Data Diary » Aust lending

Australian economy update – is the RBA serious about raising rates?

Rohan Clarke — Thu, 16 Jun 2011 11:34:02 +0000

The latest new motor vehicle sales provide further confirmation that the Australian ex-mining economy is struggling:

Still the RBA has gone to great lengths to express their concern about an Australian economy that is, in their view, operating close to its limits. From Glenn Stevens latest speech (here):

As of today, measures of capacity utilisation are not as high as at the end of 2007, and unemployment is not as low as it was then. Nonetheless, the degree of slack in the economy overall does not seem large in comparison with the apparent size of the expansion in resources sector income and investment now under way.

Most particularly, Glenn Stevens is concerned about incipient wage inflation from a tight labour market:

Re-reading his prepared thoughts, the mining boom casts a long shadow over is thinking.

In short, Stevens infers that the future of Australia is in selling our resources to Asia – he expects resource exports to increase as a percentage of GDP (though he is silent on whether this is via a contraction in real GDP). Secondly, he argues that the multiplier from resource exports is much larger than the bold numbers would suggest. While ‘less than 2%’ of the workforce is employed directly in the resources industry, there are a plethora of suppliers to the sector, we are all investors via our superannuation, and if all that fails there is always what we take in taxes. The trickle down effect to the rest of us is commensurately large.

Even if Stevens concedes that some sectors are doing it tough, it just doesn’t come across as a compelling view for the future of the Australian economy. He suggests that the higher currency is an unavoidable consequence of Asian demand for commodities and the ‘structural’ shift to being a resource exporter at the expense of all other industries is similarly a by-product of being the lucky country.

I don’t get it. It is too simplistic – and bordering on lazy with respect to how Australia could employ its resources to prepare for its future.

But equally, it is an argument that undervalues the sheer weight of money that has been borrowed and then invested in the residential housing sector. This debt burden is real and it is large by global standards.

So if you are of the camp that accepts that house prices, and by extension construction, have been elevated by an expansion of credit – and that this expansion has passed its apex – then anything that weighs on the correspondingly large mortgage pool is simply going to exacerbate an already difficult situation.

While Glenn Stevens is undoubtedly right about the forthcoming bonanza in mining investment, please consider how important housing finance is to the Australian landscape and ask whether this capital boom is really going to save those over-leveraged first home buyers that are a little further from the champagne trickle.

Australian housing finance update – confirming the turn

Rohan Clarke — Tue, 18 Jan 2011 01:10:34 +0000

Back at the desk and updating some housing finance data (it’s been a while – last housing commentary here).

At first blush, recent releases suggest a more positive tone – total volume of housing debt looks to have broken its downtrend (from ABS’s release here):

Principally driven by a jump in the total number of loans (ABS data here):

But this is where the good news ends. Certainly the decline in the average loan size to first home buyers suggests a different story:

This is not good. First home buyers are the veritable engine of the housing construction industry and by extension vast tracts of the Australian economy. Not surprisingly then, building approvals (ABS release here) look to have turned lower:

If the jump in housing finance is being driven by older demographics thinking recent softness in housing prices is a buying opportunity, we may soon see this resolve tested. SQM Research (here) reckons property listings across Australia were up 44% on a year-on-year basis to December (for a little bit of fun you can check out the change in listings in your own neighbourhood here).

Conclusion – a property price correction looks like short odds for 2011 – expect our various government’s to throw more money into the housing pit.

Australian economy update (part 2) – Credit & house prices

Rohan Clarke — Mon, 01 Nov 2010 23:19:11 +0000

Trend watching in economics can be about as interesting as watching paint dry, then fade, then peel… It generally takes time for the cycle to unfurl. So no surprises in this month’s data with the broad conclusion being that the high level of household debt (secured against inflated house prices) remains the key issue facing the Australian economy.

The data

The ABS releases (based on August data Housing Finance here and Lending Finance here) suggested that housing related lending continued to ease.

Yet the RBA’s credit aggregates suggested that household debt kicked back up again in September – growing at 8.1% annualised for the month (RBA release here).

While the RBA updated its household leverage data – which confirms that against disposable income measures, leverage is back to historical highs (note this is to end of June).

So where are we in the cycle?

If household debt has been rising at >10% per annum for over a decade, yet retail trade and new car sales have been rising at ~3% per annum (see yesterday’s post here), then where has that extra debt been flowing to? Answer – House prices.

Is this a reflection of a shortage of housing ‘supply’? Perhaps – though ’cause and effect’ is not straightforward in the real world.

I’d argue low interest rates have been a key driver of housing demand over the last decade. As is patently clear to all in a post-credit bubble world, asset prices were inflated in a self reinforcing cycle with expanding and cheap debt. If the population has been growing at between 1% and 2% p.a. across the same period, then the rise in demand beyond this has been due to declining housing density – that’s the number of people sharing a dwelling. At some point higher house prices (relative to disposable income etc) will stop this trend – the evidence suggests we are already past the turn.

The housing sector is the key driver of the Australian economy. The cycle is turning down – slowly but surely.

Australian lending (Aug10) – welcome to Easter Island

Rohan Clarke — Thu, 30 Sep 2010 22:12:46 +0000

The RBA released its monetary aggregates data for August yesterday (here). Growth in money supply as measured by M3 continues its soft shoe shuffle:

It’s the housing sector that continues to support debt growth, though lending to business has stabilised and the government is doing its bit for Queen and country:

Zooming in on growth in housing sector debt, we can see that it is at historically low growth rates.

Which brings us to the Chart of the Day – it takes a look at lending by sector as a proportion of the total. From 1990, the housing sector has risen from 20% of total lending to more like 55% currently.

Now it could well be argued that the business sector went through a property fuelled credit binge of its own that imploded in 1990, and hence the initial decline in its percentage was something akin to ‘normalising’. But still with the likes of Centro, Allco and Babcock et al doing some seriously heavily lifting more recently, don’t think we can argue that the housing sector was alone in enjoying the credit boom.

So what does it mean? While the housing sector has been shown to be the engine room of a developed economy – given it’s multiplier effect on consumption that makes up ~70% of GDP – making more houses doesn’t really add to the productive capacity of an economy. If the villagers spend all their time carving huge stone heads to put in their living rooms, then who is left to tend the crops? This trend goes a long way to explaining why GDP growth has failed to keep up with house price growth – or more simply why our incomes haven’t kept pace with mortgages.

Australian lending finance (Jul10)

Rohan Clarke — Tue, 14 Sep 2010 01:27:07 +0000

ABS released July Lending Finance today (here). Total finance continues to consolidate:

With the ratio of personal debt (including housing) to commercial debt dropping from the highs achieved during the height of the government stimulus efforts.

There’s a reasonable probability that this ratio will continue to head south given the relatively low levels of gearing across the corporate sector versus the relatively high levels in consumer’s hands. The moving average trendlines in each would suggest that this shift is underway.

Australian housing finance (Jul10) – gone but not forgotten

Rohan Clarke — Thu, 09 Sep 2010 04:21:13 +0000

ABS released housing finance data for July yesterday (here) – following is their summary of the stats:

Looks okay I guess – and that was the general response from our mainstream media (see the ABC’s coverage “Housing finance rises in July – but caution remains). As Westpac senior economist, Andrew Hanlan, said “It’s probably best to describe it as sort of levelling out at this stage, but we do expect to see an improvement in coming months with the RBA likely to be on hold for the rest of this year”. You’d expect that with ~40% of the housing loan market, Westpac would be pretty well informed.

But still I’m less optimistic. As we have suggested before (here), house price to disposable income ratios remain at elevated levels which at the very least limits the appetite for new housing debt. This is perhaps why when I look at a chart of new lending the trend appears to be down – though admittedly it’s all in the interpretation and we are already plumbing depths not seen since we entered the new millenium:

A key variable in this are the first home buyers, as they were an important catalyst in reigniting loan volumes through 2008. Post the government handouts though, loans to first home buyers have returned to more sustainable levels. Without more government stimulus, they are unlikely to be leading the charge back up the hill.

But to me the charts that really undermine the outlook for the housing sector are the following:

Housing finance has grown at over double the rate of GDP since the mid 70′s. We can see the effect of this in the increasing leverage to disposable income across the period. In turn this has been enabled by the trend to lower interest rates. The recent experience of a smorgasbord of countries suggests that the time for increasing household leverage is gone. How likely is it then that we are likely to see “improvements in coming months” – whatever that might mean?

Australian July credit – last true believer buys another house

Rohan Clarke — Wed, 01 Sep 2010 03:56:20 +0000

RBA financial aggregates for July were released yesterday (here) – in brief:

Housing credit increased by 0.5 per cent over July. Over the year to July, housing credit rose by 8.1 per cent.
Other personal credit was flat over July. Over the year to July, other personal credit increased by 3.2 per cent.
Business credit fell by 0.4 per cent over July. Over the year to July, business credit declined by 5.0 per cent.

To throw a little shawl around these statistics, the following chart provides a longer term context:

Business continues to paydown debt – even in the face of the rising tide of capital investment in the resources sector. At the same time, leverage in relation to housing remains surprisingly strong. To get a sense of how the Australian household wallet is evolving consider the following chart:

I may be suffering from selection bias here – after all, housing credit is still growing at an annualised rate of ~8% – but it looks to me like the trend for growth in housing debt is down.

So how is this credit demand flowing into the money creation machine? Looking to M3 – the squeeze on money supply growth is continuing:

It’s a less than glowing endorsement for the demand side of the domestic economy. Its interesting then to consider what the increasing preference for term deposits means for the velocity of money and risk preferences in the Australian economy.

So while term deposits reached a minimum of 23% of M3 in late 2007, they have now risen to ~33%. Wonder whether they could revisit the 40% levels last seen in the mid-90′s?

Australian lending finance (Apr10) – expect further falls in consumer debt

Rohan Clarke — Tue, 15 Jun 2010 03:25:36 +0000

Australian lending finance for April release by the ABS today (here). Overall trend is still down lead by contraction in consumer finance:

This is consistent with recent months building approvals (here) and housing finance data (here). The residential market has peaked and with it Australia’s credit expansion.

On a more positive note, commercial lending looks like it is continuing to feel out a floor:

Australia’s corporate sector is in pretty good shape – with excessive leverage being given a workout through equity placements and asset sales over the last 2 years. At best, Australia’s corporates could embark on a investment cycle that would help cushion the domestic economy from a slowing world economy. At worst, if asset price deflation is to continue to stalk markets, with reduced leverage the impact on Australia’s corporate sector will be softened.

The question is whether commercials will expand capacity in the face of economic uncertainty and declining demand at home. To put this in a longer term context consider the following charts:

This chart maps total lending since the commencement of our credit bubble. The red line is where 7.5% per annum growth would have taken us across the period. Scary really, all that expansion in debt and only 4′ish% growth in GDP per annum across the same period. Based on this evidence, there is good reason to expect further falls in total credit.

The chart looks at consumer finance as a propertion of commercial lending. At one end of the spectrum we can see the 1987 boom driven as it was by excessive corporate debt. Not even the recent Babcock and Brown, Allco, Centro and friends, corporate debt seraglio could rival our infamous 80′s entrepreneurs. Perhaps, this was because the rise in corporate debt was overshadowed by the housing boom. And with this in mind, the more recent climb in housing finance to commercial debt looks well overdone. If this chart is in mean reversion mode, then either housing debt is set to fall or commercial debt is set to rise.

Australian Lending (Mar10) – volumes stabilising, maybe?

Rohan Clarke — Wed, 19 May 2010 02:55:04 +0000

Australian Lending Finance figures for March 2010 have been released by the ABS (here). Both personal and commercial lending continued to bounce back from seasonal lows around the summer holidays – maybe commercial lending has found a floor?

Taking a longer term view of the landscape, an interesting comparable might be the long trough in lending volumes that occurred post the 1987 mushroom cloud. For reasons we have canvassed all too often, it’d be reasonable to expect that lending will remain subdued for the foreseeable future.

Australian banks reliance on international capital markets

Rohan Clarke — Fri, 14 May 2010 04:07:29 +0000

I started this post some months ago with the intention of digging deeper into our Australian banks reliance on the international capital markets. In particular wanted to get an understanding of what the impact of the government guarantee funding facility would be. I’ve been dragging my feet, so in an effort to get it out of the in-tray, herewith the thinking to date:

Australian banks trade at a premium to their international peers

Our banks are trading expensive relative to their global peers (like this simple analysis from Citibank – via Alphaville here). There are many valid arguments put forward to support this – such as “Australia has…”:

A stable (and consolidating) banking oligopoly
A mortgage market structure that has historically lead to low default rates
Recent population growth at ~2.5% per annum
An economy leveraged to the industrialisation of China and India

On the other hand, an oft cited risk to our privileged position is that as a capital importer we are reliant on the good graces of our creditors – something that becomes more fragile with national borders getting firmer by the day. How are our banks exposed to the rising cost of risk?

A snapshot of the Australian majors balance sheets

It’s a big question, and not one that can be answered in a short(ish) note. Just want to focus on the most obvious aspect of bank funding in this respect – the wholesale debt market. Following is a quick summary of the four majors balance sheets:

In short, ANZ has 20% of its loan book funded in the wholesale markets (“Bonds”), CBA 22%, NAB 35% and WBC 33%. That’s not insignificant in itself. Whether ‘deposits’ are directly exposed to international capital flows is something for further investigation – at the very least, rising risk premiums will flow through to deposit rates eventually. But let’s leave deposits for another day.

How much of this wholesale funding comes from international capital flows?

According to the RBA, Australian financial institutions have ~$320bn in offshore funding – something approaching 70% of their wholesale long term funding requirements. We can get a glimpse of the make-up of this across the market via the government guaranteed funding scheme. At it’s closure in March this year, there was approximately ~$140bn in long-term funding guaranteed. A breakdown of this guaranteed debt by borrower is:

And then looking at the maturity profile of the guaranteed debt:

So what does this tell us about our bank’s international funding requirements? Not a whole lot other than it looks like going into the end of calender year 2011, the banking sector will be hoping for a favourable pricing environment for the refinancing of a reasonable lump of debt (~$60bn) across 2012.

Wholesale funding requirements of a major trading bank

Absent the bandwidth to analyse each of the majors individually, here is a summary of CBA’s wholesale funding requirements:

CBA has a reasonable slab of debt that needs to be refinanced over the next two years – $26bn represents ~25% of its total wholesale funding requirement. Note too that amount is five times the volume of guaranteed debt. If we were to extrapolate that to the rest of the sector, the total wholesale funding requirement looks more like $300bn (of course, given the sample size it’s a highly dubious extrapolation – but point taken on it being significantly bigger than $60bn).

But does this mean the banking sector is unduly exposed to international capital markets?

Well using CBA as an example, the simple answer would be no. At just over 5% of the aggregate of its loans outstanding – the wholesale refinancing requirement of CBA for the next 2 years is manageable. The impact of higher funding costs would certainly impact margins – but it is not a game-changing event in isolation. (Note what applies to CBA may not apply for others…in the interests of expediency I’m using CBA as a litmus test.)

But cost of funds will rise

The point is that rising risk premiums in the international capital markets will flow through domestically. If international capital costs are higher, local deposit rates will ultimately follow. Bank margins will be squeezed.

Conclusion

Does this all mean Australian banks are unduly exposed to international capital markets? Based on the toe in the water, the answer is no (unless ‘deposits’ are hiding some international capital flows). The wholesale funding requirement looks like it is manageable even under stressed conditions.

However, the global cost of risk is on the rise. Not necessarily due to inflation pushing rates up (the deflation/inflation debate is one that is yet to be won) but simply because risk is being repriced. No amount of money printing will solve this – it, in fact, reinforces the trend. This is the reason why Australian banks have been forced to ratchet up loan rates ahead of official rate rises. It is a trend that has yet to run its course. And it alone is sufficient to step warily around bank earning forecasts for some time to come.

Epilogue – Expect the government guarantee scheme to be reintroduced

The scheme commenced on 28 November 2008 and closed to new liabilities on 31st March – existing commitments will remain guaranteed until they mature (subject to the requisite fee being paid).

Under the scheme, Australian ADI’s (and qualifying others) got deposits and funding guaranteed by the Commonwealth Government for up to 5 years. A fee of between 70, 100, or 150 bps per annum is payable on the guaranteed amounts subject to the rating of the entity receiving the guarantee (respectively AAA to AA-, A+ to A-, BBB+ or below and unrated).

This has been a good little earner for the government – it booked $103m in February ($111m in January) and $1.3bn to date under the scheme. The fee structure is sensitive to the exchange rate on foreign currency denominated borrowings – that is, the fee is paid on the face value of the foreign currency amount borrowed (AUD down, fees up).

Given the perceived cost of guaranteeing bank debt is low, while the revenue is large enough to be meaningful, I think we can expect the government will be credit wrapping bank debt again in the future – regardless of whether it distorts Australia’s capital markets.