Credit squeeze continues

Credit growth weakens again

Only confirming what we already knew, of course, but the Reserve Bank's latest Financial Aggregates showed that the credit squeeze went too far in 2018, and continued well into 2019.

By the end of February 2019 personal credit growth had collapsed to -2.7 per cent year-on-year, a diabolical result reflecting a third consecutive quarter of lacklustre growth in the economy.

This is now the weakest result for personal credit since the global financial crisis.

Remember this is in an economy where the population grew by about 400,000 or so heads, so in real terms and after accounting for population growth it's an epic fail.

Business credit growth was just 0.3 per cent in February, mirroring a similarly benign result in January, meaning that monthly business credit growth has also been in deceleration mode for the past six months. 

And annual housing credit growth slowed further in February. 

Investor credit growth slowed again, to the lowest level on record, while growth in credit for homebuyers is also decelerating. 

Labor confirmed this morning it would introduce its new tax laws to level the playing field for first homebuyers and reduce demand for investment housing (thinking face emoji) from 1 January 2020. 

And while I don't believe in the forward-looking power of the credit impulse as a predictor of dwelling prices, it remained flaccid up until February. 

Monday's housing market release will confirm a deceleration in price declines for the major capital cities, which is welcome.

But there's no escaping the facts: some households that bought recently are now facing down negative equity - even before transaction costs - which in turn obviously increases financial stability risks.

The latest available figures will also show that the credit squeeze has decreased activity and housing market turnover in all markets across the country, while personal credit growth is at recessionary levels.  

Labor sets drop-dead date

ALP sets cut-off date

The AFR reported this morning that the Labor Party plans to change negative gearing and capital gains tax (CGT) rules effective 1 January 2020. 

This assumes that the ALP wins the election, and that it doesn't take different advice from Treasury, and that the changes are successfully pushed through the Senate, wherein Labor may not have a clear majority (so a small amount of crossbench support will likely be required). 

There has been some hopeful talk about this stimulating construction.

I don't have a crystal ball any more than the next fellow, but I reckon in the short term it'll do precisely the opposite.

New supply now needs Australian resident buyers willing to buy new apartments, and developers confident enough and in a position to construct it, but historically and over the past 40 years at least the main driver of new supply has always been accelerating price growth. 

After all, the market has known about these prospective changes for some time now and the number of attached dwelling approvals has fallen dramatically lower over the past six months, to be more than 50 per cent lower year-on-year. 

This is in spite of very high levels of population growth into the three main capital cities. 

CGT changes stymie investment

The negative gearing changes are one thing, but hiking the effective rate of capital gains tax is a poor idea, and an obvious disincentive for investment in the economy. 

Without being too dramatic, if not a vote for a recession it's probably a vote for a slowdown in activity in the economy following on from the banking Royal Commission, which Labor also barracked hard for. 

Some of the projected Budget 'savings' are to be directed back at a Build to Rent scheme, so this may be one offsetting factor, though such optimistic ideas often flop. 

In the medium to longer term the policy might help to drive new construction, if it's around for long enough without being binned again. 

There may be some other intended consequences, not least borrowers redirecting all of their borrowing capacity into the family home, pushing up the price of desirable and family-appropriate housing. 

Granted, there are numerous other unknown factors, including whether a new Labor government might once again introduce a first home owners' grant or stamp duty relief as an offsetting stimulus to the demand side.

So many different tiers of uncertainty will almost certainly see construction rates drop, in my humble opinion.  

Loopholes

Labor's proposals haven't been very well explained for the most part.

New investors from 1 January 2020 will still be able to use negative gearing for established properties whereby they have other investment income against which to offset net rental losses, so the new rules are mainly favourable to better off investors and detrimental to younger and first-time investors. 

There will also be comparatively little impact on many wealthier investors, since they can use family trusts or other vehicles in which to invest without too much discernible impact. 

Investors that bought property prior to the drop-dead date will still be able to claim pre-existing net rental losses against their salary, and for them the existing CGT rules are grandfathered, so the changes are arguably iniquitous from an intergenerational standpoint (i.e. disproportionately favourable for those of us old enough to have invested before all the changes). 

After the drop-dead date, investors will be able to claim net rental losses against their salary for new property.

However, when they come to sell those rules won't apply to the second user of the property, so the new rules impact both the value of the new property both when it initially settles, and at the point of resale. 

Labor could have introduced a cap or a phasing out approach, but instead this is a multi-tiered dog's breakfast of a policy, which solves one problem and creates a dozen new ones.

Goodnight nurse!

Another leg down

10-year bond yields down to 1.72 per cent today.

Lowest. Yields. Evuh.

Markets now pricing more than two further cuts.

Fixed rates set to fall

Bank bills have come back quite a lot, and this is helping with funding costs.

Good news here.

Macquarie Bank will now cut its 3-year fixed P&I mortgage rates to 3.69 per cent effective 1 April for 70pc LVRs or lower, representing a tasty drop of 30 basis points.

5-year fixed rates for investors on P&I loans will also be slashed by 60 basis points for 80 per cent LVR loans or lower.

Big moves, and plenty more to come where this came from. 

Job vacancies push on in Sydney

Vacancies hold up

Job vacancies increased by about 9 per cent from a year earlier to hit a record high of 244,900 in February 2019. 

The growth rate here does now appear to be rolling over, though. 

Of course the total labour force is still growing at a fair lick too.  

But even accounting for this, if historical trends persist this level of job vacancies could still see further downwards pressure on the unemployment rate from 4.9 per cent...at least for a while. 

This survey result pushes the number of unemployed persons per vacancy down to just above 2.7, which is a fresh multi-year low (though only just!). 

Sydney retains strength

An interesting point of note is the ongoing strength in New South Wales, which notched a record high 87,800 job vacancies, while construction job vacancies were still holding up at multi-year highs in February.

There may be a clutch of lower-skilled and administrative roles in this figure, but the credit squeeze seems to have impacted other states more so than NSW from a job creation perspective as the state's infrastructure boom rolls on. 

The trend ratio of unemployed persons to job vacancies in New South Wales is approaching a record low at just 2:1, so the Reserve Bank will be hopeful that skills shortages are giving rise to wage price gains. 

Finally the annual average unemployment rates in both Sydney and Melbourne hit multi-year lows in February, but here too the trend appears to be softening gradually.  

The wrap

Pretty good numbers for Sydney and Melbourne here, but it's a race against time for the economy to start firing again before the RBA is forced to cut rates, with growth in the March quarter looking set to be soft for a hat-trick of weakened results. 

There has been some noise about loosening of lending standards, but this takes time to flow through to activity, and markets are now pricing two full cuts for the RBA.

And this is in spite of the high level of job vacancies still apparent at the end of February.

Indeed, as I write this I note Australia's 3-year bond yield has just hit the lowest level on record, so that tells you what markets think about it: stand by for rate cuts. 

Away from Sydney and Melbourne the economy does look to be pretty lacklustre. 

How do debt ratios come down?

Debt bomb deflation

A question for today: we have heard that debt levels are high in Australia, so how do household debt ratios actually come down?

There is no one simple answer.

Rather it's a combination of a whole range of factors coming together.

I'll look at ten of the ways below. 

Firstly, it's important to note that the debt to disposable income in Australia peaked 9 to 12 months ago, and now sits at 1.89 times disposable income.

So it's not over two times income (or even three times!), as is sometimes claimed, and the ratio is not still rising. 

There's been a lot of alarmist reporting about this (surprise!) but these things can have a way of balancing themselves out, and within about 18 months the ratio will probably have eased to more comfortable levels.

We will also likely see debt serviceability ratios declining to remarkably easy levels, as we'll see below.

Source: ABS

So how does the debt ratio come down? 

Here are ten of the ways:

1 - Slower mortgage growth

Monthly housing finance has come down from around $35 billion to under $30 billion as fewer transactions are taking place, and dwelling prices have fallen from their peaks. 

2 - Negative growth in personal debt

Personal credit has been in outright decline for years now (hardly a sign of chronically stressed household finances, it must be said). 

3 - Fewer new interest only mortgages

Now down to about 15 per cent or so of new loans, from nearer 40 per cent at the peak, so more people are now paying down their mortgages immediately.

4 - Lower fixed mortgage rates

Funding costs and fixed mortgage rates are falling, allowing for greater mortgage prepayments.

5 - Loan switching

There's been a massive voluntary migration across from interest-only (IO) to P&I mortgages thanks to the more favourable terms. IO loans may be only about a fifth of mortgages by value by the end of 2019, which is an enormous shift from nearly 40 per cent at the peak.

6 - Tax cuts

Bracket creep has seen real tax payable per capita rising relentlessly for the past five years. This has balanced the Federal Budget, but now it's time for some tax cuts to be delivered back to households (note that disposable income in the chart above is calculated after tax). 

7 - Rate cuts

The market is now pricing in two further interest rate cuts by August 2020. This alone doesn't reduce debt ratios, but it will give households plenty more breathing space to make faster repayments if desired. 

8 - Accelerated repayments

The ABS figures for household finances and wealth will be released tomorrow, and this will show how interest payable to income ratios have fallen dramatically over the past decade, allowing households to build up a war chest of cash and deposits totalling more than $1,150,000,000,000. 

This is totally unprecedented, and shows that the 'record' household debt story is only one part of the equation. 

9 - Income growth

Wages growth has been very slow in recent years, but is now off the lows and rising back towards 3 per cent per annum.

Household income growth is projected to rise further over the years ahead. 

10 - Slower SME loan growth

Another impact of the credit squeeze has been less credit being made available to sole traders and small business owners. 

The wrap

This is just a brief overview of a far more complex story, but offers a few insights into a few of the ways in which the household debt to income ratio will now ease back.

The reality is households have been building up enormous mortgage buffers in recent years, so with a bit of netting down the issue could become a non-issue relatively soon.  

Capital cities grow strongly; unit pipeline shrinks

Capitals expand

The ABS released its regional population growth estimates for FY2018, with some endlessly fascinating stats. 

The big picture is that it remains very difficult to tempt Australians to go regional, with capital cities expanding by 307,800 (or 1.9 per cent) over the financial year, but regional Australia in its entirety growing by only 83,200.

You can click the ABS graphics below to expand them: 

Source: ABS

Greater Melbourne (+119,400) grew at a rampant rate of 2½ per cent to approach a headcount of 5 million, while Sydney (+93,400) remained a very attractive place to live as its population passes 5.3 million today. 

Annual population growth in Brisbane picked up for a fourth consecutive year to more than 50,000, or 2.1 per cent. 

Source: ABS

Population growth has been tremendously strong over the past four years in Sydney (+388,000) and Melbourne (+487,300), while population growth in Brisbane has accelerated for four years in a row now thanks to interstate migration trends.

Greater Melbourne has thus increased by about 600,000 persons in only five years.

Source: ABS

There was significant regional population growth at Gold Coast (17,000), Sunshine Coast (8,000), Geelong (7,000), Melton, Newcastle (6,000), Wollongong (4,000), and Central Coast (3,000). 

The northern part of Melbourne CBD has Australia's densest population per square kilometre at more than 27,000, but overall Sydney has many more of the most densely populated areas, now spread across more than 50 square kilometres of the harbour city. 

Unit pipeline crashes

Darwin saw its population in decline.

This may be no surprise when you look at the impact the winding up of the Ichthys LNG construction phase has had on engineering construction in the Northern Territory.

Engineering construction activity in the NT has fallen by about three quarters over the past year alone. 

Today's engineering construction figures for Q4 2018 were old news to some extent, but fit with the broader picture of the credit squeeze having virtually crippled activity in the economy, with engineering construction nationally plunging 7 per cent lower year-on-year.

The Reserve Bank of New Zealand has now introduced a dovish bias, and the RBA is widely expected to follow suit.

Figures released by the UDIA today showed that 110,000 planned capital city apartments were stalled or abandoned in 2018 (up from only 22,000 in the prior year), with some 168,850 residential units in total failing to attract a green tick. 

That points to a dramatic fall in residential construction over the years ahead. 

The jump in abandoned apartment projects were felt most keenly in Melbourne, Sydney, and Brisbane - in that order - with the "sharp declines in projects leading to greater supply problems and shortages" as the pendulum swings back in the opposite direction (The Australian). 

What is an interest-only loan?

Interest-only loans: The big idea

A few people have had questions for me on interest-only mortgages of late, so I thought I'd do a quick 'back to basics' post to explain why they are useful and so popular, and some of the possible disadvantages. 

As the name implies if a bank writes a mortgage on interest-only terms, this means that the borrower initially pays an interest charge on the amount borrowed but doesn't pay down the balance of the loan.

Why would you do that?

Well, it makes an awful lot of sense for an investor.

That's because the initial repayments may be lower, and all of the interest may be tax deductible.

But here's the clever part: you can combine your everyday savings or transaction account with your mortgage into an offset account, so your savings can reduce the amount of interest you pay on your loan.

Very simple, and very effective. 

So it makes perfect sense for an investor, it's highly tax-efficient, and since it allows you to build up a nice buffer in case of a rainy day it's also a safer way to borrow for sensible investors. 

The risks

There seems to be an increasingly prevailing view or rebuttable presumption that interest-only loans are 'bad' and/or riskier.

But as you can see above in many ways an interest-only loan can be less risky, since it encourages smart borrowers to build up mortgage buffers.

And in fact in aggregate this has happened to an unprecedented degree in Australia, even if some borrowers have not been quite so prudent. 

Where risks can arise is when the borrower reaches the end of the interest-only period - typically five years - and where they may have become so used to repaying only the interest that the extra repayment of principal comes as something of a shock.

The risk is increased if the borrower has multiple interest-only (IO) loans resetting at the same time, or if they have borrowed more than they can comfortably afford.

The risks may also be higher where dwelling prices have been falling and the borrower has not made inroads into paying down the mortgage, such as in Western Australia. 

Paradoxically the clampdown on IO lending also increased risks for a time, because it became significantly tougher for borrowers to seek lower mortgage rates or different products elsewhere, effectively trapping them into their present deal.  

Whereas a sensible lending environment would allow a stressed borrower simply ask to postpone repayments for an agreed period or to extend the IO period, this has not always been an option for some borrowers. 

A few years ago IO loans became very popular, and this stampede led to a clampdown on the widespread use of these terms.

Most borrowers have managed the reset comfortably thanks to their buffers and ongoing low mortgage rates, but there has been a small increase in mortgage arrears lately.

The impact has mainly been on investors, though not exclusively, as some homebuyers took out interest-only loans too.

And the impact has been felt most keenly in Western Australia where the economy was already weakened, but there has been an impact across the board. 

Fortunately most loans today are assessed very conservatively, ensuring that the higher repayment at the end of the IO period can comfortably be afforded, and it's also become much harder to get multiple loans for the average or marginal borrower. 

The outlook

Some years ago I wrote a paper on 'the interest-only cliff', running some scenarios on what night happen if too many borrowers are pushed on to principal and interest repayments at the same time. 

Banks had introduced a mortgage rate differential (nice work if you can get it!) so that IO borrowers paid considerably higher rates for these products. 

I'm hopeful that we have now been through the worst, with the regulatory cap on interest-only loans now having been lifted. 

I don't have a crystal ball, but it seems to me that the quantum of interest-only loans should stabilise, albeit at a much lower level (it's actually a much smaller share of a much smaller mortgage pie). 

One of the major banks has been angling for new business through offering rates of a tick under 4 per cent IO plus a cash rebate for new customers bringing loans across, and others may now allow the interest-only period to be extended out to a maximum of ten years without triggering complicating new credit assessments.

Shayne Elliott of ANZ, still another of the major banks, said that lending standards are now easing back towards a sensible equilibrium (and indeed ANZ introduced new and more favourable IO terms recently too). 

It was only last month that Royal Commission final report was handed down, but it does seem that there will be some gentle relaxation at the margin - mainly through brokers, and with little fanfare - which hopefully should help to act as a pressure release valve. 

The mechanically forced reset now longer applies, and lenders should have no interest in pushing the marginally stressed borrower into arrears unduly. 

Will Australia spark Armageddon?

A 10 minute discussion live last night on Your Money.

Click below on the image to watch:

Perhaps a better example of a country with relatively low debt that had a recession leading to a banking crisis would be Greece...just in case you picked up on that point.