Bill Evans: RBA at ease over bubbles

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Bill Evans of Westpac sees a still comfortable RBA despite today’s pointed warnings to Sydney:

The Reserve Bank has released its Semi annual Financial Stability Review for September.

This report is of more than usual interest as it provides the Bank with its most appropriate vehicle for highlighting any concerns around potential property market and household balance sheets stemming from the current low interest rates. (Note that despite the overnight cash rate being 2.5%, below the previous cyclical low of 3.0% in 2008/9 the headline (before discounts) variable mortgage rate is 5.95% compared to 5.75% in 2008/9).

Our reading of the Review indicates that there is no high degree of concern from the bank around property market or household balance sheet excesses.

There are some “responsible” warnings, “Of particular importance is that banks maintain prudent risk appetite and lending practices, especially in the low interest rate environment”.

The Bank notes “the risk profile of new household borrowing remains reasonably sound and indicators of household financial stress are reasonably low” there is “a continued rate of excess repayments on home loans”.

The centre of strongest housing activity is concentrated in NSW it is “important that those purchasing property do so with realistic expectations of future dwelling price growth”. It is suggested that over the medium term that should be around the growth rate in nominal incomes.

The Bank is particularly focussed on the strong buffer which existing borrowers have built up due to the jump in the savings to around 11% and the consistent falling interest rates. It notes that “around half of households have not reduced repayments as rates have fallen” and “mortgage buffers remain near highs since (first measured) in 2008”.

These buffers which are commonly known as mortgage offset or redraw facilities average 14% of loan balances indicating borrowers could cover 21 months of interest payments in the event of losing current cash flow through,say, unemployment.

The Bank accepts that some of the results particularly from the “wisest savings” questions in the Westpac Melbourne Institute Consumer Sentiment Survey point to “a slight shift in household preferences towards riskier assets”. We discuss these issues extensively in Westpac’s September Red Book. Fall in proportions of respondents preferring bank deposits (down around 10 ppt’s over the last year to 29%) and pay back debt (down around 7 ppt’s to 14 %) were partly offset by increases in real estate (up 8 ppt’s to 28%) and equities (up 3 ppt’s to 9% ) – described by the Bank as still “quite low”.

However the Bank seemed quite relaxed, “increased financial risk taking is an expected outcome of lower interest rates”.

It did correctly note that the centre of the strong housing activity has been in NSW, pointing out that 40% of new lending approvals in NSW have been to investors, who are responding to the recent pick up in Sydney house prices – the highest proportion since 2004, although this was qualified because it partly reflected the marked decline in First Home Buyers.

Indicators of household stress provided no grounds for concern. The non performing share of banks’ housing loans was steady at 0.7%; data on securitised housing loans suggests arrears rates have fallen since peaking in mid 2011.

Lending standards are assessed as having been broadly maintained since late 2011. The distribution of high LVR share of loan approvals has shifted down since 2009. The share of low doc loan approvals has remained steady at 1% in 2013.

The share of fixed rate loans being approved has jumped from 9% a year ago to 19%.

Self Managed Superannuation funds (SMSF) come in for scrutiny. They are assessed as now representing 33% of the total pool of super savings which has now reached $1.6 tr. That is up from 9% in 1995.

These SMSF’s hold around 15% of total assets in property assets, although 77% of those assets are commercial property, with small business able to move business property assets into their SMSF’s.

My point would be that these investors should be put into perspective. Residential real estate assets represent around 3.5% of the SMSF’s investments – around $ 20bn in assets. That represents around 1.5% of total housing credit outstanding and around 5% of investor credit. With such a low share of the stock it seems highly unlikely that the SMSF sector could significantly influence prices through its flow.

The Bank notes that a new source of demand might exacerbate property price cycles. However the actual size of this sector to date indicates that the “rise” of the SMSF is unlikely to drive a housing bubble in Australia of its own volition.

We expect that the more appropriate reason for the Bank’s attention to this sector is around financial stability issues with the Bank noting an ASIC report highlighting “pockets of poor advice” given to individual SMSF investors around geared residential property investment.

Conclusion

There has been considerable media attention around potential property bubbles in Australia which might constrain the Bank from cutting rates further.

An appropriate opportunity to highlight that case was available in the September Financial Stability Review.

There is no convincing evidence from this Review that the Bank is concerned about such prospects.

I agree with the last line but not the first. The RBA is not going to cut again if Sydney investors continue to go nuts.

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About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.