CBA: Desperately Seeking Housing Affordability

Last week, the Commonwealth Bank of Australia (CBA) – Australia’s largest bank – released a presentation on the Australian housing market to support an upcoming overseas tour by senior management who are meeting overseas investors. The CBA’s press release for the presentation read as follows:

Australian Residential Housing

Sydney, 9 September 2010: Senior executives from the Commonwealth Bank of Australia (“the Group”) will soon be travelling overseas to meet with some of the Group’s offshore shareholders and other investors interested in Australia and the Australian banking sector.

In the light of recent commentary from a number of sources on the robustness of the Australian residential housing market, the Group (given its significant exposure to this section of the economy) anticipates that this will be an important issue for many of the investors it is scheduled to meet with.

In anticipation of these discussions, the Group has produced a presentation entitled “Australian residential housing mortgages: CBA mortgage book secure”. A copy of this document has been lodged with the ASX today (see here).
 
The presentation is clearly aimed at reassuring foreign investors that:

  1. the CBA’s exposure to the Australia’s housing market is safe; and
  2. Australia’s house prices are not a bubble and, instead, reflect sound fundamentals.

The CBA’s motives are understandable. Australia’s banks have financed Australia’s housing boom by borrowing heavily offshore (see below) when the global cost of credit was cheap. Now they need to refinance this debt in a less-forgiving, more capital competitive world. And this refinancing task will be all the more difficult and costly if international investors perceive the banks’ housing loan portfolios – which comprises around 58% of the banks’ total lending – to be at risk from a significant house price correction.

The problem is, the CBA’s presentation is full of holes and misleading data.

Juking the stats:

For starters, page 4 of the CBA presentation compares house price to income ratios in Australia with those from a number of coastal cities overseas, with the argument being that Australia’s relatively high house price to income ratios are a by-product of the fact that Australia’s major cities are all located on the coast and that prices are actually comparable with other coastal cities (see below).

However, as highlighted by Kris Sayce of Money Morning (here and here) and Professor Steve Keen, there are glaring inconsistencies with the CBA data. All the non-Australian numbers in that table come from
Demographia (Schedule 1 on pages 31-37), but none of the Australian numbers come from there. According to Mr Sayce:

In order to make their point, the CBA have used the Demographia numbers as a reference point for all the non-Australian cities, yet they’ve used the UBS numbers for the Australian cities.

Why on earth would the bank do that?

Simply because if they’d used the Demographia numbers it would draw exactly the opposite conclusion to the argument they’re trying to make. The fact is, they’ve conveniently grabbed the bunch of numbers that fits their argument and discarded the ones that don’t.

If they’d used the Demographia numbers for all the cities, including the Australian cities, the table would look like this:

Paints a slightly different picture doesn’t it? Actually, it paints a completely different picture. One shows an unsustainable bubble, the other shows a bunch of figures comparable to elsewhere in the world (Kris Sayce, Money Morning).

In fact, had the CBA instead used Demographia’s data, Australia’s house price to income ratios would have looked like this (note the sharp reduction in housing affordability since 2000):

Moreover, Demographia’s data ranks Australia’s housing market as the most unaffordable in the world, with a national median price to income ratio of 6.8 – well ahead of the other nations in the survey (see below table):

So why the large divergence between the CBA’s and Demographia’s numbers? Well it gets down to how they measure household disposable income (the denominator of the ratio). You see, instead of using the Australian Bureau of Statistics (ABS) measure of median household disposable income – $1,366 per week or $71,018 per year as at 2007/08 (see below table) – the CBA has used UBS’ estimated average disposable income figure of $98,000 as its starting point! The scary thing is that the UBS estimate wrongly includes ‘imputed rent’ in its calculation of disposable income, which is the estimated market rent that a dwelling would attract if it were to be commercially rented.

By contrast, Demographia’s household income data appears to be based on single full-time earnings, which yields a lower disposable income figure than the ABS.

It shouldn’t necessarily matter which disposable income measure is used as long as they are applied consistently across countries and across time periods. However, with the CBA applying the higher UBS measure of disposable income for Australia whilst using the lower Demographia measure for the other countries, they have deliberately made Australia’s house prices appear much more affordable relative to overseas markets, whilst down playing the risk of a housing bubble. Very sneaky.

On this issue, I concur with Professor Steve Keen when he suggests that overseas investors ask the CBA the following questions about their house price comparison:

  • Why did you use UBS data exclusively for the Australian cities, and Demographia data exclusively for the overseas cities?
  • Demographia’s numbers show the “median house price divided by gross annual median household income” (p. 7). How are UBS’s numbers calculated?
  • What would the ratios be for the non-Australian cities, if the UBS methodology was applied to them?

I, too, would be very interested in hearing the answers to these questions.

Perhaps they could also ask why Australia’s real house prices have risen so strongly, whilst rents have remained flat in real terms, suggesting substantial over valuation and a housing bubble (see below)?

Beating the population/shortage drum:

The CBA’s presentation also reaches for the population growth / housing under supply story to explain Australia’s high house price growth (see below):

Notice how the chart on the right panel gives the impression that dwelling starts tracked population growth until 2005 when a severe housing shortage developed.

Again, things are not as they seem. A correct examination of population increases to housing starts would multiply the left-hand axis by 2.5 times, since the average household size in Australia is around 2.5 persons. Such treatment would then show any shortage, whereby the red line (population growth) exceeds the blue line (dwelling starts) as well as periods of excess home building.

Had the CBA adopted this approach, the graph would have shown a much larger difference during the period of excess construction and a smaller difference on the right (where shortages exist). In fact, the graphs would not have crossed from excess to shortage until after 2008, suggesting that Australia has been over building for much of the past 20 years.

Further, if housing shortages had underpinned Australia’s house price growth, then why have dwelling prices outside the capital cities (where population growth is low) increased at the same rate as the capital cities (see below)?

Similarly, why have house prices in Hobart and Adelaide skyrocketed when population growth has been low and the level of building activity high in those states (see below)?

Dwelling size up, but land size down:

The CBA then claims that Australia’s propensity for larger homes has also contributed to valuation growth, with the average floor area for a new home now 50% larger than in 1986 (see below).

Again, this is selective reporting by the CBA since they fail to mention that the average land size for new homes fell from 802sm in 1993/94 to 735sm in 2003/04. Also, land size in established areas has been falling due to sub-divisions which, other things equal, should have reduced house prices.
 
Household debt levels a serious concern:
 
The CBA presentation suggests that Australia’s household debt levels are not a concern since they are similar (albeit higher) to many other developed countries (see below):
 

Yet this fact should provide cold comfort to foreign investors given that house prices have fallen considerably in many overseas markets, in particularly the US and UK (see below):
 

Demographic headwinds:
 
The CBA presentation also argues that Australia’s debt levels are safe since the increase in debt has been taken on by those segments in the strongest position to service it (see below).
 

I disagree. The rise in debt levels of the older cohorts (over 55’s) is a significant risk to the housing market, since these people are approaching retirement and many will likely need to sell their housing investments or downsize in order to fund their lifestyles in retirement (putting downward pressure on prices).
 
Further, the suggestion that debt levels are safe because higher income earners are holding most of the debt is also contradicted by the ATO Taxation Statistics 2007/08 (page 15), which shows that 77% of negatively geared properties are held by those earning less than $75,000 per year (see below).
 

Leverage not so conservative:
 
The CBA provides the below charts to show that Australia’s leverage on the housing stock is far lower than the United States and that wealth levels have increased in line with debt (thereby providing a buffer).
 

However, in 2006, just prior to the US housing crash, leverage was only 40% in the US (see left panel) and asset values had also risen in line with debt prior to the crash (see below):
 

The point is, if a housing correction occurs, asset levels will fall whilst debt levels remain the same. Therefore, the CBA’s charts should provide little comfort to foreign investors, in light of what has occurred in the US housing market.
 
Economy strong, provided China holds-up:
 
Finally, the CBA presentation spruiks Australia’s low unemployment level and high GDP growth, claiming that these factors minimise the downside risks to Australia’s economy (see below).
 

But Australia’s economy depends on the continuing strength of China, which is currently experiencing a massive housing bubble of its own. Indeed, any collapse in export prices arising from a slowing of China’s economy risks significantly lowering Australia’s growth and increasing unemployment, with obvious flow-on effects for Australia’s housing market.
 
I am interested to hear reader’s thoughts on the CBA’s presentation, in particular whether there is anything that you think I have missed.
 
Till next time.
 
Cheers Leith

Leith van Onselen

Leith van Onselen is Chief Economist at the MB Fund and MB Super. Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.

Comments

  1. It's also interesting to see, how they use unemployment rates to measure strength of economy and stability of house prices. They use unemployment rate for Australia before housing crash and compare it with US data after bubble burst. It will be interesting to point that unemployment in US before crash was less than 5% – lower than rate in AU today.

  2. Thanks again, Leith. As usual, I agree with all your major points.

    Personally, I think the single most important element which CBA could have (and failed to) highlight in order to justify Australia's high property prices is the extent to which our Government is willing to do whatever it takes to keep prices high and, indeed, drive them higher… Extraordinary negative gearing concessions, no CGT on the family home, FHOG (apparently to improve housing affordability?!) and – perhaps worst of all – the ill conceived FHOB.

    But, after the RSPT fiasco, you can imagine why the Big Four are loathe to flag such issues with foreign investors… After all, in the eyes of the broader public are mainstream press, they are "super profit" machines!

    Surely there will come a day when our politicians are forced to respond to the declining rate of home ownership amongst young Australians (which CBA seemed to say was a positive on page 8 of the presentation!) and the excessive drain on tax revenues care of negatively geared investors / speculators… What then?!

  3. The enduring strength of Aussie homeowners (not investors) is that we tend to pay down mortgage debt as fast as possible. This despite the best efforts of financial advisors that encourage us to withdraw home equity, funded at 7.5%, and pump it into Telstra yielding 10% fully-franked. Capital losses? Bah, hold for the "long term"!

    So, CBA cherry-picked their numbers for the presentation. I have never taken CBA seriously since their "equity mate" TV ads but this is pretty special. They really should have focused on the good quality of their loan book – I actually agree with that overall but to get into the semantics of house prices vs. income was ill-advised.

    I like your posts overall but I suspect we're going to disagree on Australian population growth. We should fling the doors open to Malaysia, Indonesia and even the Philippines – get skilled workers through the doors to build the country. You want cheaper housing – there's the solution.

  4. The Australian housing market looks solid… but only when you lie about it.

    Here is another classic example of a complex situation being expressed in a few, wonderfully incisive words. I love it.

    For me, the takeaway from all of this is just how pliant and docile we as a culture have become. Where's the outrage? Where are the placard wielding protestors outside the head office?

    Come on! These people are making a fortune and keeping it ALL to themselves, but when their pack of lies collapses WE are all going to have to pay for it.

    Why wait until after the economy turns to shit to prosecute them?

  5. Great post. CBA's presentation is clearly self-serving and borders on being downright shameful.

    I have been following the Australian housing bubble and China's capital spending bubble (calling it a housing bubble is too narrow a term) for some time, so you're preaching to the choir!

  6. Scratch that, they've removed a key comment

    “Worse still, as Money Morning uncovered Friday, the statistics are cherry-picked from different sources to ensure the most favorable comparisons.”

    Looks like SMH just published a watered down version. I'll look for more inconsistencies when I have a closer read on the train.

  7. Will Mr.Joye's following words come back to bite CBA when it all goes south?

    Remember- CBA posted this stuff on the ASX as part of their disclosure requirements!

    "And there really are some killer slides in this. The first slide below provides a simulation that assumes mortgage rates rise to 14%, unemployment hits 10%, while house prices fall by 30%.

    On this basis, CBA reckons they would only incur losses of circa 0.2% of the value of their book….."
    http://christopherjoye.blogspot.com/2010/09/very-cool-cba-data.html

    "Killer" …….LOL Onya Chris!

    That is really going to hurt.

  8. Hi Leith
    A former colleague here. Congratulations on the blog and a great article. Frankly, I think the CBA presentation should be illegal and its makers criminally prosecuted. The House Price to Income ratio data misuse violates all standards of financial research. It's these very kind of presentations – and government's willingness to allow them – that caused the financial crisis in the first place. Imagine the outrage if this was an Engineering company misrepresenting the safety data on a new product by selectively using data sources. This is one reason I was fed up with the industry. Keep up the excellent work.