Pete Wargent blogspot

Co-founder & CEO of AllenWargent property buyer's agents, offices in Brisbane (Riverside) & Sydney (Martin Place), and CEO of WargentAdvisory (providing subscription analysis, reports & services to institutional clients).

4 x finance/investment author - 'Get a Financial Grip: a simple plan for financial freedom’ (2012) rated Top 10 finance books by Money Magazine & Dymocks.

"Unfortunately so much commentary is self-serving or sensationalist. Pete Wargent shines through with his clear, sober & dispassionate analysis of the housing market, which is so valuable. Pete drills into the facts & unlocks the details that others gloss over in their rush to get a headline. On housing Pete is a must read, must follow - he is one of the better property analysts in Australia" - Stephen Koukoulas, MD of Market Economics, former Senior Economics Adviser to Prime Minister Gillard.

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Thursday, 27 March 2014

RBA sees financial stability

Comprehensive review

I've made the point a few times that when it comes to monetary policy and other regulatory actions it matters rather less what people say on chat forums and rather more what the Reserve Bank of Australia (RBA) and APRA say, since ultimately they are the bodies tasked with making the key decisions.

While plenty of people disagree with the RBA, a couple of hours spent reading yesterday's Financial Stability review should tell you how comprehensively the central bank assesses risk.

Fortunately, I spent the two hours so you don't have to.

The four points you're probably most interested in:

1- Banking sector

The Australian banking industry emerged from the financial crisis relatively unscathed, but events elsewhere showed that if ever there was a time to bolster capital requirements and shore up risk, it is surely now.

The RBA reported that the banking sector got stronger in 2013 - asset performance is improving and bad and doubtful debt charges declined.

Having increased from essentially nil in 2003, bank's non-performing loans are now declining as households enjoy very low interest rates.

Businesses too, are finding the terrain a little easier than they were during the financial crisis, and bank loan books look much healthier for that.




The non-performing share of banks’ domestic housing loan portfolios fell over the six months to December 2013, to 0.6% down from a peak of 0.9% in mid 2011, helped by low interest rates and tighter mortgage lending since 2008. 

The ratio of impaired housing loans has fallen recent quarters with rising dwelling prices helping banks to deal with their troubled assets and being able to report a reduction in mortgages-in-possession.

Those are the bare numbers, but a bit of context here might be helpful:


We have just been through the greatest financial crisis since the Great Depression, so non-performing loans of 0.6% is a very sound result.

2 - Lending standards and bank balance sheets

Low-doc lending continues to represent less than 1% of loan approvals, while the share of loan approvals with loan-to-valuation ratios (LVRs) greater than or equal to 90% has been fairly steady since 2011 at around 13%.

The share of banks’ funding sourced from domestic deposits has increased from about 40% in 2008  to around 57% currently.

That's a good thing.

Australia's major banks (classified by APRA as "D-SIBS) have bolstered their capital and funding structures since the financial crisis and are in fact already well-placed to meet APRA's more stringent Basel III capital requirements which will kick in in 2016.



A key point here:

Banks are generating imperiously strong, comfortably double-digit returns on equity (ROE) and colossal net profits after tax (e.g. even after tax Commbank cleared a net profit of $7.8 billion in their 2013 financial year - before tax the figure was closer to $11 billion).

Surely then, herein lies a golden opportunity to enforce the strengthening of capital ratios further through earnings retention, reducing dividend payments or scaling back share market purchases in order to offer dividend reinvestment plans (DRPs).

Of course, bank execs will want to continue chasing the golden egg of 15% ROEs through reinvestment and greater expansion of their loan books, but if our major lenders are to receive an implicit government guarantee then, stuff it, make them shore up their capital ratios, I say.

It would be better for everyone over the long term.

3 - Household finances

The overall financial position of the household sector was little changed in 2013 and indicators of financial stress remain low, reported the RBA.

Households continued to manage their finances with greater prudence than a decade ago, household wealth continued to increase, the saving ratio was within its range of recent years and, importantly, households continued to pay down mortgages much more quickly than required.

The household saving ratio remained within its range of recent years, at about 10%.




The proportion of disposable income required to meet interest payments on household debt has now stabilised over the past 6 months, having previously declined in line with the fall in mortgage interest rates in recent years. 

The good news is that households have used lower interest rates to continue paying down their mortgages much more quickly than required.

Remarkably, the aggregate mortgage buffer has risen to almost 15% of outstanding balances, which is equivalent to two full years of total scheduled repayments at current interest rates. 

The RBA notes that therefore households have considerable scope to continue to meet their debt obligations even in the event of temporary unemployment. 

Overall, aggregate indicators of financial stress remain low.

4 - Housing market

As for the housing market, the RBA noted that lending to self-managed super funds (SMSFs) is now being tightened up and remains only a small part of the market, as do purchases by non-residents.

Housing loan approvals are picking up across Australia, but are really firing in New South Wales (read Sydney).




The financial crisis seems to have scared households away from the share markets and towards housing according to surveys. Note how sentiment towards equities hit lows just when share market valuations became cheap and more attractive!

The RBA noted that "the pick-up in investor activity in the housing market does not appear to pose near-term risks to financial stability" but "developments will continue to be monitored closely for signs of excessive speculation and riskier lending practices."

The Reserve Bank is very keen to ensure that lending standards in Australia remain high.

Summary

There is much more besides which you can read here, but that is the flavour of the report.

Lending standards will be monitored but on the face of it the RBA appears to be more focused on aggregate loan impairments and indicators of financial stress than dwelling prices.