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).

5 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 finest property analysts in Australia" - Stephen Koukoulas, MD of Market Economics, former Senior Economics Adviser to Prime Minister Gillard.

"Pete is one of Australia's brightest financial minds - a must-follow for articulate, accurate & in-depth analysis." - David Scutt, Business Insider, leading Australian market analyst.

"I've been investing for over 40 years & read nearly every investment book ever written yet I still learned new concepts in his books. Pete Wargent is one of Australia's finest young financial commentators." - Michael Yardney, Australia's leading property expert, Amazon #1 best-selling author.

"The most knowledgeable person on Aussie real estate markets - Pete's work is great, loads of good data and charts, the most comprehensive analyst I follow in Australia. If you follow Australia, follow Pete Wargent" - Jonathan Tepper, Variant Perception, Global Macroeconomic Research, and author of the New York Times bestsellers 'End Game' and 'Code Red'.

"The level of detail in Pete's work is superlative across all of Australia's housing markets" - Grant Williams, co-founder RealVision - where world class experts share their thoughts on economics & finance - & author of Things That Make You Go Hmmm...one of the world's most popular & widely-read financial publications.

"Wargent is a bald-faced realty foghorn" - David Llewellyn-Smith, MacroBusiness.

Friday, 30 May 2014

Credit

Credit growing strongly

The Reserve Bank released its Financial Aggregates for April 2014, and the result was another strong one, with total credit expanding by 0.5% in the month of April (click chart):


Over the past year, credit growth now looks solid and is well up over the last year by a further 4.6%. Housing credit growth at 6.1% leads the way implying that the housing markets will continue to be strong in the months ahead (click chart):


Drilling in to the numbers shows that it is investment loans (+8.2%) that is driving the growth more than owner occupied credit (+5.0%), the reason being obvious enough - ongoing low interest rates and woeful returns on term deposits.

Business credit was up in the month too, leading annual growth up to 2.7%.

This normally leads to comments about how housing credit is crowding out productive lending for business.

It's unquestionably true that the share of credit has become more skewed towards housing since lending markets were deregulated in 1986. I explained the reasons why this happened here, but in short:

"The traditional distinction between savings banks and trading banks was removed in 1989 and prior to that, in the mid 1980s, 15 foreign banks were given licences to operate in the Australian market. The major change in market was that a number of building societies and credit unions converted to banks.

Becoming a bank allowed these institutions a much greater capacity to expand their capital base, and from the early 1990s forth, a number of factors contributed to the banking system shifting its focus from lending to business towards housing.
Summarily, an elevated number of bank loans to businesses became impaired during the 1990s recession, so lending for housing got the green light. With reduced assets ratios also now required by the banks, it was time for the banks to get lending on homes...and how.
Between 1991 and 1995 the share of banks' business loans fell from 63% to 48%, but the share of loans for housing soared from 30% to 46%. Lower inflation, falling interest rates and the strong performance of housing loans saw the percentage of housing loans roar up to nearly 60% by 2010."
Graph 1: AFI Housing Credit
Business lending

In truth, banks have never been too keen on lending heavily to small business, and the change in share of credit has been driven as much by the increasing credit for housing as it has a decline in lending  to businesses.
Lending for housing tends to be more attractive to banks because even if you default on your mortgage and do a runner, your house ain't going anywhere. This fact provides comfort to the lender, as do the very low default rates, with only around 0.6% of loans in Australia presently deemed to be impaired.
More than that, business loans often aren't that appealing to borrowers either.

It's an issue I faced in the UK myself. Why would I take a small business loan at a punitive rate of 7-8% with covenants and other restrictions when I could far more easily use a line of credit against one of our investment properties at a preposterously cheap 1.50% over the Bank of England base rate of 0.50% - as close to free money as I'm ever likely to see (spoiler: I obviously wouldn't).

Housing lines of credit are easier for the bank because they have the security of a property rather than the flimsy promises of a fledgling business owner, and it's preferable for the borrower too because it's so much cheaper, and ultimately, so much easier.

Friends, fools and family?

It is traditionally said that start-ups are funded by "friends, fools and family", but the data doesn't really back that up at all.

When analysing the data, the limited use of many sources is striking, with only one source, that being personal savings, being used by more than 50% of all start-ups.

Apart from credit card debt, even a major source such as bank funding is used only by a minority, while samples show that funding by business angels and venture capital firms is close to non-existent in Australia.


In fact, about half of start-ups are founded by entrepreneurs with previous experience of having done so and are thus able to fund themselves via their own seed capital and early revenue streams (which, of course, is the very hallmark of a skilled entrepreneur).


Productivity

Is the lack of business lending killing productivity? There's an argument to say that to a small extent it might be, since higher land prices in our two largest capital cities are likely hold back some enterprises.

This is one of the reasons why where possible small businesses and start-ups should be encouraged to be located away from the inner suburbs of Sydney and Melbourne (where land prices are high) instead of adding to the already sky-high and increasing demand for inner city land.

Australia has to date failed to promote its regional centres as well as it might have done.

That said, over the years we have not seen a decline in the number of small businesses (or indeed, the total number of businesses) despite the impacts of the global financial crisis, which suggests that the story is far from bleak.

As perhaps an inevitable consequence of the financial crisis the number of business exits in Australia began tipping in at around 300,000 per annum.

And yet, despite the GFC, exits were still well exceeded by nascent business entries in 2008, 2009, 2010, 2011 and 2012, before finally a small reversal in 2013 as unemployment ticked up and the mining construction boom finally peaked (click chart):


Therefore I don't expect to see any dramatic changes to the existing structure of credit. 

It suits banks, and evidently nascent small businesses with drive are often able to find a way without the need for bank business loans, either through existing savings and capital, government grants, housing lines of credit, equity from family members, advance payment from customers or other means. 

Small business loans will likely remain a minority play, while Australians seem unlikely to embrace high volumes of venture capital. Whether governments introduce more grants or incentives...I don't know. But it's unrealistic to expect banks to change their approach radically of their own accord or voluntarily.