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
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.
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
The EA remains trapped by PS debt levels and outdated policy rules
The key chart
Slowing GDP growth confirms the need for a major policy reboot (% YoY) Source: ECB; Haver; CMMP analysis
Summary
Today’s 4Q19 GDP data confirms that the euro area (EA) is growing at its slowest rate since the ECB introduced expansionary measures in June 2014 (0.1% QoQ, 0.9% YoY).
The region remains trapped by its debt overhang and out-dated policy rules – a major policy reboot is long overdue.
Progress towards dealing with the debt overhang in Europe remains gradual and incomplete. The EA continues to display the characteristics of a “private sector balance sheet-driven” slowdown rather than a “structural slowdown”. In this context, it is unsurprising that unorthodox monetary policy measures (1) have been only partially successful, at best, and (2) have unintended, negative consequences for growth, leverage, financial stability and income inequality.
Financial sector balances send clear message about the causes of the slowdown (4Q sum, % GDP) Source: ECB; Haver; CMMP analysis
Last month, I introduced my balance sheet framework and applied it to the UK economy. There are two key messages from this framework that are applicable to the current EA situation:
When the private sector is running a financial surplus in spite of negative/very low policy and deposit rates (see graph above), this is a strong indication that the economy is still suffering from a debt overhang
Fiscal space, like debt sustainability, is at its core a flow concept, not a stock concept (see graph below)
Following from this (and deliberately simplifying a complex policy debate), when growth, inflation and inflation expectations are below target and when interest rates are already zero or negative, fiscal policy should lead with an expansionary stance and monetary policy should cooperate by guaranteeing low interest rates for as long as needed. In short, this is a very different economic context to the one that existed when the current fiscal policy rules were chosen.
Germany’s private and public sectors are running simultaneous net financial surpluses in the face of slowing economic growth – does this make sense for Germany and/or the EA? Source: ECB; Haver; CMMP analysis
Unfortunately, despite strong and repeated calls for fiscal stimulus by the ECB, fiscal policy is only expected to be moderately supportive in 2020. Rules, designed to address different challenges at different times, are preventing stimulus in counties where policy makers would like to spend more (Italy, Spain) and national policy choices are limiting policy expansion in countries that have room for further stimulus (German, Netherlands). This is compounded by the lack of a central fiscal capacity at the euro area level that could strengthen the ability to deploy fiscal policy, complementing monetary policy, in case of significant euro area-wide downside dynamics (see https://www.imf.org/en/News/Articles/2020/01/28/sp012820-vitor-gaspar-fiscal-rules-in-europe ).
Are current fiscal rules still fit for purpose – government deficit/surplus as % GDP (y axis) plotted against government debt as % GDP (x axis)? These rules were designed for a different typ of recession and constrain required policy responses today. (Red lines indicate current rules) Source: ECB; Haver, CMMP analysis
Conclusion
Marco Perspectives frameworks illustrate why a major policy review that begins with differentiating between different types of recessions is required if the EA is to escape from the current debt and policy trap. The ECB has announced a review of monetary policy in the EA, but the need for a wider fiscal policy review/reboot appears more urgent, in my view.
I presented the investment implications of this analysis at “The 5th Global Independent Research Conference” in London earlier this month. Please contact me to dicusss these implications and for access to the detailed analysis behind the summary comments above.
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
The developed world continues to deleverage but risks remain
The key chart
Only Italy, Austria, Greece, Germany and the US have NFC and HH debt ratios (% GDP, 1Q19) below BIS “maximum threshold” levels (dotted red lines) Source: BIS; Haver; CMMP analysis
Summary
The developed world continues to deleverage. This process has already led to dramatic shift in the structure of global private sector debt (see “The Changing Face of Global Debt”). With private sector debt levels still “too high” in the developed world, this trend is set to continue.
Risks associated with excess credit growth in the developed world are lower than in past cycles and remain concentrated by economy (Sweden, Switzerland, Canada and France) and by sector (NFC credit more than HH credit). Despite lower borrowing costs, affordability risks are still evident is both the NFC (Canada, France) and HH sectors (Norway, Canada, and Sweden).
Progress in dealing with the debt overhang in the Euro Area remains slow and incomplete. Long term secular challenges of subdued GDP, money supply and credit growth persist while unorthodox monetary policy measures risk fuelling further demand for less-productive “FIRE-based” lending with negative implications or leverage, growth, stability and income inequality (see “ Fuelling the FIRE” – the hidden risk in QE).
Trends in DM debt ratios
Aggregate private sector debt ratios for the Euro Area, and the BIS sample of advanced and emerging economies (% GDP) – the developed world continues to deleverage while the emerging world plays “catch-up” Source: BIS; Haver, CMMP analysis
The developed world continues to deleverage. Private sector credit as a percentage of GDP has fallen from a peak of 181% in 3Q09 to 162% at the end of the 1Q19. This has involved a (relatively gradual) process of “passive deleveraging” where the stock of outstanding debt rises but at a slower rate than nominal GDP.
The process of deleveraging in the Euro Area started later. Private sector credit as a percentage of GDP peaked at 172% in 1Q15 and has fallen to 162% at the end of 1Q19, in-line with the average for the BIS’ sample of advanced economies.
The outstanding stock of debt continues to rise ($ billion) but at a slower rate than nominal GDP Source: BIS; Haver; CMMP analysis
This process has led to a dramatic shift in the structure of global debt. In 1Q00, the advanced world accounted for 90% of global private sector credit, with advanced economies excluding the Euro Area accounting for 70% and the Euro Area 20%. Emerging markets accounted for only 10% of global private sector credit with 7% from emerging markets excluding China and 3% from China.
The changing face of global debt (% GDP) – shifting East and towards emerging markets Source: BIS; Haver; CMMP analysis
At the end of 1Q19, the advanced world’s share of global debt had fallen to 64% (advanced economies ex Euro Area 47%, Euro Area 18%) while the emerging markets share has increased to 36% (EM ex China 12%, China 24%).
Where are we now?
The key chart repeated. The Netherlands, Sweden, Norway, Canada, Switzerland and Denmark have NFC and HH debt ratios (% GDP, 1Q19) above BIS threshold levels (dotted red lines) Source: BIS; Haver; CMMP analysis
With debt levels remaining “too high” in the advanced world this trend is likely to continue. The BIS considers corporate (NFC) and household (HH) debt ratios of 90% and 85% respectively to be maximum thresholds above which debt becomes a constraint on future growth.
In our sample of advanced economies, only Greece, Germany, Italy, Austria and the US have debt ratios below these thresholds in both sectors. In contrast both NFC and HH debt levels are above the BIS thresholds in the Netherlands, Sweden, Norway, Switzerland, Denmark and Canada. NFC debt ratios remain above the threshold in Ireland, Belgium, France, Portugal and Spain and while the UK has “excess” HH debt. In short, progress towards dealing with high levels of private sector debt remains incomplete.
Associated risks
Private sector growth risks
The highest rates of “excess credit growth” (3-year RGF 1Q19) have occurred in economies where PSC debt levels are already high: Switzerland, Sweden, Canada, France Source: BIS; Haver; CMMP analysis
Risks associated with “excess credit growth” in developed markets are lower than in past cycles. I introduced my Relative Growth Factor analysis in “Sustainable debt dynamics – Asia private sector credit”. In short, this simple framework compares the relative growth in credit versus GDP (3 year CAGR) with the level of debt penetration in a given economy.
Among the high risk economies, Canada has seen the most obvious adjustment (trends in 3-year RGFs since March 2002) Source: BIS; Haver; CMMP analysis
In terms of total private sector debt, the highest “growth risks” can be seen in Sweden, Switzerland, Canada and France. Private sector credit in each of these economies has outstripped GDP growth on a CAGR basis over the past three years despite relatively high levels of private sector debt. Canada has made the most obvious adjustment among this sample of relatively high risk economies with the RGF falling from over 4% two years ago to 1.8% currently.
NFC sector growth risks
NFC sector growth risks are highest in Switzerland, Sweden, Canada and France (3-year CAGR) Source: BIS; Haver; CMMP analysis
In the NFC sector, the highest risks can be observed in
Switzerland, Sweden, Canada and France. RGFs for these for these economies were
3.9%, 3.0%, 2.7% and 1.8% respectively, despite NFC debt levels that are well
above the BIS threshold. As above, Canada’s rate of excess NFC credit growth is
slowing in contrast to trends in Switzerland and Sweden.
Contrasting trends between NFC sector risks in Canada versus Switzerland and Sweden Source: BIS; Haver; CMMP analysis
HH sector growth risks
HH sector growth risks are lower than NFC sector growth risks (3-year CAGR) Source: BIS; Haver; CMMP analysis
In the HH sector, RGF analysis suggest that the highest risks are in Norway, Switzerland, Canada, Norway (and the UK). RGFs in these economies were 1.3%, 1.1%, 0.7% and 0.4% respectively. In other words, excess HH credit growth risk is lower than in the NFC sector. Furthermore, the rates of excess HH credit growth in each of these economies is lower than in the recent past, especially in Norway and Canada.
Rapid adjustments in Norway and Canada among relatively high HH sector growth risk economies Source: BIS; Haver; CMMP analysis
Affordability risks
Despite lower borrowing costs, affordability risks remain. BIS debt service ratios (DSR) provide, “important information about the interactions between debt and the real economy, as they measure the amount of income used for interest payments and amortisations.” (BIS, 2017). The perspective provided by DSRs complements the analysis of debt ratios above but differs in the sense that they provide a “flow-to-flow” comparison ie, the debt service payments divided by the flow of income. In the accompanying charts, DSR ratios for private sector, corporate and household credit are plotted against the deviation from their respective long term averages.
Canada and France display the highest NFC affordability risk levels (1Q19 DSR versus LT average) Source: BIS; Haver; CMMP analysis
NFC affordability risks are highest in Canada and France. Debt service ratios (57% and 55% respectively) are not only high in absolute terms but they also illustrate the highest deviations from their respective long-term averages (47% and 49% respectively). In the HH sector, the highest affordability risks are seen in Norway, Canada and Sweden, although the level of risk is lower than in the NFC sector.
Norway, Canada and Sweden display the highest HH sector affordability risk (albeit lower than in the NFC sector) Source: BIS; Haver; CMMP analysis
Implications for the Euro Area
Progress in dealing with the debt overhang in the Euro Area remains slow and incomplete. Long term secular challenges of subdued GDP, money supply and credit growth persist. The European Commission recently revised its 2019 forecast down by -0.1ppt to 1.1% and its 2020 and 2012 forecasts down by -0.2ppt to 1.2% in both years, with these forecasts relying on “the strength of more domestically-oriented sectors.
Subdued Euro Area growth forecast to continue (% YoY) Source: European Commission; Haver; CMMP analysis
Growth in broad money (5.5%) and private sector credit (3.7%) in September remains positive in relation to recent trends but relative subdued in relation to past cycles. Furthermore, the renewed widening in the gap between the growth in the supply of money and the demand from credit (-1.8%) indicates that the Euro Area continues to face the challenge of deficiency in the demand for credit.
Gap between growth in supply of money and demand for credit illustrates the fundamental problem – a deficiency in credit demand across the Euro Area (% YoY, 3m MVA) Source: ECB; Haver; CMMP analysis
This has on-going implications for policy choices. Unorthodox monetary policy measures risk fuelling further demand for less-productive “FIRE-based” lending with negative implications or leverage, growth, stability and income inequality (see “ Fuelling the FIRE” – the hidden risk in QE).
“Fuelling the FIRE” – split in EA lending over the past twenty years between productive (COCO) and less productive (FIRE) based lending (% total lending) Source: ECB; Haver; CMMP analysis
Please note that the summary comments above are abstracts from more detailed analysis that is available separately.
