What’s The Correlation Between Mortgage Stress And Loan Non Performance?

Last night DFA was involved in a flurry of tweets about the relationship between our rolling mortgage stress data and mortgage non-performance over time. The core questions revolved around our method of assessing mortgage stress, and the strength, or otherwise of the correlation.

We were also asked about our expectations as to when non-performing mortgage loans will more above 1% of portfolio, given the uptick in stress we are seeing at the moment.

Our May 2017 data showed that across the nation, more than 794,000 households are now in mortgage stress (last month 767,000) with 30,000 of these in severe stress. This equates to 24.8% of households, up from 23.4% last month. We also estimate that nearly 55,000 households risk default in the next 12 months.

However, it got too late last night to try and explain our analysis in 140 characters. So here is more detail on our approach to mortgage stress, and importantly a chart which slows the relationship between stress data and mortgage non-performance.

Our analysis uses our core market model which combines information from our 52,000 household surveys, public data from the RBA, ABS and APRA; and private data from lenders and aggregators. The data is current to end May 2017.

We analyse household cash flow based on real incomes, outgoings and mortgage repayments. Households are “stressed” when income does not cover ongoing costs, rather than identifying a set proportion of income, (such as 30%) going on the mortgage.

Those households in mild stress have little leeway in their cash flows, whereas those in severe stress are unable to meet repayments from current income. In both cases, households manage this deficit by cutting back on spending, putting more on credit cards and seeking to refinance, restructure or sell their home. Those in severe stress are more likely to be seeking hardship assistance and are often forced to sell.

We also make an estimate of predicated 30 day defaults in the year ahead (PD30) based on our stress data, and an economic overlay including expected mortgage rates, inflation, income growth and underemployment, at a post code level.

Here is the mapping between stress and non-performance of loans.

The red line is the data from the regulators on non-performing mortgage loans. In 2016 it sat around 0.7%. There was a peak following the 2007/8 financial crisis, after which interest rates and mortgage rates came down.

We show three additional lines on the chart. The first is our severe stress measure, the blue line, which is higher than the default rate, but follows the non-performance line quite well. The second line is the PD30 estimate, our prediction at the time of the expected level of default, in the year ahead. This is shown by the dotted yellow line, and tends to lead the actual level of defaults. Again there is a reasonable correlation.

The final line shows the mild stress household data. This is plotted on the right hand scale, and has a lower level of correlation, but nevertheless a reasonable level of shaping. After the GFC, rates cuts, plus the cash splash, helped households get out of trouble by in large, but since then the size of mortgages have grown, income in real terms is falling, living cost are rising as is underemployment. Plus mortgage rates have been rising, and the net impact in the past six months, with the RBA cash rate cut on one hand, and out of cycle rises by the banks on the other, is that mortgage repayments are higher today, than they were, for both owner occupied borrowers and investors. Interest only investors are the hardest hit.

Households are responding by cutting back on their spending, seeking to refinance and restructure their loans, and generally hunkering down. All not good for broader economic growth!

So, given the severe stress, mild stress and our PD30 estimates are all currently rising, we expect non-performing loans to rise above 1% of portfolio during 2018. Unless the RBA cuts, and the mortgage rates follow.


The Latest Top 10 Post Codes In Risk Of Mortgage Default

Today using our latest mortgage stress and probability of default data, we explore the top ten highest risk post codes across the country. Specifically, we look at where we expect the largest number of mortgage defaults to occur over the next few months.

We explore the latest mortgage stress and default modelling, using data to the end of April 2017. We have already highlighted that overall mortgage stress is rising, with more than 767,000 households in stress compared with last month’s 669,000. This equates to 23.4% of households, up from 21.8% last month. 32,000 of these are in severe stress. We also estimate that nearly 52,000 households risk default in the next 12 months.

But now we look at individual post codes, and explore the top ten based on the number of households we expect to default. This is calculated using our 52,000 household sample with economic overlays for employment, inflation, interest rates and costs of living.

Note the labels in the chart above are only examples of locations within the postcodes.

As a general observation, many of the worst hit post codes are areas containing large numbers of newer property in the outer urban ring. Households here have large mortgages and limited income growth relative to house prices. But there are some important differences in terms of recent house price movements across the post codes.

We will count down the top 10, from 10th down to the highest risk postcode. So stay with us to the end!

The tenth highest risk post code in Australia is 6027 in Western Australia. This is the city of Joondalup and includes places like Ocean Reef and Edgewater. It is about 25 kilometres north of Perth. It’s a fast growing area with lots of young families, lots of new homes and large mortgages relative to income. The average house price is $510,000, down from $570,000 in 2014. We estimate there are more than 1,900 households in mortgage stress in the area, and 211 are likely to default in the next few months.

In ninth spot is Victorian post code 3064. This includes Craigieburn, Mickleham and Roxburgh Park. This area is about 25 kilometres north from Melbourne. The average house price is $438,000, up from $330,000 in 2014.  Again it is a fast growing area, with more than 60% of households holding a mortgage. The average age here is 30 years. We estimate there are 4,320 households in mortgage stress, and 212 are likely to default in the next few months.

Next at number eight is 4740 in Queensland. This includes Mackay and the surround areas, including Alexandra, Beaconsfield, Richmond and Slade Point. This area is more than 800 kilometres north of Brisbane, and is the gateway to the Bowen Basin coal mining reserves of Central Queensland. The average house price is $240,000 compared with $400,000 in 2014.  We estimate there are more than 3,600 households in mortgage stress in the region, and 244 are likely to default in the next few months.

We go back to Victoria for the seventh placed postcode which is 3029, Hoppers Crossing. This is a suburb of Melbourne about 23 kilometres’ south-west of the CBD and has grown to become a substantial residential area, with about half of properties there mortgaged. The average age is around 35. The average house price is $440,000 compared with $340,000 in 2014. We estimate there to be more than 3,400 households in mortgage stress, and we expect 266 households to default in the next few months.

In sixth place in Western Australia, is 6164, the city of Cockburn. It is about 8 kilometres south of Fremantle and about 24 kilometres south of Perth’s central business district. It includes areas like Jandakot, South Lake and Success. Around 40% of homes in the region are mortgaged and the average age is 31 years. Average house prices are around $730,000 about the same as in 2014. More than 2,530 households are in mortgage stress here, and the estimated number of defaults in the next few months is 308.

Next, counting down to number five, is another WA location, 6065, the city of Wanneroo which is around 25 kilometres north of Perth on the rail corridor. Again a fast growing suburb, the city has had the largest population expansion out of any other local government area in greater Perth. The average house price is $425,000 compared with $480,000 in 2014. Nearly half of households here have a mortgage, and more than 7,400 are in mortgage stress. We estimate that 339 households are likely to default in the next few months.

In fourth spot is Cranborne in Victoria, 3977. It is a suburb in the outer south east of Melbourne, 43 kilometres from the central business district. Its local government area is the City of Casey which is one of Victoria’s most populous regions, with a population of well over a quarter of a million. The average house price is $425,000 compared with $330,000 in 2014. In 3977, close to half of all homes are mortgaged, and we estimate 2,750 households are in mortgage stress, including 344 in severe stress. We estimate around 340 households will default in the next few months.

So down to the top three. The third most risky postcode according to our analysis is Victorian post code 3030 which is the region around Derrimut and Werribee. Werribee is a suburb of Geelong and is about 29 kilometres south west of Melbourne. The median house price is $405,000, well above its 2014 level of $310,000. Here 3,730 households are in mortgage stress, and 342 are likely to default in the next few months.

In second place is another Western Australian post code, 6155, Canning Vale and Willetton. It’s a large southern suburb of Perth, 20 kilometres from the CBD. The population has been growing quickly with significant new builds, and 60% of households have a mortgage. The average house price is around $560,000, down from $610,000 in 2014. The average age is 32 years. We estimate there are 4,150 households in mortgage stress and 342 households risk default in the next few months.

So finally, in top spot, at number one, is another Western Australian postcode 6210, Mandurah. This also includes suburbs such as Meadow Springs and Dudley Park. Mandurah is a southwest coast suburb, 65 kilometres from Perth. The average home price is around $300,000 and has fallen from $340,000 since 2014. Here there are 1,430 households in mortgage stress but we estimate 388 are at risk of default in the next few months.

As a final aside, in twenty second place, is the highest risk postcode in New South Wales, 2155, Kellyville, which is 36 kilometres north-west of the Sydney central business district in The Hills Shire. The average house price here is $1.1 million, compared with $860,000 in 2014. We estimate there are 1,240 households in mild stress and we estimate 151 households risk default in the next few months.

So that completes our analysis of the current most risky postcodes. We will update our modelling next month, so check back to see how the trends develop. But in summary households in Western Australia are most exposed in the current environment, especially with house prices there falling.

Relative Value At Risk By State

After I posted the summary data on owner occupied mortgages yesterday, including the latest estimated probability of 30-day default, I was asked if I could estimate the relative value-at-risk by state represented by these numbers, with a focus on WA.

Hi Martin, It looks as if WA is in some serious trouble. Do you know if the big banks are very exposed there? Thanks

In today’s post I will try to answer this question. Bear in mind that there is more than $1 trillion owing on owner occupied residential mortgages. We can apply the estimated PD30 (30 Day Default Probability) values to each mortgage pool and so estimate the value of loans at risk by state.

The charts below displays the output from the analysis. Each state is shown separately, together with its relative share of outstanding owner occupied mortgages by value – as a percentage of the total. But we also show the value – in billions – of loans at potential default risk and their relative distribution.

For example, in NSW, whilst around 30% of all households who have a mortgage live there, the total value of those mortgages is worth around $467 billion, which is 44% of the total national OO mortgage pool. From our modelling, $6.5 billion are at PD30 risk, which is 39% of the risk value pool.

But now compare this with WA. Around 12% of all households who have a mortgage live there. The total value of these mortgages is worth around $133 billion, which is also 12% of the total mortgage pool.  But from our modelling, $3.3 billion are at PD30 risk, which is 20% of the risk value pool.

This highlights the relative higher risks in the WA mortgage portfolio, which is why lenders are being more cautious.  Not all lenders are equally exposed, indeed some are targeting NSW and VIC, but WA is clearly a problem area in terms of risk assessment and management.

Any changes to the lending standards or capital rules needs to take account of the different characteristics in the various local markets.  Lenders need to calibrate their risk models accordingly.

Mortgaged Households, Vital Statistics

We have pulled out the latest data on residential mortgaged households, incorporating the latest mortgage increases and market valuations. So today we run over the top-level vital statistics.

To explain, our market model replicates the industry, across all lenders banks and non-banks and looks beyond the performance of just the securitised mortgage pools (as some of the ratings agencies report). It is looking from a “household in” perspective, not a “lender out” point of view.

To start, we look at the average home price, and average mortgage outstanding across the states, plotted against the relative number of households borrowing.  NSW has the largest values, and thus mortgages, on average. But note that WA runs ahead of VIC though in the west prices are falling.

Next we look at average loan to value (LVR) marking the market value to market, and the latest loan outstanding data. NSW has the highest LVR on average, at ~75%. We also plot the average loan to income (LTI) and again NSW has the highest – at more than 6x income.

Then we look at debt servicing ratios, where again NSW leads the way on average at more than 23% of income, even at these low rates. VIC and WA are a little lower but still extended. Finally, we look at estimated probability of 30-day default, projecting forward to take account of expected economic conditions, interest rates and employment. WA has the highest score, followed by SA. NSW is a little lower, thanks to relatively buoyant economic conditions. That could all change quite quickly, and as highlighted the high leverage in NSW suggests that risks could become more elevated here.

We will update the market model again next month, and track movements across the states. Be warned, averages of course tell us something, but the relative spreads across segments and locations are more important. But that, as they say, is another story!

Mortgage arrears trending upwards nationally

Mortgage arrears underlying prime residential mortgage backed securities (RMBS) have increased from 1.14% to 1.15% from the third to fourth quarter last year says S&P, as reported in Australian Broker.

These values are determined through the Standard & Poor’s Performance Index (SPIN), which measures the weighted average arrears of more than 30 days past due on residential loans in publicly and privately rates Australian RMBS transactions.

Analysts at S&P Global Ratings have said this increase is in line with expectations of a cyclical rise towards the end of the year.

While arrears in the fourth quarter were up by 19% year-on-year, levels remain far below the historical peak of 1.69% according to the S&P report, RMBS Performance Watch – Australia.

Reasons for these low levels of arrears include a low interest rate environment, and, for RMBS, seasoned loans with established payment histories, S&P Global Ratings analyst Narelle Coneybeare, told Australian Broker.

S&P predictions, however, indicate that arrears are likely to rise towards the decade-long average of 1.25% which may put some areas at risk.

“Areas where unemployment is high may be facing increasing pressure. The recent trend has, to date, been Queensland and WA facing the most pressure on arrears performance,” Coneybeare said.

New South Wales (NSW) and Victoria experienced low rates of mortgage arrears – supporting the stable SPIN levels found in the report. Together, these states account for around 55% of total prime RMBS exposures.

While the SPIN in NSW and Victoria helped to offset higher levels of arrears in other states, analysts warned that further interest rate rises could still have negative effects.

“The majority of underlying loans in the portfolio are variable-rate mortgages, and a rise in interest rates is likely to exacerbate debt serviceability pressures, particularly for borrowers with higher loan-to-value (LTV) ratios and limited refinancing prospects,” the report stated.

Breaking down by the states, the levels of 30+ day mortgage arrears, as well as the quarterly and annual changes are as follows:

Thirty-day arrears for non-conforming loans also increased from 4.36% to 4.43% from the third to fourth quarter last year, but were down from 4.63% in Q4 2015. The latest figure is also well below the 17.09% peak experienced after the financial crisis.

“The non-conforming arrears trend reflects a few factors, including low interest rates, accompanied by a relatively benign economic environment and stable unemployment conditions,” Coneybeare said.

“We’ve also observed changes in the overall mix of loans/borrower types in the nonconforming space, with more recent vintages having lower exposure to low-doc loans, as an example.”

Mining Areas Are Taking A Property Hit

From Reuters.

Australia’s quarter-century run of uninterrupted economic growth has made its property market one of the world’s most expensive, but mortgage pain in towns hit by a commodities downturn is beginning to be felt in parts of the financial system.


While most Australians are able to pay their debts, alarm bells have sounded around pockets of distress in the mining-heavy states, raising warnings from policymakers, ratings agencies and the Organisation for Economic Co-operation and Development.

In the remote mining town of Karratha in Western Australia, 61-year-old Peter Lynch received a letter advising him that his bank was going to repossess his house at the end of the March.

“My property in 2010 was worth $905,000, today it’s worth $260,000,” Lynch said, estimating that seven out of 20 homes on his suburban street were for sale.

Two decades ago, Lynch borrowed money to buy a five-bedroom house in the town, thinking his job as a railway maintenance worker at Rio Tinto would last until he retired.

But the end of a one-in-a-century mining boom changed all that.

He now owes $222,000 and earns $42,000 a year as a cleaner, or roughly half his pay at the mine.

Western Australia is the hardest hit Australian state, with mortgage delinquencies topping 2.1 per cent, up by nearly half year-on-year, according to credit ratings house S&P Global.

S&P Global said 30-day arrears on mortgages packaged in issued securities were at multi-year highs.

Alena Chen, a senior analyst at Moody’s, expects rising underemployment and weak wage growth to drive delinquencies higher in mining-intensive states.

Signs of stress are now showing in the mortgage insurance market – shares in Australia’s largest mortgage insurer, Genworth Mortgage Insurance, are down 19 per cent since early February.

The company, which provides protection to lenders from borrowers defaulting on their home loans, last month reported an 11 per cent profit drop in 2016 due to a jump in mortgage delinquencies.

Borrowers typically pay for insurance when they have less than a 20 per cent deposit on their home purchase.

Genworth said in February that last year’s loss ratio of 35.1 per cent, up from 24 per cent in 2015, reflected higher average paid claims in resources-exposed regions, particularly Queensland and Western Australia.

Pockets of pain

Australia’s arrears rate of under 1 per cent, according to industry estimates, is still modest compared with the US peak of 27 per cent seen during the 2007-09 subprime mortgage crisis, and Australia has almost no subprime loans as such.

For now, rising arrears have not materially impacted the wider property market or financial system.

The major banks remain in good health and the mortgage-backed securities market, which finances the loan books of smaller banks and lenders, enjoys strong investor demand. And unlike the US, Australia has had no mortgage-backed bond defaults.

But investors and economists are worried stress could spread should there be a sudden loss of faith in the property market.

Concerns ‘already present’

Real estate is a national obsession in Australia, where two-thirds of households own a home. Since 2009, home values in the nation’s largest city of Sydney have more than doubled, while Melbourne has increased 88 per cent.

Australian households are among the world’s most indebted with a debt-to-disposable income ratio at an all-time peak around 180 per cent, compared with about 100 per cent in Germany and 150 per cent in the US.

Domestic mortgage debt stands at a whopping $1.7 trillion, equal to the country’s entire annual economic output.

Last week, the OECD singled out a “dramatic house-price correction” as the biggest threat to the Australian economy.

Reserve Bank of Australia governor Philip Lowe last month said the bank was wary of easing further for fear of creating housing vulnerabilities, particularly in the mining states.

Steven Hur, acting head of credit at AMP Capital which manages around $58 billion in fixed income, said market concerns about property prices were already present.

“It may push sellers to move first, thereby potentially signalling to the market a decrease in house prices, which may in turn spark further pressure on pricing,” Hur said.

Rate Cuts Help Lower Australian Mortgage Arrears in 3Q16

Australia’s mortgage arrears decreased by 8bp to 1.06% in 3Q16, as borrowers benefitted from the May and August 2016 Reserve Bank of Australia rate cuts and continued low mortgage rates, says Fitch Ratings in the latest Dinkum RMBS Index report.

The lower arrears were primarily in the 30-59 days bucket, but when compared to 3Q15, arrears were actually up by 16bp, despite Australia’s strong economic environment of appreciating house prices and low interest rates. Fitch believes underemployment and the mining sector slowdown, which have led to lower house prices in the regional areas of Queensland, Western Australia and the Northern Territory, may have also affected borrowers.

Losses experienced by Australian RMBS transactions remained extremely low, with lenders’ mortgage insurance payments and/or excess spread sufficient to cover principal shortfalls during the quarter.

Fitch’s Dinkum RMBS Index tracks arrears and performance of mortgages underlying Australian residential mortgage-backed securities

Genworth FY16 Results Highlight Changing Market Conditions

Lender’s Mortgage Insurer Genworth released their results to December 2016 today. From it, we get insights into the changing nature of the housing market, and also a view of the pressure LMI’s are under.

Genworth reported a statutory net profit after tax (NPAT) of $203.1m, down 10.9% on prior year. After adjusting for the after-tax mark-to-market move in the investment portfolio of $9.1m, underlying NPAT was $212.2m down 19.8% on prior year. The loss ratio was 35.1%, compared with 24% last year. They remain strongly capitalised, and though claims are higher, they declared a final fully franked dividend of $14.00,  a FY16 payout ratio of 67.2%, but down from last half.

Banks are clearly writing less high LVR mortgages, thanks to APRA, and when households default, and are forced to sell, there is sufficient capital appreciation in most properties to avoid a LMI claim due to strong price rises.  The banks, can’t loose! (Remember the LMI protects the bank, not the borrower). However, in regions where prices are falling – for example in the mining belts of WA and QLD, and home prices are falling, claims are up. This does not bode well if home prices were to revere more widely.

Genworth was listed in 2014, but since then has completed share buy-backs to reduce the number of issued shares. Further restructure will simplify the corporate structure in 2017, with a view to driving efficiency. They are the only separately listed LMI in Australia, (the banks have their own LMI captives, and the other player in the market is less transparent).

We will look at the market data they provided first, then look at the drivers of their results more specifically.

Genworth had an in-force portfolio of approximately $324 billion at Dec 2016. Standard LMI accounted for 91% of the book, and Low Doc 5%. 26% of the book relates to Investment loans.

The seasoning picture is interesting.  This shows the evolution of Genworth’s 3 month+ delinquencies (flow) by residential mortgage loan book year, from issue.

The delinquency population by months in arrears aged buckets shows that over the past two years, the mortgagee in possession (MIP) as a proportion of total delinquency is trending down. This is because the strong property market has allowed stressed households to sell and release equity, with no LMI claim.

With regards to the current results, a range of factors influenced the lower outcomes.

New Insurance Written (NIW) fell 18.4% in FY16, to $26.6 billion. Moreover, NIW above 90% LVR decreased 39.8%, and 80-90% LVR fell 17.2%. This reflects changing appetite among lenders for higher LVR business, following regulatory intervention from APRA.

Lower Sales (Gross Written Premium – GWP) fell 24.8% compared to previous period due to the lower number of high loan-to-value (LVR) penetration in the market and a lower LVR mix of business.

The average price for Flow (GWP/NIW) decreased from 1.63% to 1.51% in FY16. However, they got some benefit from premium repricing in the second half.

Lower Revenue (Net Earned Premium) – NEP fell 3.6% reflecting lower earned premiums from current and prior book years.

Higher Net Claims Incurred – Net claims incurred increased by $46.1 m to $158.8m due to an increase in the number of delinquent loans relative to a year ago, and a higher average claim amount.  The performance in QLD and WA is “challenging”, reflecting increased delinquencies, especially in resource exposed regions. NSW and VIC were better performers.  Overall, the delinquency rate rose from 0.38% to 0.46%.

Whilst financial income (interest income and realised and unrealised gains/losses) increased by $18.1 m, to $126.0 m in FY16, the yield on the investment portfolio dropped 3.69%.

Regulatory capital fell from $2,600 m in 2015 to $2,213 m in 2016. CET1 decreased in FY16 mainly reflecting the $250 m of dividends, $202 m capital reduction and $86 m decrease in the excess technical provision, offset by $203 m NPAT. Tier 2 capital decreased following the redemption of $50 m of the $140 m notes issued. The PCA coverage ratio was consistent with FY15.

Increase in delinquencies predicted for 2017

From Australian Broker.

After sitting at historically low levels for 2014 and 2015, the number of mortgage delinquencies rose last year. This signalled the start of a trend which analysts expect to continue throughout the coming 12 months.

S&P Global Ratings’ RatingsDirect noted that arrears increased in 2016 despite low interest rates and stable unemployment rates.

This rise – which commenced in November 2015 and continued until May – was driven by a surge in the rate of under and part-time employment while fulltime employment growth declined.

“When we say they’ve gone up, these are modest increases. It was slightly under 1% a year ago and it’s 1.15% now but clearly there’s a trend. If you’re looking at year-on-year comparisons, these have been moving upwards,” Erin Kitson, primary credit analyst at S&P Global Ratings told Australian Broker.

This trend would persist if the Reserve Bank of Australia (RBA) increases the cash rate or if lenders continue to move out-of-cycle. Conversely, a drop in rates would see arrears performance trend lower.

“In terms of any meaningful movement, it will largely be driven by what happens with interest rates.”

These predictions are based on the Australian residential mortgage backed securities (RMBSs) that S&P rates, Kitson said. This includes about $140 million worth of loans outstanding.

“So it’s really a bit of a snapshot of the overall mortgage performance. Obviously, it doesn’t include every single loan in the Australian mortgage market.”

Since most of the loans included in these RMBS’s have variable rates, there is a correlation between what interest rates and arrears are doing, she said.

However, Kitson noted that overall numbers of delinquencies are still relatively low with even the 90+ day mortgage arrears around 0.55%.

“Your 90+ day mortgage arrears are a good proxy for default. At 0.55%, that’s still quite a low number. Given that, my opinion is it’s probably not likely to tip over into lots of defaults which then impact the housing market.”

Mortgage holders at greatest risk of rising interest rates and economic changes are those with higher loan to valuation (LTV) ratios as they have less wriggle room and less equity in their home loans, she said.

“If we’re looking at the RMBS portfolio, about 17% of borrowers have an LTV of greater than 80%. Generally in terms of when an economic situation starts to change, that will be felt first on higher LTV borrowers.”

Prime mortgage arrears rise 25% from a year ago

From Mortgage Professional Australia.

Prime mortgage arrears are up 25% from a year earlier, but remain relatively low, a report by S&P Global Ratings shows.

However, the number of prime home loan delinquencies fell in November 2016 from the previous month.

A total of 1.15% of the mortgages underlying Australian prime RMBS were more than 30 days in arrears in November, as measured by Standard & Poor’s Performance Index (SPIN), down from 1.16% in October.

Arrears fell month on month for most originator categories apart from regional banks, which recorded an increase in arrears to 1.88% from 1.85% a month earlier.

Nonbank financial institutions have maintained the lowest arrears, at 0.63%, followed by nonbank originators, at 0.95%, then other banks, at 0.96%. Major bank arrears were unchanged month on month in November.