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Mortgages 2017: Finding focus in a complex market

30 March 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. Co-author of the Deloitte Australian Mortgage Report financial services partner James Hickey said: “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.”

Source: Deloitte Australian Mortgage Report 2017

Hickey explained that this moderating settlement growth was 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 report’s key themes for mortgages in 2017 build on this background of moderated growth, and are dominated by affordability, pricing, funding costs and conduct.

Key themes of 2017

  1. Housing affordability: In particular the pace of the Sydney and Melbourne property markets
  2. Mortgage pricing: Political and public scrutiny into bank lending and mortgage pricing
  3. Funding costs: Upwards pressure on rates and the role of offshore events
  4. Conduct: Spotlight on banks’ treatment of customers in a fair and equitable manner and remuneration practices of sales staff and brokers

Affordability and Mortgage Pricing

Hickey said: “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,” Hickey said.

The Deloitte 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.

Hickey said: “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.”

Deloitte Access Economics’ Director Michael Thomas said that the housing market story is a people story – or more accurately a population story. “Population growth drives demand for housing, and the strength of Australia’s population growth over the past decade has fuelled the current surge in building.”

Source: Deloitte Australian Mortgage Report 2017 / ABS

Thomas explained that Australia’s population grew on average at around 220,000 p.a. from 1985-2005, with the number of new dwellings starts averaging around 150,000 p.a. “If we account for replacing existing stock and a decline in the size of households, the underlying demand for new houses exceeded the average pace of building towards the end of that period.

“But in 2005 things changed dramatically. Driven by stronger immigration and a new baby boom, Australia’s population stepped up to 360,000 p.a. And the average growth rate jumped from 1.2% p.a. to 1.6% p.a. However the home building response was tardy. Unmet demand mounted until 2013, when work on 170,000 new homes kicked off.”

National Real Estate and Construction Leader Alex Collinson added: “Since then building activity has surged, with dwelling starts reaching record heights of 226,000 in both 2015 and 2016. Given that overall Australia’s population growth is likely to stay above 300,000 p.a., underlying demand is also likely to be notably higher going forward, at around 180-200,000 p.a. This means if dwelling starts drop back below these underlying levels, price pressures will begin to build again.”

Funding Costs

Graham Mott, Deloitte Financial Services partner and funding practice leader, said: “While most Australians may struggle to understand why a change in the cash rate does not correlate to an exact change in mortgage rates, pricing of mortgages is far more of an art than most of the public are aware.

“Banks have an economic duty to make sure their Net Interest Margins are healthy given the global focus on capital and the continuous need for book growth. 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.”

Heather Baister, Deloitte funding partner added: “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.”

Conduct

Deloitte Global Regulatory Strategy Centre leader Kevin Nixon said: “Regulators look at the Australian markets against an international backdrop, and the post crisis reform agenda is still working its way through the system. However we need to remember that this regulatory agenda is far broader than just capital.

“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, and toughening whistleblower protection, together with the targeted conduct and risk culture reviews being undertaken, highlight the direction for conduct risk.

“It is likely to involve considerable reflection and review of existing processes for all market participants in the medium term. And no doubt there will be implementation challenges, but we will end up with a system that is more focused on customer outcomes in the longer term.

“Good conduct for instance 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.”

Innovation

Deloitte Partner and Customer Practice leader Jenny Wilson said most of the mortgage lenders and brokers at the Deloitte Mortgage Report roundtable said they would be better able to use the technology around their client data to personalise offers to customers this year. In this way finally driving some of the innovative changes in mortgages they have been striving for.

“This year the sector will be closer to applying innovation to the technology that manages the data and actually get the sophistication and analytics that make the data an asset in itself. Banks and brokers will be better equipped to provide their frontline with the information to offer customers what they need.”

Wilson said: “I would like to see the data inform the next best conversation to have with a customer. Not necessarily the next best offer. That level of sophistication around understanding how a consumer is behaving around their accounts, and what lenders or brokers can be doing to enable them to make better decisions around their financial situation, is the conversation you want to be having with the customer.

“We are not there yet, although next best offer programs are out there and being achieved.”

For an in-depth look at the Report and detail from the roundtable itself see the Mortgage Report webpage here.

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