent transaction patterns and commission changes. Our last snapshot was in November last year. Brokers are doing very well at the moment, thanks to increases in the average mortgage transaction value, lifting volumes, and more generous commission rates from the banks who are actively competing for business in the low interest rate environment. In addition, more households are turning to mortgage brokers for assistance, especially those seeking deals for investment loans. You can see our research on household attitudes to brokers here.

The overall share of new loans via the broker channel is up, reaching 46% of loan applications. We expect volumes to continue to grow.

BrokerJan14Mortgage broker commissions took a hit following the GFC, with volumes down, and commission rates cut. But through 2013, we saw some upward tweaks to mortgage broker commissions.

Most mortgage brokers are aligned with one of the 50 or more aggregators, who provide services for the brokers, marketing support, and negotiates bi-lateral commissions with individual banks. The MFAA maintains a list of aggregators here. Commission structures vary between lenders and broker groups, and individual rates are not always easy to find. Some aggregators, like Mortgage Choice maintain a fixed commission payment to brokers, irrespective of deals with the banks, others pass-through commissions to brokers as they change, perhaps retaining a cut. In addition to hard commissions, aggregators may negotiate tiered structures based on specific volumes or product types, and may receive special deals from individual lenders at different times as well as soft benefits including bank sponsorship of conferences, holidays for top brokers, and other benefits. Most brokers will choose to align with a single aggregator, although some maintain multiple relationships for different types of loans.  A small number of aggregators rebate some commission back to borrowers, but this is relatively unusual. The number of lenders on individual aggregator panels varies.

In July 2013, Bankwest increased its upfront commissions from 50 basis points to 70, whilst scrapping its trailing commission for the first year of 15 basis points. This was in response to Westpac offering to pay 10 basis points extra to September in an attempt to stimulate broker led deals, offering 60 basis points upfront. Others followed, with St George, AMP and Rock Building Society lifting rates of commission. Macquarie Group in November raised its up-front and trailing commissions for business written via Mortgage Choice, one of the biggest aggregator groups.

In 2013, mortgage brokers pocketed commissions of about $1.5bn, including both upfront and trails.

BrokerPool14Factoring in the recent changes, we see that commissions received by brokers overall are up. We baseline our model to the previous commission peak in 2007, before the GFC, and we see that commissions are now back over 80% of the previous high levels. We expect commissions to continue to grow.

BrokerComJan14How do changes in commissions impact the dynamics of the market?  Commissions must be disclosed to prospective borrowers, and the loan must not be unsuitable – a weaker level of protection than being the “best” loan. It is clear though that the industry believes they can get competitive advantage from tweaking broker commissions, and our research confirms that brokers will consider the commissions they receive, along side factors like speed of decision and broker service when selecting a lender from their panel.

Commissions are paid to brokers by the lender, based on the value of the transaction, so it could be argued there is no cost to potential borrowers. Actually, many lenders incur more costs originating a loan via their branch network than via a broker. The truth is, origination and commission costs are all scrambled in the banks books, and the costs have to be recovered somewhere, so it will flow into overall margins and fees. Whether a prospective purchaser gets a better deal via a mortgage broker compared with negotiating direct with a bank is a moot point. Brokers with a good panel of lenders may be able to find a better deal. That said, brokers often do the heavy lifting when it comes to managing and tracking a loan application and many customer think this is worthwhile.

At the moment, brokers are enjoying their day in the sun as momentum in the mortgage market continues to build.

The next big thing will be the continued rise of direct digital channels which has the potential to disrupt the mortgage broking model. Digital Natives expect to use their mobile devices instead of face2face interactions, and as yet brokers are yet to rise to the challenge of the digital revolution. We discussed this yesterday.

Should Debt To Income Servicing Ratios Be The Mortgage Policy Tool of Choice?

Last November the Bank of International Settlements published an interesting working paper entitled “Can non-interest rate policies stabilise housing markets? Evidence from a panel of 57 economies “. The paper discussed the relative effectiveness of a number of policies, over and above the blunt instrument of interest rates, and capital buffers which are designed to help manage the dynamics of the property market. These additional Macroeconomic levers targetting credit policy as the Economist reported last year are important.

“ECONOMICS undergrads learn early on about two levers to manage the macroeconomy: fiscal policy and monetary policy. Events of the last five years make clear that there is a third lever that while poorly understood and difficult to model, it is at times critical: credit policy”.

The BIS, using research analysis covering multiple markets, reached an interesting conclusion in their paper. Whilst there may be some benefits in capping Loan-To-Value ratios (as New Zealand has done, and the IMF advocated), the best mechanism to manage house prices is to target debt service to income ratios. The logic is because LVR controls won’t impact borrowing in a rising market, (as house prices rise, borrowing can grow). On the other hand a debt service to income ratio is not impacted by rising house prices, so consumers would not be in a position to borrow any more even if house prices did rise. Therefore it is a more effective control.

Reading recent papers from the UK, including evidence given by Bank Of England Governor, Mark Carney, it appears that UK is actively considering such measures, despite reassurance to Parliament there that a housing bubble was unlikely (even though there has been a bounce in lending and prices have risen more than 5%). He also said they were actively monitoring lending standards in the UK.

“It’s been that deterioration in lending standards…that type of behaviour that drives the last bubble-like phase of the housing market and creates the financial stability problem.”

Given the current state of the Australian market, with prices rising fast, demand for investment loans in particular high, and banks willing, perhaps desperate to lend at higher LVRs, perhaps APRA/RBA should also be looking at debt servicing to income ratio targets in Australia. Not least because the current HIA-CBA Housing Affordability Index used by the banks is pretty weak, especially when interest rates are low.

Its weakness was highlighted last week in a good article from the ABC’s Michael Janda highlighting the problematic affordability measures used by the banks currently. His conclusion was:

What is certain is that Australian housing isn’t affordable unless you’re betting the house on rates staying at record lows for decades, and that’s a very risky financial move – just ask the now homeless honeymoon rate buyers in the US.

It is time for policy review on debt to income servicing ratios, and the BIS paper offer some important pointers – I hope our regulators are across its contents!