RGF – Chris Mallin Macro Perspectives

“Crocodile jaws”

Resilient demand masks tough times for UK mortgage providers

The key chart

**Resilient mortgage demand masks tough times for UK mortgage providers (% YoY)** (Source: Bank of England; CMMP analysis)

The key message

The relative stability/resilience of mortgage markets in the UK (and in the euro area) has been a consistent theme in the “messages from the money sector” during the COVID-19 pandemic.

UK mortgages grew 2.9% YoY in August, unchanged from July, and monthly flows have been steadily increasing from their April 2020 lows. This recovery has also been the main driver in the rebound in overall household borrowing, with mortgages accounting for £3.1bn in August’s £3.4bn increase in total lending to individuals. Looking forward, the number of mortgage approvals for house purchases also increased sharply in August to 84,700, the highest number since October 2007.

So far, so good – but there is always a “but”…

Current mortgage demand is very subdued in relation to past cycles despite the low cost of borrowing. One factor here is that, despite the deleveraging seen since 1Q10, the UK household debt-to-HDP ratio remains at 85%, the threshold level above with the BIS believes that debt becomes a drag on future growth. Unsurprisingly, the CAGR in HH debt (primarily mortgages) has trended between only +/- 1% nominal GDP growth since early 2016 – not much of a “growth story” here.

More concerning for mortgage providers, the effective rates on new and outstanding mortgages have fallen 28bp and 32bp respectively over the past 12 months to new lows of 2.14% and 1.72% respectively. The gap between the rate on outstanding and new mortgages was 38bp in August, indicating further downward pressure on net interest margins and income.

With subdued growth and further NIM compression ahead, mortgage providers will need to embrace digitalisation to deliver effective market segmentation/client knowledge, alternative revenue sources, further efficiency gains and more effective liquidity and risk management.

Seven charts that matter

The relative stability/resilience of mortgage markets in the UK (and euro area) has been a consistent theme in the “messages from the money sector” during the Covid-19 pandemic. Outstanding mortgage balances grew 2.9% YoY in August, unchanged from July but slightly below the 3.1% growth recorded in June. In contrast, the growth in consumer credit hit a historic low (-3.9% YoY) while corporate lending grew 9.7% YoY (see key chart above).

**Monthly flows have recovered steadily since their April 2020 lows** (Source: Bank of England; CMMP analysis)

The recovery in monthly HH borrowing flows since April’s lows (see chart above) has been the key driver in the recovery in overall household lending (see chart below). In August, for example, mortgages accounted for £3.1bn out of a total £3.4bn monthly flow.

**Mortgages are driving the recovery in household lending** (Source: Bank of England; CMMP analysis)

**Approvals suggest positive momentum** (Source: Bank of England; CMMP analysis)

Looking forward, the number of mortgage approvals for house purchases also increased sharply in August to 84,700, the highest number since October 2007. This partially offsets the March-June weakness – there have been 418,000 approvals YTD, compared with 524,000 in the same period in 2019.

So far, so good – but there is always a “but”…

**Current demand is very subdued in relation to past cycles in nominal and real terms** (Source: Bank of England; CMMP analysis)

Current mortgage demand is very subdued in relation to past cycles (see chart above), despite the low cost of borrowing. One factor here is that, despite the deleveraging seen since 1Q10, the UK household debt-to-HDP ratio remains at 85%, the threshold level above with the BIS believes that debt becomes a drag on future growth (see chart below).

**HH debt ratios remain elevated at the BIS threshold level** (Source: BIS; CMMP analysis)

Unsurprisingly, the CAGR in HH debt (primarily mortgages) has trended +/- 1% nominal GDP growth since early 2016. The chart below comes from CMMP Relative Growth Factor (RGF) analysis, which considers the rate of growth in debt in relation to GDP on a three-year compound growth basis with the level of debt expressed as a percentage of GDP. This graph illustrates the UK HH RGF on a rolling basis. There is little to get excited about in this chart.

**An unexciting “relative growth” story – rolling 3-year CAGR in HH debt versus rolling 3-year CAGR in nominal GDP** (Source: BIS; CMMP analysis)

More concerning for mortgage providers, the effective rates on new and outstanding mortgages have fallen 28bp and 32bp respectively over the past 12 months to new low of 2.14% and 1.72% respectively. The gap between the rate on outstanding and new mortgages was 38bp in August, indicating further downward pressure on net interest margins and income.

**The challenge of delivering top-line growth** (Source: Bank of England; CMMP analysis)

Conclusion

Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.

“Too much, too soon?”

China’s HH debt in the spotlight

The key chart

**China’s HH credit growth continues to outstrip GDP growth (8ppt) despite the fact that the HH debt ratio (56%) is already close to the average for all BIS reporting countries (60%)**
*Source: National Bureau of Statistics; Haver; CMMP calculations*

Summary

The PBOC published its annual Financial Stability Review (2019) this week in which it highlighted the risks associated with the rapid accumulation of household (HH) debt in China. It noted that, “the debt risks of the household sector and some low-income households in some regions are relatively prominent and should be paid attention to.” (Financial Times, 2019). This supports my recent analysis of debt sustainability in Asia, in which I concluded that “relatively high excess HH growth rates in India and China remain a key focus point.“

I understand* that the PBOC’s analysis considers the period up to the end of 2018. In this post, I analyse how these risks have developed over the first three quarters of 2019 and conclude that they remain considerable. China’s HH debt ratio has risen further during 2019, with HH credit growing 9ppt faster than GDP on a three year CAGR basis. The rate of “excess credit growth” has moderated very slightly, but is still of concern given that China’s HH debt ratio (56%) is now close to the average HH debt ratio (60%) for all BIS reporting countries.

My analysis highlights two key points: (1) the level of debt needs to be considered in relation to its rate of growth (and its affordability and structure); and (2) even, in the most benign outcome, China’s increasing HH debt burden represents a key headwind for economic growth and the transition to a consumption-driven economy.

(* n.b. I have been unable to find an English version of the 2019 FSR, so my comments on its content here are based on secondary sources)

A review of last month’s analysis

**High excess HH credit growth in India and China remain a key focus point (3-year CAGR RGF analysis)**
Source: BIS; Haver; CMMP analysis

Last month I concluded that:

“In summary, the risk associated with excess credit growth across EM are lower than in previous cycles. Asia stands out, however, because the highest rates of growth have occurred in economies that already have high debt ratios. In China and Hong Kong, these risks are compounded by high debt service ratios indicating rising “affordability” risks. RGFs in both economies are adjusting sharply lower in response. Risks in intermediate and emerging Asian economies appear lower, but the relatively high excess HH growth rates in India and China remain a key focus point.“

**Excess credit growth dynamics show divergent trends in the HH and NFC sectors in China – the NFC sector is adjusting, the HH sector is not.**
Source: BIS; Haver; CMMP analysis

2019 update (as at end 3Q19)

**Nominal HH credit growth is slowing but remains high (17% average monthly YoY growth YTD)**
Source: National Bureau of Statistics; Haver; CMMP analysis

HH credit has continued to grow strongly YTD. The average monthly YoY growth rate was 17% in nominal terms over the first nine months of 2019. This compares with an average of 19% for the full year 2018. HH credit growth continues to exceed nominal GDP growth – by 8ppt in 3Q19. As highlighted above, this is despite the fact that China’s HH debt ratio of 56% (3Q19 estimate) is closing rapidly on the average HH debt ratio for all BIS reporting economies.

The key chart repeated. There is little sign that excess credit growth is slowing sufficiently (red bars) despite the fact that the HH debt level (blue line) has closed rapidly on the BIS average for all reporting economies
Source: National Bureau of Statistics; Haver; CMMP analysis

Experience suggests that the key risk here is less to do with the level of debt and more to do with its rate of growth. In “Sustainable debt dynamics“, I introduced the simple concept of relative growth factor (RGF) analysis that I have used since the 1990s as a first step in analysing the sustainability of debt dynamics. In short, this approach compares the rate of “excess credit growth” with the level of debt penetration in a given economy. Red flags are raised when excess credit growth continues in economies that exhibit relatively high levels of leverage.

**The rate of excess HH credit growth is slowing but remains unsustainably high (3Y RGF analysis)**
Source: National Bureau of Statistics; Haver; CMMP analysis

The trend in China’s HH RGF is illustrated in the chart above (rolling 3Y basis). The rate of excess HH credit growth has slowed in relation to recent history but remains unsustainably high in absolute terms, in my experience. At the recent peak, HH credit was growing 11ppt faster than nominal GDP (4Q17), hence the steep gradient in the earlier chart illustrating the HH debt ratio. As at the end of 3Q19, my estimates suggest that this excess growth rate has slowed to 9%.

Conclusion

As a macro and monetary economist, I start by analysing the level of debt in absolute terms and in the context of its rate of growth, affordability and structure. In my experience, this is the most important feature of the LT secular investment outlook with direct implications for: economic growth; the supply and demand for credit; money, credit and business cycles; policy options investment risks and asset allocation.

The risks associated with excess HH credit growth in China remain elevated and this analysis presents a relatively extreme example of the importance of considering the level of debt together with its rate of growth. History suggests that current trends in China are unsustainable. The most benign outcome is that the rate of growth in HH borrowing slows more rapidly with negative implications for consumption and aggregate demand. In short, China’s increasing HH debt burden represents a key headwind in the transition to a consumption-driven economy.

Please note that the summary comments above are abstracts from more detailed analysis that is available separately

“Sustainable debt dynamics” – Asia private sector credit

Global finance is shifting East but are current Asian PSC debt dynamics sustainable?

The key chart

**Figure 1: A striking feature in Asia is that the highest levels of “excess credit growth” (3-year RGF 1Q19) have occured in economies where debt ratios are already high**
Source: BIS; Haver; CMMP analysis

Summary

In “The Changing Face of Global Debt”, I argued that global finance was shifting East and towards emerging markets. In this post, I summarise my analysis of the sustainability of current Asian PSC trends. The key points:

Classifications of Asian economies as either “advanced” or “emerging” economies are over-simplistic and unhelpful
Relative growth factor (RGF) analysis provides a simple, first tool for assessing the sustainability of debt dynamics
The risks associated with “excess credit growth” across EM are much lower than in previous cycles
The striking feature in Asia, however, is the fact that the highest levels of “excess credit growth” have occurred in economies that already exhibit high debt levels (Hong Kong, China, Korea and Japan)
In Hong Kong and China, these risk are compounded by debt service ratios that are close to peak levels and well above LT averages (“affordability risk”)
RGF-related risks appear relatively low in Asia’s two large and “genuine emerging markets” – India and Indonesia
Relatively high excess HH growth rates in India and China remain a key focus point.

Time for new classifications?

The BIS classifies Asian reporting countries into two categories: three “advanced” economies (Japan, Australia and New Zealand) and eight “emerging” economies (China, Hong Kong, India, Indonesia, Korea, Malaysia, Singapore and Thailand).

Such broad classifications are unhelpful, at best, and inaccurate, at worst. The classification of Japan, Australia and New Zealand as advanced economies is logical but masks different exposures to HH (Australia and New Zealand) and NFC (Japan) debt dynamics.

**Figure 2: HH and NFC debt ratios (% GDP) for Asian reporting economies plotted against BIS threshold levels (in red)**
Source: BIS; Haver; CMMP analysis

The grouping of China, Hong Kong, India, Indonesia, Korea, Malaysia, Singapore and Thailand together as emerging economies is more troublesome as it ignores the wide variations in market structure, growth opportunities, risks and secular challenges.

I prefer to consider China, Korea, Hong Kong and Singapore as unique markets. China is unique in terms of the level, structure and drivers of debt and in terms of the PBOC’s policy responses. Korea is unique in terms of having NFC and HH debt ratios that exceed both advanced economy averages and the BIS thresholds above which debt becomes a drag on future growth. Hong Kong and Singapore are both distinguished by their roles as regional financial centres but have different HH debt dynamics.

Malaysia and Thailand can be considered intermediate markets given that either both HH and NFC debt ratios (Malaysia) or one debt ratio (Thailand HH) exceed the average for emerging markets ex China. This leaves India and Indonesia as genuine emerging markets among the BIS reporting economies, with debt ratios below the emerging markets ex China average and well below BIS threshold levels (see Figure 2 above).

RGF analysis – “excess credit growth”

The theory

I have used the simple concept of relative growth factor (RGF) analysis since the early 1990s as a first step in analysing the sustainability of debt dynamics. In short, this approach compares the rate of “excess credit growth” with the level of debt penetration in a given economy.

The three year CAGR in debt is compared with the three year CAGR in nominal GDP to derive a relative growth factor. This is then compared with the level of debt expressed as a percentage of GDP (the debt ratio).

The concept is simple – one would expect relative high rates of “excess credit growth” in economies where the level of leverage is relatively low and vice versa. Conversely, red flags are raised when excess credit growth continues in economies that exhibit relatively high levels of leverage.

Low average risk in EM

**Figure 3: Risks associated with “excess credit growth” across emerging markets are lower than in previous cycles (Trends in EM 3-year RGFs since March 2002)**
Source: BIS; Haver; CMMP analysis

Figure 3 above, illustrates rolling 3-year RGF trends for EM economies highlighting previous unsustainable levels that peaked in 1Q04, 3Q09, 4Q11 and 2Q15. The current excess growth rate of 1.3% suggests, however, that EM sustainability risks are relatively low. If anything, the lack of growth/slowing growth are more immediate challenges

How does Asia stand out?

**Figure 4: The key chart repeated! Asia RGF analysis illustrated as at end 1Q19 (3-year CAGR)**
Source: BIS; Haver; CMMP analysis

Spotlight on Asia’s unique markets

A striking feature across Asia has been that some of the fastest rates of excess credit growth have occurred in economies where debt levels are already very high – Hong Kong, China, Korea and Japan (see Figure 4 above).

**Figure 5: Trends in RGF for Asian economies with already high PSC debt ratios. China and Hong Kong slowing rapidly, Japan recovering**.
Source: BIS; Haver; CMMP analysis

The level of excess credit growth is already slowing sharply in Hong Kong and China from peak levels in excess of 6% (Figure 5). With debt service ratios in both economies close to peak levels and well above LT averages (Figures 6 and 7) a return to recent periods of excess growth is (1) unlikely and/or (2) would be associated with high levels of risk.

**Figure 6: Hong Kong’s PSC debt service ratio is close to its historic high and well above LT average**
Source: BIS; Haver; CMMP analysis

**Figure 7: China’s PSC debt service ratio is also close to its historic high and well above LT average**
Source: BIS; Haver; CMMP analysis

In contrast, Japanese PSC growth is recovering from sustained periods of deficient credit demand, helped by relatively low debt service ratios that are well below their LT averages (Figure 8 below). The recent uptick in excess Korean growth is unlikely to be sustainable, however, given that both HH and HFC debt levels are above BIS thresholds (Figure 2 above)

**Figure 8: Japan’s PSC debt service ratio displays a very different dynamic – the DSR is low in absolute terms and well below LT average**
Source: BIS; Haver; CMMP analysis

Asia’s intermediate and emerging markets

RGF factors for intermediate and emerging Asian markets indicate relatively low levels of sustainability risk. Both India and Indonesia have been through periods of adjustment from previous phases of excess credit growth.

**Figure 9: Rolling 3-year RGFs for Asia’s intermediate and emerging economies**
Source: BIS; Haver; CMMP analysis

In the former case, there are very different dynamics between the rapidly growing HH and slow growing NFC sector. The risks associated with excess credit growth in the HH sector (from a low base) are rising but remain relatively low in the NFC sector which is still in an adjustment phase.

**Figure 10: India’s HH and NFC sectors are displaying sharply contrasting debt dynamics**
Source: BIS; Haver; CMMP analysis

Indonesia’s growth rates have adjusted from the 2000-14 period of “super-charged” growth which was driven largely by exogenous factors including the commodities super-cycle and portfolio inflows during the period of global QE and record low US interest rates.

In summary, the risk associated with excess credit growth across EM are lower than in previous cycles. Asia stands out, however, because the highest rates of growth have occured in economies that already have high debt ratios. In China and Hong Kong, these risks are compounded by high debt service ratios indicating rising “affordability” risks. RGFs in both economies are adjusting sharply lower in response. Risks in intermediate and emerging Asian economies appear lower, but the relatively high excess HH growth rates in India and China remain a key focus point.

Please note that the summary comments above are abstracts from more detailed analysis that is available separately.