Yes, the Reserve Bank scolded banks and other home lenders about a drift in lending practices – but on the whole, the sector remains conservative and well placed financially, as tipped in yesterday’s email.
"Australian banks have increased their resilience to adverse shocks by strengthening their capital positions and funding structures since the global financial crisis," the RBA’s first Financial Stability report of the year started.
And interestingly, the RBA said "Over the past six months, banks’ net deposit flows have continued to significantly exceed their net credit flows: banks’ deposits are currently growing at an annualised rate of about 9 per cent, well above credit growth of around 41⁄2 per cent."
But while the bank pointed to falling arrears and impaired loans were signs of improved conditions in the sector, it scolded the banks about some poor habits that are now emerging.
There were also reminders to the banks to behave themselves, and some straight talk to home buyers, especially investors who have led the housing recovery in some areas, especially in NSW.
The RBA said that while lending standards had generally been maintained by Australia banks, as evidenced by consistent LVRs and a low portion of low-documentation loans, there was early evidence of aggressive lending.
"One area that warrants particular attention is banks’ housing loan practices.
"While rising housing prices and greater household borrowing are expected results from the monetary easing that has taken place and are helping to support residential building activity, they also have the potential to encourage speculative activity in the housing market," the RBA said.
It said that banks are expanding into new geographies and products and "some evidence of less conservative serviceability assessments when determining the amounts they are willing to lend.
"While rising housing prices and greater household borrowing are expected results from the monetary easing that has taken place and are helping to support residential building activity, they also have the ability to encourage speculative housing activity."
"It is important for investors and owner occupiers to understand that a cyclical upswing in housing prices when interest rates are low cannot continue indefinitely and they should therefore account for this in their purchasing decisions," the RBA said.
"(I)t is noteworthy that a number of banks are currently expanding their new housing lending at a relatively fast pace in certain borrower, loan and geographic segments.
"There are also indications that some lenders are using less conservative serviceability assessments when determining the amount they will lend to selected borrowers. In addition to the general risks associated with rapid loan growth, banks should be mindful that faster-growing loan segments may pose higher risks than average, especially if they are increasing their lending to marginal borrowers or building up concentrated exposures to borrowers posing correlated risks.
"As noted above, the investor segment is one area where some banks are growing their lending at a relatively strong pace.
"Even though banks’ lending to investors has historically performed broadly in line with their lending to owner-occupiers, it cannot be assumed that this will always be the case.
"Furthermore, strong investor lending may contribute to a build-up in risk in banks’ mortgage portfolios by funding additional speculative demand that increases the chance of a sharp housing market downturn in the future," the bank said.
But the bank pointed out that households have continued to manage their finances with greater prudence than a decade ago: household wealth continued to increase; the saving ratio was within its range of recent years; and households continued to pay down mortgages more quickly than required.
The RBA estimated that the current mortgage buffer balances in mortgage offset and redraw facilities – has risen to almost 15% of outstanding balances, which is equivalent to around 24 months of total scheduled repayments at current interest rates.
"This suggests that many households have considerable scope to continue to meet their debt obligations even in the event of a temporary spell of reduced income or unemployment," the bank commented. That’s a big positive, along with the improved arrears and write offs.
The RBA also warned banks about chasing loans in the commercial property sector (tradtionaly the one area that brings our banks undone, not housing). And there was a specific warning about the rapid growth of a new form of financing
Noting once again the rising risk appetite among Australian households as they chased income in a low-yield environment, the RBA after worrying about the high demand for bank issued hybrid securities (it was worried investors didn’t understand them), the central bank has signalled what it described as "retail securitisation funds".
It said these funds invest in the lower ranking or mezzanine tranches of mortgage backed securities and offer higher yields (because the risks are higher than the higher ranking sections of mortgage backed securities).
These funds are offered in return for higher interest payments that agree to take losses on home loan defaults ahead of other higher ranking investors.
"Although the size of these retail securitisation funds is quite small they have grown strongly. It is important that the potential risks associated with these products is adequately communicated to and understood by households," the bank cautioned yesterday.
As we pointed out yesterday, the RBA repeated its warning that bank profits may not be sustainable particularly as demand for loans remained low. Bank lending has grown at a moderate pace of around 6.5 per cent over six months to January 2014 with investment loans growing at a higher 8.5 per cent.
"With banks bad and doubtful debt charges now at relatively low levels and in an environment of moderate credit growth, the sources of profit growth may be more limited in the period ahead."
And it was a similar story elsewhere in the financial system.
For example, the bank said "The profitability of the general insurance industry remains strong: annualised return on equity was 18 per cent in the second half of 2013. Insurers’ domestic profits have been underpinned by premium rate increases following the natural catastrophes in 2011 and 2012, and catastrophe claims were relatively low in 2013.
"The industry is expecting slower premium rate growth in the period ahead due to stronger competition, particularly in those business lines that have experienced strong premium rate growth recently, such as home insurance. These competitive pressures increase the risk that insurers respond by relaxing pricing and reserving policies to maintain market share."
So a small niggle there and a reminder to insurers not to sacrifice profits for market share and not to bolster earnings by larger than expected releases from reserves (which some wonder if Insurance Australia Group and Suncorp might have done in the past reporting season).
And our huge funds management sector continues to grow: The consolidated assets held by Australian funds management institutions grew at an annualised rate of 15 per cent over the six months to December 2013, to $1.8 trillion.
"Growth was driven by more favourable conditions in financial markets, including equity and corporate debt markets. Superannuation funds, which account for around three-quarters of assets, recorded the strongest growth in assets under management."
But there was one major exception – the life insurance sectors where the likes of the AMP and Tower of NZ are the major players. Here times are much tougher.
"Operating conditions are more difficult in the life insurance industry, with ongoing competitive pressures and higher claims contributing to a reduction in profits in 2013," the RBA said.
"The life insurance industry is currently facing a difficult operating environment.
"Life insurers’ profit – both in levels and as a share of net policy revenue – has declined substantially, reflecting a number of structural and cyclical issues," the bank commented.
So why these problems? Well, the RBA explained "Strong competition for superannuation ‘group’ life insurance policies led to an under-pricing of risk over recent years, partly because insurers did not allow enough for their reduced knowledge of the health of individuals insured in a group (which is more limited than that for individual policies).
"There has also been an increase in disability insurance claims since 2010, particularly relating to stress and mental illness.
"Policy lapse rates have also been increasing, which may be due to households cutting back on discretionary expenses, or incentives for financial advisors being tilted towards obtaining new business rather than focusing on long-term customer retention.
"APRA has introduced measures to improve the collection of insurance information by superannuation funds, and is monitoring life insurers’ efforts to adjust their group insurance business practices," the RBA concluded.
You only have to look at the poor interim and full year results for the AMP for 2013 to see the problem. Big and continuing losses in its life business, especially the wealth protection area where mis-priced products were hurting the bottom line, along with high levels of policy lapses and claims.
The AMP has lost more than $160 million in this area in the past year to 15 months. Foreign-owned insurers are also big losers as well with losses in the hundreds of millions of dollars in the past two years.
