Via Damien Boey at Credit Suisse:
- Loan demand could stabilise, but … New loan approvals are falling in trend terms, foreshadowing weaker growth in the stock of credit in the near term as the back-book of loans catches down to deteriorating flows. However interestingly, our proprietary credit conditions index, which takes into account banks’ willingness to make high loan-to-value ratio loans, banks’ willingness to make interest-only loans and inverted credit spreads (as a proxy for for the easiness of corporate lending standards), is pointing to a bottoming out process in loan approvals longer term. After all, in 1Q, we note a loosening of mortgage lending standards, and more recently, we see credit spreads narrowing on central bank intervention. All of this said, we need to recognise that perhaps our summary measure of lending conditions does not capture all of the nuances. Indeed, there is anecdotal evidence that banks are tightening their lending standards in 2Q, or more precisely, applying old lending terms despite more fragile economic conditions. So there is directional risk to loan approvals. In any case, the more important issue in our view is not what happens to loan demand as a result of macro conditions and bank lending standards – but rather, what happens to repayment activity. The RBA is of the view that high unemployment and high uncertainty might make households think twice before committing to buying a home. But the reality is that high unemployment and high uncertainty are causing heavily-levered housing investors to pay back their mortgages at an accelerated pace. Indeed, the step up in their mortgage repayments is offsetting the step down in repayments from owner-occupiers on debt repayment holidays. And this behaviour is entirely rational when we look at housing investor incentives through the lens of risk parity investing. Housing investors lever up on what they perceive to be the lowest risk asset class in housing. On the flipside, they de-risk and de-lever when they are wrong-footed on this assumption. And right now, they are getting wrong-footed because house price declines are accelerating and housing volatility is on the rise. Worse still, with COVID-19 still out there and potentially mutating, no-one really knows how long soft border closures will need to remain in place for. Indeed, for as long as the borders are shut, we should expect to see sharply reduced population growth from immigration and much lower rates of household formation, creating excess supply in the housing market and contributing to price weakness.
- Beware the effects of fiscal fade on the credit impulse. We see many reasons to worry about the health of the private sector credit impulse. Fortunately for now, we do not really notice the effects of de-leveraging pressure, because the public sector is gearing up aggressively, putting us into a leverage transfer regime, rather than a “paradox of thrift” regime (where the more we pay, the more we owe, because incomes fall faster than debt). But the longer-term concern we have is that the public sector credit impulse is set to fade. If it does, we could be left with the reality of a weak (if not negative) private sector impulse. And turning this around would not be easy. After all, the RBA has no more room to cut rates. Also, the private sector credit problem is multi-dimensional. It is not just the willingness and ability to borrow that are shaping new lending – but also the effects of uncertainty on principal repayment activity. In a pinch, we think that the government will come to the party by injecting more stimulus into the economy. But current rhetoric suggests that policy makers do not see an immediate need to keep ramping up emergency stimulus. Indeed, if they do increase stimulus, it would be targeted and concessionary. Fiscal policy makers are arguably becoming reactive rather than proactive, and this is where the danger to the economy lies, in our view.
Right, so let’s be sensible here. There is zero chance of rising private credit over the remainder of 2020. The economic damage is too severe. The psychology is too damaged. The ongoing blows from the virus are too persistent.
Ahead are further house prices falls that will by September punch a new hole in household confidence and begin to sink consumption, even before we get to the prospect of any rational drawdown for stocks.
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