Australia’s mortgage arrears remained stable in 2Q17, with a 4bp decrease to 1.17% from the previous quarter, reflecting Fitch Ratings‘ expected seasonal recovery from Christmas and holiday spending.
The 30+ days arrears were 3bp higher from 2Q16, despite Australia’s improved economic environment and lower standard variable interest rates for owner occupied lending.
Unemployment improved by 20bp and real wage growth was low, but positive. Underemployment also improved by 20bp, reflecting a proportional increase of full-time employment during the quarter.
Repayment rates have decreased as borrowers recover from Christmas and holiday spending. The Dinkum RMBS Index borrower payment rate fell to 21.2% at end-2Q17, from 21.9% in the previous quarter. The conditional prepayment rate also dropped qoq to 19.1%, from 19.8%.
Losses experienced after the sale of collateral property remained extremely low, with lenders’ mortgage insurance payments and/or excess spread sufficient to cover principal shortfalls in all transactions during the quarter.
Fitch’s Dinkum RMBS Index tracks arrears and performance of mortgages underlying Australian residential mortgage-backed securities.
Home prices in the United States have now climbed to levels last seen a decade ago, though unlike 10 years prior, much of the country’s growth is now sustainable, according to Fitch Ratings in its latest quarterly U.S. RMBS sustainable home price report.
Home prices grew at nearly a 5% annualized rate last quarter and are 36% higher nationally since reaching their low in 2012. As a result they are now slightly above peak levels reached in 2006 – 2007. The difference this time around compared to a decade ago rests with several other notable factors aside from the much talked about low mortgage rates and falling unemployment.
“The U.S. population has increased by more than 30 million people and personal income per capita has increased by more than 30% since 2006,” said Managing Director Grant Bailey. “Both the significantly higher population and income levels provide much greater support for the price levels today.”
That said, growth remains somewhat disjointed in some regions of the US. “Prices in major metro areas of Texas are now more than 50% higher than they were in 2006, while prices in New York, Philadelphia and Washington DC are still 4% – 10% below 2006 levels,” said Bailey. “Elsewhere, home prices in major cities throughout Florida remain more than 15% below 2006 levels.”
The overheated home price pockets remain largely in the Western United States (Texas, Portland, Phoenix and Las Vegas), which Fitch lists at more than 10% overvalued.
Genworth, the listed Lenders Mortgage Insurer updated the ASX yesterday of the results of the outcomes of recent rating agency reviews. The ratings agencies appear somewhat split on how to assess the risks in the sector.
Fitch ratings affirmed the A+ IFSR and maintained the outlook at stable – saying Genworth had a robust standalone credit profile, solid operating performance, strong capital ratios and conservative investment approach. They noted a generally stable operating environment which continues to support the performance of the insurance portfolio.
Standard & Poor’s rating affirmed the A+ IFSR and maintained the outlook at negative noting standalone credit profile, business risk profile and strong capital and earnings position. “Claims paying resources, which include conservatively invested capital, claims reserves and external reinsurance are supportive of the company’s ability to absorb a significant level of claims if Australia were to experience a severe extended economic downturn”.
Moody’s has however revised its unsolicited IFSR on GFM1 from A3 with a negative outlook to Baa1 with stable outlook. This follows Moody’s wider rating action on financial institutions in June 2017 to reflect its view that “risks in the Australian housing market have risen, heightening the financial sector’s sensitivity to adverse shocks”.
So, you “pays your money and takes your choice!”
Fitch Ratings says Australia’s mortgage arrears increased by 12bp qoq to 1.21% at end-1Q17, due to seasonal Christmas/holiday spending and possible difficulties faced by consumers because of low real-wage growth. The qoq increase in arrears from 4Q16 to 1Q17 was less than 1Q16 (16bp qoq to 1.10%).
The 30+ days arrears in 1Q17 were 11bp higher yoy, despite an improved economic environment and lower standard variable interest rates. Unemployment increased slightly by 2bp and real wage growth was low, but positive. Underemployment has been growing despite relatively stable unemployment.
Fitch Ratings expects arrears to fall in 2Q17 and 3Q17 after the holiday season due to the current low interest rate environment and decreasing unemployment.
Fitch-rated residential mortgage-backed securities transactions have continued to experience extremely low levels of realised losses since closing and an increasing lenders’ mortgage insurance (LMI) payment ratio since 4Q12. Excess spread was sufficient to cover principal shortfalls during 1Q17
The new higher target set for Australian banks’ common equity Tier 1 (CET1) ratios will support their credit profiles and bolster the banking system’s resilience to downturns, says Fitch Ratings. The four major banks should all be able to meet the requirements comfortably through internal capital generation and existing dividend re-investment programmes.
The Australian Prudential Regulation Authority (APRA) has increased the minimum CET1 ratio from 8% to 9.5% for the major banks – ANZ, CBA, NAB and Westpac – and has given them until January 2020 at the latest to meet the new targets. The capital requirements have been raised in response to the recommendation by a 2014 financial system inquiry (FSI) that Australian banks’ capital ratios should be “unquestionably strong”. The decision to focus on CET1 and take a long-term, through-the-cycle approach, rather than tying capital ratios to the top quartile of international banks, was in line with our expectations.
The major banks already have CET1 ratios that are 150bp-200bp above the current minimum in anticipation of the changes. This capital surplus is likely to fall to a more normal 100bp as the new standards are implemented, which implies CET1 ratios will rise to at least 10.5%, from an average of around 9.5% at end-2016.
It is possible that the major banks will issue fresh equity if they see a benefit in raising the extra capital ahead of schedule. There is also a chance that lending rates could be increased to offset the cost of holding more capital. However, the new capital requirements are unlikely to create significant pressures for any of the four major banks, with APRA estimating that the additional capital could be raised by the deadline without any changes in business growth plans or dividend policies.
The minimum CET1 ratio for smaller banks using standardised models is set to rise by about 50bp, but most already run surpluses above the current requirement and are unlikely to need additional capital.
APRA had hoped that the FSI recommendation could be addressed together with revisions to the risk-weighting framework that are currently being debated by the Basel committee. The new international framework is likely to raise internal-ratings based risk weights for investor mortgages and mortgages with high loan-to-value ratios. This change would further add to Australian banks’ capital needs, but strengthened capital requirements for mortgage lending are already part of APRA’s future regulatory plans to ensure banks are unquestionably strong – and it expects any further capital requirements to be met “in an orderly fashion”.
The paper that APRA released to announce the new minimum capital ratios also noted that capital is just one aspect of creating an unquestionably strong banking system, with liquidity, funding, governance, culture, risk management and asset quality also important. APRA reiterated that its supervisory philosophy will continue to assess all of these factors – as well as the operating environment – when assessing bank risk profiles. It also highlighted improvements since the 2008 global financial crisis in some of these areas, such as liquidity and funding.
Unsustainable home prices and record high household leverage render the Toronto and Vancouver housing markets increasingly vulnerable to a steep price correction, though key structural features will safeguard Canada from repeating the U.S. housing crisis, according to Fitch Ratings in a new report.
Home prices in Toronto and Vancouver are up 45% and 36%, respectively, since January 2015 through May of this year. Additionally, household debt to disposable income remains elevated at 167% in 1Q17, the highest amongst G7 sovereigns.
Mortgage-market reforms are also increasing the focus on a private label RMBS market in Canada. This will inevitably draw comparisons by some in the market to the U.S. RMBS market and the influential role it played in the U.S. housing crisis a decade ago. “However, Canada is unlikely to mirror the declines and fallout experienced during the U.S. housing crisis due to major differences in the housing and mortgage finance systems,” said Fitch Director Kate Lin.
“Canadian banks are subject to rigorous oversight and regulations requiring prudent mortgage lending and underwriting standards,” added Lin. “What’s more, credit quality for Canadian mortgage loans remains strong unlike the drift towards weak borrower and loan quality that we saw a decade ago in the U.S.” Further, nonprime credit quality originations in Canada are low, making up approximately 10% of volume compared to 50% in the U.S. during the peak. The Canadian government has also been proactive in managing the risk of the nation’s housing market by taking unprecedented steps to tighten credit and limit speculation.
Home prices continue to hit new highs which could cause challenges for Canadian banks if there is a severe economic shock, according to Fitch Ratings‘ latest North American FI Chart of the Month. Banks with more mortgage exposure to greater Toronto and Vancouver may be more sensitive to any rapid market correction in these two markets.
“Home price growth in Toronto and Vancouver is outpacing fundamentals however most Canadian banks should be able to withstand a market correction, but in the event of an adverse unemployment shock or rapid rise in interest rates, banks could be more heavily impacted,” said Doriana Gamboa, senior director, Fitch Ratings.
In the event of a severe economic shock, Fitch expects that Canadian Mortgage and Housing Corporation (CMHC) would act as a shock absorber for the insured mortgage exposure, which is about an average 55% of total mortgage exposure for the Big Six. Ratings could be affected in such a scenario; however, Fitch believes banks have adequate capital cushions to absorb this risk.
“Recent attempts by federal, provincial and local governments to cool the housing market through various measures, so far have not dampened prices and risks may escalate for banks, though given healthy capital levels a modest correction would be manageable,” added Gamboa.
The big six Canadian banks still dominate the housing sector and Fitch does not see this changing even with the rise of the nonbank mortgage sector. Currently, nonbank mortgage companies account for 13% of the $1.4 trillion mortgage market. With eyes on Home Capital Group (HCG), the largest alternative mortgage lender, Fitch notes that the liquidity issues are specific to its business model and current credit measures do not suggest asset quality problems.
“It’s unlikely that nonbank mortgage companies will dominate the housing sector anytime soon as the tightening of CMHC mortgage insurance rules implemented in October 2016 impacted a significant funding source for mortgage companies,” concluded Gamboa.