Mortgages 2017: Finding focus in a complex market

Read­ing time: 3 mins

James Hick­ey, Part­ner at Deloitte Actu­ar­ies & Con­sul­tants, dis­cuss­es afford­abil­i­ty and mort­gage pric­ing based on the Deloitte Mort­gage Report 2017.

The pre­dic­tions for the Aus­tralian mort­gage mar­ket in 2017 from Australia’s lead­ing lenders and mort­gage bro­kers are for an increas­ing­ly per­son­alised, sub­dued mar­ket, dom­i­nat­ed by issues of avail­abil­i­ty and afford­abil­i­ty, and inter­na­tion­al reg­u­la­tion.

While mar­ket par­tic­i­pants remain con­fi­dent about the fun­da­men­tals, they can see signs of growth slow­ing to a mod­est 1 – 5% for new lend­ing. Over the 12 months to Decem­ber 2016, total new lend­ing, includ­ing refi­nanc­ing, was flat at $384 bil­lion.

 

This was the first year since 2012 that set­tle­ments did not grow, due to:

  1. APRA’s sound lend­ing bench­mark of 10% new annu­al growth to investors, which reduced lend­ing to investors in 2015 and the first half of 2016 (although it has is grown since the sec­ond half of 2016)
  2. More strin­gent ser­vice­abil­i­ty cri­te­ria, espe­cial­ly around non reg­u­lar and off­shore income sources, and bor­row­ers’ capac­i­ty to repay in times of high­er inter­est rates.
  3. Greater pric­ing for risk, par­tic­u­lar­ly for high­er Loan to Val­ue Ratio (LVR) lend­ing, investor lend­ing and inter­est only repay­ments.
  4. More selec­tive lend­ing e.g. reduced par­tic­i­pa­tion in cer­tain parts of the mar­ket, such as lend­ing to prop­er­ty devel­op­ments or off the plan.

The Deloitte Aus­tralian Mort­gage Report 2017’s key themes for mort­gages in 2017 build on this back­ground of mod­er­at­ed growth, and are dom­i­nat­ed by afford­abil­i­ty, pric­ing, fund­ing costs and con­duct.

Affordability:

It is impor­tant to draw a dis­tinc­tion between ‘afford­able hous­ing’ and ‘hous­ing afford­abil­i­ty’. While afford­able hous­ing is vital­ly impor­tant in assist­ing house­holds of low­er socio‑economic stand­ing be able to have appro­pri­ate hous­ing, it is hous­ing afford­abil­i­ty that is often dis­cussed around the inabil­i­ty of oth­er­wise finan­cial­ly able house­holds to afford prop­er­ty, espe­cial­ly in the Syd­ney and Mel­bourne prop­er­ty mar­kets.

How­ev­er there is more to Aus­tralia than just those mar­kets. Across the oth­er states and region­al areas of NSW and Vic­to­ria, the afford­abil­i­ty issue is quite dif­fer­ent. It is not so much prop­er­ty prices, but rather employ­ment and avail­abil­i­ty of jobs and cer­tain­ty of income which is the con­cern.

This cre­ates a dilem­ma for reg­u­la­tors and pol­i­cy set­ters in that any lever to damp­en demand in Syd­ney and Mel­bourne may have unin­tend­ed con­se­quences on oth­er cap­i­tal cities and region­al areas.

The report points out that the debate around solu­tions to afford­abil­i­ty and avail­abil­i­ty in the short and longer term needs to broad­en and cov­er both demand and sup­ply. The ben­e­fi­cial role of prop­er­ty own­er­ship and invest­ment from a tax and pen­sion eli­gi­bil­i­ty posi­tion is well jus­ti­fied to be debat­ed. Cer­tain­ly neg­a­tive gear­ing ben­e­fits many aver­age Aus­tralian house­holds, how­ev­er there are sig­nif­i­cant advan­tages it has for the more wealthy and spec­u­la­tive investor such as con­ces­sion­al cap­i­tal gains tax and no lim­it on the amount of deduc­tion which can be claimed. The role of a land tax ver­sus stamp duty, while giv­ing lim­it­ed short term ben­e­fit to afford­abil­i­ty, may be a longer term struc­tur­al change to assist future gen­er­a­tions.

There is also a whole area to be explored around the greater release of exist­ing sup­ply par­tic­u­lar­ly if retirees are encour­aged to down­size with­out any adverse impact on their pen­sion eli­gi­bil­i­ty. They could also be fur­ther incen­tivised by not hav­ing to pay stamp duty on their repur­chase.

Mortgage Pricing & Capital

While most Aus­tralians may strug­gle to under­stand why a change in the cash rate does not cor­re­late to an exact change in mort­gage rates, the pric­ing of mort­gages is heav­i­ly depen­dent upon the mix of fund­ing required to be sourced by lenders togeth­er with man­ag­ing net inter­est mar­gins to ensure eco­nom­i­cal­ly sus­tain­able returns.

Banks have an eco­nom­ic duty to make sure their Net Inter­est Mar­gins are healthy giv­en the glob­al focus on cap­i­tal. They need to bal­ance social and rep­u­ta­tion­al issues, as well as those fis­cal ones of deposit man­age­ment. Also around 70% of banks’ whole­sale fund­ing is from inter­na­tion­al investors and so vul­ner­a­ble to off­shore geopo­lit­i­cal uncer­tain­ties.

In 2015 the Mur­ray Report spec­i­fied that banks need­ed to be ‘unques­tion­ably strong’. And in July 2016, APRA imple­ment­ed high­er risk weights on Aus­tralian mort­gages mea­sured under the IRB approach. This is esti­mat­ed to have increased the bank’s cap­i­tal require­ments by up to 100bps. These increased cap­i­tal demands have meant that banks are under pres­sure to cov­er the cost of the increased cap­i­tal require­ments.

Dif­fer­en­tial pric­ing has now emerged in mort­gages. Where for the past sev­er­al years rates for own­er occu­pi­er and investor were rarely dif­fer­ent, dif­fer­en­tial pric­ing for investor lend­ing, high­er LVR loans and inter­est only loans are now com­mon­place. This reflects risk returns on cap­i­tal, togeth­er with enforc­ing pru­den­tial reg­u­la­to­ry desires around slow­ing down lend­ing to cer­tain parts of the mar­ket viewed as being of longer term struc­tur­al risk to the sec­tor.

Conduct

Although pru­den­tial reg­u­la­tion will con­tin­ue to pose chal­lenges for lenders, con­duct risk reg­u­la­tion is a becom­ing a much big­ger focus. Con­cern from politi­cians and reg­u­la­tors about bank­ing cul­ture, hold­ing exec­u­tives to be more account­able, tough­en­ing whistle­blow­er pro­tec­tion and tar­get­ed con­duct and risk cul­ture reviews being under­tak­en all high­light the direc­tion for con­duct risk.

Good con­duct is not just about mak­ing sure that a mort­gage prod­uct, or its rec­om­men­da­tion, is suit­able for today. It is about mak­ing sure that rec­om­men­da­tion, or that prod­uct, remains suit­able through­out the life of the loan.

The full report can be found at https://www2.deloitte.com/au/en/pages/financial-services/articles/mortgage-report-2017.html

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About the author

James Hickey

James is a partner at Deloitte Actuaries & Consultants and has been involved in a range of financial services work within Australia, New Zealand, South Africa and the UK. James has extended the role of actuaries in banking, specialising in mortgage portfolio strategy, product design, financial and pricing analytics and business operating models.

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