I was forwarded a link to an article earlier today for comment. Reading it, I just felt like putting my head in my hands and crying – how could a financial journalist write something like this and get it so wrong? It looks like he has taken a press release or a letter to APRA from an LMI (Lender’s Mortgage Insurance) provider and tried to rework it – while misunderstanding it.
I thought writing this up into a piece here would be a good start – but where to start? Can I question his journalism, use of stats or factual issues first? Maybe paragraph by paragraph.
The first two paragraphs are error free – good start, but these seem to be just a rewording of the press release / letter.
The third and fourth start the rot. A 50% risk weight the capital required to be held for a $100 loan is not $50, as stated, but $4 ($100 *50% * 8%). The 8% figure is the full risk weight capital ratio, and is not changing under the new regime. If you are interested in why 8%, my take on it is here. He has also totally missed the new operational risk capital amount, so the drop will not be from 50% to 35%, even for the safest, it will be (probably, but not certainly) a drop from 50% to a number that depends on the operational risk calculation.
Paragraph 5 is partially correct, but the 50% capital weight only applies between 90 and 100%, when fully covered by LMI – which, admittedly, most (but not all) are – but, again, you need to add on the operational risk capital number.
Paragraph 6 is useless – “growing from less than 10 per cent a few years ago to more than 10 per cent today”? This could be an increase from 9.9999% to 10.0001% or from 0% to 100%. I suspect the change is more like the first than the second.
Para 7 – “often these people find it hard to get money from the big banks so they are forced to use smaller institutions, which tend to charge higher rates, especially now because of the fall-out from the sub-prime crisis in the US.” Nonsense – the LMI is passed on to you and the big boys are happy to lend here, provided you pay the LMI. Smaller ADIs, if anything, as more conservative than the big ones. Going to the non-ADIs (Rams, Aussie etc.) will often get you a better deal anyway – and they are not APRA regulated.
“The more such lenders rely on short-term funding, the higher the costs, depending, of course, on how long the crisis lasts.” Over the last few years those relying on short term funding have (largely) done well. It may not be the least risky profile, but it was their call. Did well for a while, badly for a while. One provider with a temporarily higher cost of funds will not destroy a system. Also, their borrowers have not been affected – they have not put their rates up by more than others. All the ADIs, who provide the bulk of home loans, moved in lock step.
Para 9 makes no sense – loans at 90% LVR with (or even without) LMI are not risky – the APRA standards make no comment on “regarded as risky”.
Paragraph 10 essentially blames APRA for the (perceived) drop in system capital. Wrong – it is the international standards that APRA is implementing. Besides, the types of institutions making the “riskier” loans that he is talking about previously are not APRA regulated, as mentioned.
Para 11 – all of obvious, trite and not entirely true. A drop of $1 in capital will (all other things being equal) increase profits – meaning that a one dollar drop in capital is partially offset by increased profitability. Besides, the improvements in risk management as part of this should also reduce overall risk in the system, reducing the need for capital.
The next para is talking about the reduction in risk available through LMI – I think. I can’t make much sense of it.
Next one – why would borrowers want to get involved in a flight to quality? Apart from the hassle of trying to re-finance the loan, they are not going to make a loss out of the collapse of their lending institution. They will go for the cheapest, as they should.
If anything, APRA’s excessively conservative view on the riskiness of home loans, covered here, has probably wiped most, if not all, this advantage out for the big boys.
The rest of it, down to the coverage of the sub-prime stuff, is just space filler.
His take on the US sub-prime stuff is also irrelevant to Australia. One thing we do have APRA’s excessive risk aversion to thank for is that there are no substantial losses in the offing in housing loans in Australia. The vast bulk of the loans have been written well, with good procedures, low LVRs and fully covered by LMI – a lot of which was not true about the US market.
Give a read to Glenn Stevens, covered in my last post, if you are in any doubt.
Sorry, John Durie – you may be a good corporate reporter (I don’t know) but you need to read up on banking before you sail on these seas again.
Thanks to the Sheet for the link to Durie’s piece.