RBA warning to banking sector; More people in homes

Financial Stability Review

• RBA highlights risk to banking sector. “Risks to the Australian banking system have increased somewhat over the past six months from banks’ lending to other sectors. The outlook for some commercial property markets has deteriorated further, and banks will need to be especially vigilant in their commercial property risk appetite and the maintenance of sound lending practices in the period ahead.”
• The Bank provided further colour on the housing sector “in particular, there are a few tentative signs that sentiment may be turning in the housing markets of the two largest cities”.
• On Australian households the RBA noted “Indicators suggest that household financial stress remains fairly benign, despite measures of unemployment being somewhat elevated…“Labour market conditions, which strongly influence the extent of household financial stress, have improved so far this year”.
• The number of people per home rose from 2.57 to 2.59 in 2013/14 – the highest levels in 14 years. The number of bedrooms per home hit a record high of 3.14 in 2013/14, up from 3.11 bedrooms in 2011/12.
• Almost 61 per cent of households indicated that they had one or more spare bedrooms in the 2013/14 survey, down from 61.7 per cent in the 2011/12 survey.

What does it all mean?

• The Financial Stability Review usually is a straight-forward document with few controversial issues raised. But in the latest report the Reserve Bank has been uncharacteristically forthright, warning banks for the need to be vigilant and continue to maintain tighter lending standards. The RBA notes that the “risks to the banking system have somewhat increased over the past six months” but “tighter lending practices will, over time, leave the industry better placed to cope with any future deterioration in the housing market and the broader economy”.
• In effect this time round the Financial Stability Review reads a bit like a report card on the banking sector and in that context Aussie banks have been given a pat on the back for the efforts to ensure higher quality loan books. However there is no doubt there is a much more concerned tone from policymakers about the outlook. In effect the report highlighted potential future concerns and stressed that the right measures are put in play now to avoid instability. The key is to ensure that lending standards are not being compromised.
• The RBA did provide a further warning to banks on the commercial property sector and even more so on international exposure – “especially housing and agricultural lending in New Zealand where the risks have continued to grow”.
• Interestingly the last time policymakers provided a warning of this sort was on the Aussie dollar and the likelihood that it was overvalued and would fall at some point in the future – a result that has played out over the past year.
• Encouragingly the Financial Stability Review highlighted the low levels of financial stress being faced by household. Confirming that “labour market conditions, which strongly influence the extent of household financial stress, have improved so far this year”. And importantly there is more comfort within the report with the RBA noting that 16 per cent of borrowers are ahead in repayments by two years or more.
• CommSec expects the Reserve Bank to remain on the interest rate sidelines. However the focus over the rest of this year is likely to be on the movements in the Australian dollar and the likelihood of further lifts in the mortgage rates by banks – adding to the downside risks to interest rates.
• According to the latest housing occupancy data, 61 per cent of households have at least one spare bedroom. The data confirms recent trends showing that there is plenty of spare capacity in our existing homes, even though we have been utilising some of this extra capacity in the past five years. The latest figures have clear implications for the housing industry. If Australians are keen to utilise their homes more efficiently then construction will be more constrained in coming years.

What does the report say?

• On Australian Banks, the RBA noted: “As noted, most banks have now strengthened the serviceability metrics used in their mortgage lending and taken steps to slow the pace of growth in investor lending towards APRA’s expectations. Banks also report that they are becoming increasingly wary of lending to property developers in markets that look oversupplied. The large banks have enhanced their resilience recently by raising substantial amounts of fresh capital in advance of new prudential requirements.”
• On Australian businesses the RBA noted “Outside the property sector, risks to the financial system from non-financial businesses remain low and the sector’s finances are generally in good shape. Business failure rates have fallen significantly across most industries and states over recent years and, in aggregate, are close to decade lows, although business failures have picked up a little in recent month”.
• On Australian households the RBA noted “Many households have likewise been bolstering their resilience in a number of ways, including paying down their debt faster than contractually required and increasing their offset account balances.” .. “Aggregate mortgage buffers – as measured by balances in offset and redraw facilities – remain around 16 per cent of outstanding loan balances, equivalent to more than two years of scheduled”.
• Further, the RBA noted “Moreover, price competition for new and lower-risk owner-occupier borrowers remains strong, despite the forthcoming increase in the indicator rate announced by Westpac”.
• On housing, the RBA said “Large data resubmissions by several banks also indicate that the level of investor lending over recent years has been higher than had initially been reported. Over recent months, lenders have announced changes to a range of price and non-price lending terms and conditions to strengthen lending practices and respond to supervisory expectations (for details, see ‘The Australian Financial System’ chapter). Since then, there have been tentative signs that investor demand has started to cool..”
• On commercial property the RBA noted “So far, the near-term risks to the domestic financial system from the commercial property sector appear modest, but they are rising. Although banks’ commercial property exposures declined as a share of their total assets after the financial crisis, growth in this type of lending has picked up in recent years, driven by the major Australian banks and by Asian-owned banks.”
• The RBA has provided special sections in the report dealing with Australia’s shadow banking system. At present “The shadow banking sector represents only around 5 per cent of financial system assets in Australia. This share is down from over 10 per cent in 2007 and well below that for a number of large economies”. “Because of its small size and minimal credit and funding links to the regulated banking system, the shadow banking sector in Australia is judged to pose limited systemic risk. Nonetheless, the Reserve Bank and other Australian financial regulators continue to monitor shadow banking activity for signs of risk”.

Housing Occupancy & costs

• In 2007/08, the number of people, on average, in Australian homes lifted for the first time since records were first maintained in 1910. The number of people per home rose from 2.51 to 2.56; lifted further to 2.57 in 2009/10 and has lifted further to 2.59 in 2013/14. The number of people per home lifted to the highest levels in 14 years.
• The number of bedrooms per home hit a record high of 3.14 in 2013/14, up from 3.11 bedrooms in 2011/12.
• Almost 61 per cent of households indicated that they had one or more spare bedrooms in the 2013/14 survey, down from 61.7 per cent in the 2011/12 survey.
• The proportion of households that owned their homes outright rose from 30.9 per cent to 31.4 per cent in 2013/14. Owners with a mortgage fell from 36.6 per cent while renters lifted from 30.3 per cent to a record high of 31.0 per cent

What is the importance of the economic data?

• The Financial Stability Review is published by the Reserve Bank every six months. The report is basically a health check on the financial sector but it also assesses the state of household and business balance sheets.
• The Bureau of Statistics releases estimates of Housing Occupancy & Costs every two years. The data shows whether people are buying or renting and how efficiently people are utilising their homes.

What are the implications for interest rates and investors?

• The Reserve Bank has highlighted an array of potential risks for the financial system and in essence given further credence of the need to maintain tighter bank lending standards. Overall the report suggests a slightly dovish tone to the broader economic landscape.
• There is significant spare capacity in Aussie homes and there has been a greater willingness in recent years for younger people to share accommodation with others or stay longer in the family home. The trends in housing occupancy have clear implications for builders, developers and building material companies. If the trend to greater utilisation of homes continues then there will be less need to build more homes.
• CommSec expects interest rates to stay on hold over the next few months although the risks lie with another rate cut.