Banks selling to raise capital , a way past the APHRA doom and gloom ?

Couldn’t link past the pay wall on the AFR article , but this article in the SMH covers the same area though the AFR article appears to go into more detail .

CBA could raise $4 billion from fund manager float

Basically by selling assets the CBA will raise enough funds to cover any further requirements for capital funds . They talk about getting back to their core businesses .

Westpac has just done similar by selling its part ownership in BT management .

I think this is an interesting development and might fast track any period of readjustment in lending moving forwards .

@euro73 , you know more about the fine details of this than I do . What’s your take ?

Cliff

 

I thought they'd met their capital raising targets about 12 months ago.

 

Yes, but Basel IV requires more Tier 1 capital provisioning than Australian banks currently hold. The banks took great steps towards this in the first major capital raisings @ 2 -3 years back, but that was always only the first stage. BASEL IV has recommended that banks be at 3-3.5% Tier 1. Australian banks are a little shy of that. They are in the mid - high 2% range. BIg improvement over the high 1% range where they started, but not quite there yet.

APRA hasnt officially announced what they are going to want the banks to increase their Tier 1 ratios to. They may say 3%, which is the lower end of the BASEL recommendations. if that happened, very little additional capital raising would be necessary. If APRA goes for 3.5% , that will mean quite a large amount will need to be raised.

APRA was supposed to have started "consultations" with the banks by early 2017, as the BASEL IV stuff is supposed to be implemented by mid 2018... So while I havent seen anything official about any of this in the media for some time, perhaps APRA has started privately telling the banks what they expect those numbers to look like, to give them a head start on getting ready.

What we do know from the first round of capital raising from @ 2-3 years back is this. When the banks went from @ 1.90 ( 1.9%) of capital heldper $100 to @ 2.7% (2.70) , it reduced their ROE and that resulted in rate rises of @ 45 -50 basis points from memory... although Id need to double check that, but I think it was in that range... If there's another increase in Tier 1 requirements , expect some rate rises to restore banks ROE. Modest , but rises nonetheless. And expect the lions share to go to I/O borrowers.

 

Fine details from AFR article

The proceeds from the life sale will lift the CBA’s CETI by about 0.7 % to 10.8 % , above the 10.5 % benchmark set by APRA

cliff

 

The only thing that seems certain is that between APRA and ASIC and the media, the loose ( or loose"ish" ) business practices that created the gravy train of ever expanding profits that the banks have enjoyed for the past 2-3 decades are coming under severe scrutiny.

We have already seen aggressive regulatory intervention on the resi lending side of things, from both regulators ( APRA and ASIC ). Policy settings around borrowing capacity, cost of living , debt amortisation ( via caps on I/O volumes and length/terms) etc have all been targeted.

We are seeing more and more aggressive intervention on culture / business practices. One CEO is gone. Heads of departments are gone. Expect more to come as the pressure ramps up.

And we are seeing the implementation of BASEL start to take effect. As banks are required to restructure/recalibrate... profit margins will shrink.

This makes me think that resi investment lending is not going to get any easier. May not get any tougher - but wont get any easier any time soon... the credit environment as it stands today is likely to be the new norm.

The banks arent going to just accept lower profits , so they will just seek to make their margins elsewhere. So from the resi investor side of things, dont expect I/O rates to get much cheaper. Dont expect borrowing capacity to get much easier/better. Do expect that because of these realities, accumulating a portfolio will require a rethink about managing that borrowing power / P&I repayment environment in a different way.

 

all is well but if this tightening sends the economy into a tail spin all bets are off.

govt don't get elected if people dont have jobs.

besides.....look at Europe...they are still a basket case

 

Thats precisely why APRA stepped in. Our banks were WAAAAAY overweight in I/O loans, with many loans at levels unlikely ever to be repaid if it was allowed to continue.

And its also why you probably arent going to see "actuals" back anytime soon on lender servicing calcs. Nor 10,15,20 year I/O terms being available to all and sundry. Nor a lifting of the 30% I/O cap, the 10% speed limit or the high LVR I/O caps.

One day maybe... but not anytime soon

This "tightening" only really affects speculative investors who are seeking to leverage to high LTI ratio's at high LVR's using long term I/O lending . The effects on others, with lower LTI ratios, lower LVR's and who are able to manage P&I repayments, is far less.

 

Its already having an impact on Sydney where loan amounts are the largest and inner also inner Melbourne....

Judging by way things are going we could see some developers go under from next year onwards. Lots of buyers are now not able to settle on OTP......as the fear sets in ...it will cascade...time will tell.

Not the first time I have seen this.

On the other hand quality rentals catering to modern lifestyle requirements - i.e. well appointed smaller 3x2x2 homes near transport/amenities with low maintenance gardens are in huge demand!

 

quote..

Thursday, 21 September 2017 (Sydney): Commonwealth Bank today announced the sale of 100% of its life insurance businesses1 in Australia ("CommInsure Life") and New Zealand ("Sovereign") to AIA Group Limited ("AIA") for $3.8 billion (the "Transaction"). The sale agreement also includes a 20-year partnership with AIA for the provision of life insurance products to customers in Australia and New Zealand..


quote

Thursday, 21 September 2017 (Sydney): Commonwealth Bank today announced that with the agreement for divestment of its Australian and New Zealand life insurance businesses now finalised, Annabel Spring, Group Executive Wealth Management, has decided to leave the Group in December.

Can you hear the bells ringing..
AGM Date:
Thu, 16/11/2017 ...

 

None of this is news... I have written several detailed posts about the multiple changes that were coming to the credit environment, over the past several years.

1. higher I/O rates - already happened
2. tougher servicing criteria - already happened
3. reduced LVR's - already happened
4. tougher cash out policies - already happened
5. shorter I/O terms - already happened (the P&I cliff hasn't happened yet - that's stage 2)
3. Basel IV - 2 big items of note . Increased Tier 1 capital requirements plus a change to the minimum RMBS terms. This means banks will be required to start using RMBS terms of 12 months minimum... which will also place some modest upward pressure on their cost of funds. Many banks currently use 90 day or 180 day RMBS terms to keep their cost of funds as low as possible.

So really, there's no new news in any of this. Its all playing out as expected. The only unknown at this stage is which Basel IV recommendations APRA embraces, and how . They may not choose to request that banks raise additional capital. Or they may request that the banks raise more than Basel IV recommends. Similarly, they may not request that banks move to minimum 12 month RMBS contracts. They may push for 18 months or 24 months... or they may not push for any changes at all.

It's the BASEL IV stuff that is yet to play out with any clarity or certainty. But my feeling is that the regulators have already provided the banks with pretty direct guidance behind closed doors, and much of what we are starting to see is a result of that.

 

You called it, and it's happened. Where do you think we are going to from here?

 

1. There will be lower growth than people have become used to. Growth will still happen, but it will be slower and lower. MUCH slower and lower, potentially. Far less I/O availability and far less borrowing capacity for everyone who participates in this game we call property, will ensure this will be the case. Momentum creating "magic dust" ie ever expanding borrowing power and almost limitless I/O availability - cant be removed or restricted or rationed and not have momentum slowing consequences.

2. Past cycles/trends , as well as the data that people use to make arguments for them, are already irrelevant. This will only be further proven to be the case as more time passes. Those still in denial at this point will come to accept it. Again, far less I/O availability and far less borrowing capacity for everyone who participates in this game we call property, will ensure this will be the case as well.

3. Debt reduction/yield /cash flow will start to become more attractive propositions than they are right now. They will eventually become highly sought after as the masses ( those with median incomes and PPOR mortgages and aspirations to grow a resi portfolio ) accept the reality of the regulated credit environment and realise that accumulation combined with debt reduction will end up a smarter play, as equity from growth alone doesn't equate to borrowing power .

4. Those who have accumulated portfolios rapidly but who have ignored cash flow will find themselves drowning when the P&I cliff arrives - especially if they are operating on skinny yields . Plenty of "young guns" on here who have this to deal with at some point...

5. APRA and ASIC wont be allowing banks to revert to the old ways, any time soon... if ever.
This is the new norm.... probably for as many years as anyone cares to guess...




If those propositions sound reasonable, I think it's also reasonable that there are two considerations every young or new investor should probably be giving quite some serious time to.

1. How to expand a portfolio when borrowing capacity rules have changed so radically and perhaps more importantly ;
2. How to hold a portfolio with weak yields when the P&I cliff arrives...



Those with mature portfolio's will not be affected too much - they have the yields necessary to deal with any P&I cliff that will eventually come their way . Cash cows are far less helpful or necessary for them and really, their only issue is expansion ( borrowing capacity) . Holding is the easy part for them.

Those on very high incomes will also be largely unaffacted - they have the income necessary to deal with any P&I cliff that will eventually come their way. So cash cows are also less necessary for them. Although that assumes they stay on a very high income. Remember that mature portfolios with mature yields provide a better safety net than a high salary subject to economic winds... so I personally see great value in the insurance/safety net a cash cow provides to higher income earners as well as they seek to grow their portfolios.

Everyone else... ie those with median incomes and PPOR mortgages and aspirations to grow a resi portfolio - debt reduction is , in my view at least , THE thing to be concentrating on. It will address/assist with both the issues noted above.

1. How to expand a portfolio when borrowing capacity rules have changed so radically and perhaps more importantly ;
2. How to hold a portfolio with weak yields when the P&I cliff arrives...


As far as interest rates and policy settings are concerned...I dont see anything other than the status quo being maintained for at least the next several years, by the regulators.

In the end, they want Australian lenders to hold much more capital as a shock absorber against any future global events, and they also want far less I/O debt being carried, and they also want far more debt being paid down. They have taken 3 years and 2 sets of policy adjustments to get to where they needed to be... and I dont think there is any prospect at all that they ease up on these policies any time soon or for many years...

No idea whether the RBA wants the cash rate up... I suspect they do ( a touch) but would be wary of the effects on the $AUD... so I suspect we will just plod along with a cash rate at or near to todays levels, and they'll just hope that over 5,6,7,8 years the I/O quotas start driving household debt down as more and more borrowers are unable to use IO to avoid debt amortisation.

 

Selling insurance arm (commbank and ANZ) has been on the card for a long time.
'People insurance' especially the direct business has been struggling for a while.

 

Based on your analysis, does that means the higher end market($1m plus) will be the most affected market where as the lower end market will be much more attractive. Which may help drive the price up for those properties within the $500k mark?

 

@euro73 hi mate, do you think commercial lending will get tougher?
And also, what is your take on non bank lenders, do you think they are going to somehow become under the thumb of APRA/ASIC like bank lenders in the the near future?
And for People starting out like myself, do you think simply paying down principle debts as much as possible, will enable us to grow large portfolios in this new credit environment, what LVRS should we be aiming for?

As always loving the helpful posts.

 

Already very difficult for developers to get money for new builds. Has been for a good 2 years or so. This is why several high profile developers have shelved new projects. It will stay this way until the current pipeline of apartments are delivered... the banks dont want to add any additional surplus supply into the apartments markets . They dont know whether they're going to get their money back, at this stage. How many of these OTP apartments wont settle ? No one knows. So they definitely arent interested in priming that pump any further by opening up the commercial books to one and all, in a hurry.

They are already under the APRA thumb. Pretty much have been since Day 1 of APRA's changes, as most non bank lenders warehouse their loans in major banks before securitising them. This means they are by default, subject to the same rules. The only non bank lender of note who doesnt warehouse domestically is Liberty - and its the reason they are the only lender still using pre APRA servicing calcs.

Depends on income levels , borrowing capacity etc, but as a general rule if you try and replicate the "business model" of pre APRA investors , it will fail. By "business model" I mean buy, hold, wait for growth, harvest that growth and repeat. That model worked because
1. rates fell consistently for 20-25 years
2. wage growth and double income households grew consistently for 20-25 years
3. LVR's expanded during the 90's from 80% to 90%, and then to 95%
4. Borrowing capacity multiples expanded from 3.5 x income to as much as 15 x income if the right lenders were used in the right order

None of those things are available to you now

1. rates are bottomed. And even if they fell, it has no impact on assessment rates
2. wage growth has peaked. wage inflation is now at its lowest point in 2 decades so unless Australia embraces polygamy, double income households wont suddenly become triple or quadruple income households
3. LVR's have nowhere to go. Unless 110LVR loans come into play. No chance of that
4. Lenders are introducing debt servicing ratios that will limit most investors to 8 x income

Put simply... there is little to no chance of the pre APRA business model working as successfully in the post APRA credit era. For these reasons, I believe a dividend reinvestment plan will serve the next generation of investors better than a speculative investment plan. No doubt speculative investing was stupendously successful for the pre APRA generation...but I dont live in the past, where every expanding LVR's and borrowing capacity and limitless I/O terms hung from every branch of every lenders tree. I live in the "what does APRA mean to me " present, where LVR's are not expanding, borrowing capacity contracts ( severely ) with each I/O dollar owed, and I/O terms are now rationed.

Buying assets with strong yields ( dividends) then reinvesting the surplus cash flow towards debt reduction is the only way you can ensure that you are creating equity and improving borrowing capacity simultaneously. It also provides for protection against rate rises, P&I cliffs etc...

No matter how many ways others may try and argue differently - I understand servicing calculators exceptionally well, and the maths are the maths are the maths.

 

@euro73 absolutely excellent reply...so helpful.

So basically, we now have to be very active in our investments (value add properties for equity gains) and be smart with surplus cash flow (pay off as much debt as possible) to be able to grow a portfolio to similar sizes as investors of the past.? Or do you think us Newcomers are still more limited? I guess it depends on how disciplined you are with your surplus cashflow and paying down as much debt to continue borrowing...
Are we looking at LVRS of say 50% now, to be able to continue to build large portfolios? And have the banks on our side.

Oh and what’s meant by “the P&I cliff”

 

@euro73 some great points there and agree with some but the biggest standout for me is, VERY few people know who BASEL is, what they do and how they can influence...

Dr Andrew Wilson has the same view of growth as you do, but I do believe the human species keep doing the same thing eventually... Potentially another boom in a few years after a correction/bust???

 

I would ask a question of you; what value does equity offer without the ability to harvest it?

Even a strategy of purchasing "value add" properties for equity gains needs to account for this question....

LVR's aren't the issue. Borrowing capacity is the issue. To accumulate 2 million worth of INV properties for example... whether thats 4 x 500K, 8x 250K or something in between, requires $2Million borrowing capacity .... Ask yourself the question; how does equity , whether from growth or from value add...get you that capacity when each dollar borrowed is assessed at 7.25% or worse, and at P&I? Especially when rental income is assessed at 80% of market value.

The answer is, you would need to be purchasing at yields above 10% in order to be able to pursue that strategy effectively. Or you'd need to be on a very high income.

And that's before you take credit card debt, personal loans, PPOR debt etc into account...

This is the point that pre APRA investors continue to fail to acknowledge... every dollar they borrowed was assessed without a buffer. Every dollar. They also enjoyed long term I/O availability. These two things allowed them to hold their portfolios long enough that their rents matured... and all during a period of high wage inflation and falling rates.

Cant bake the same cake as them when you are working with totally different ingredients

 

I have been posting about BASEL for several years. Just like I have been posting about lending changes, the value of cash cows for debt reduction etc...

Those who understand mortgages ( and I mean REAL understanding of how mortgages work - which excludes almost all brokers and borrowers ) know that the ingredients have changed forever, and as I keep saying...you just cant bake the same cake using different ingredients .

There are still plenty on here in denial. They appear to live in some sort of hope that the good old days are coming back. Typically those who have those views have accumulated their portfolio's well before the rules changed, so I always find their ignorance particularly disappointing, especially as they keep encouraging others to follow their business model, rather than acknowledging its fools gold for the next generation... they must surely understand that fundamentals like "actual" repayments, endless I/O and and pretty much every other borrowing capacity advantage they enjoyed, which is the ingredient that got them where they are , have ended....? It's very sad for the next generation of investors who think that they can follow the same model and replicate the outcomes. They will be sorely disappointed, in all likelihood. They will exhaust their borrowing power much more quickly, revert to P&I far sooner and find holding on long enough to be rewarded , incredibly difficult . They just wont get very far employing those methods. But 'tis what 'tis I guess.