COVID 19 has held the world in a firm grip. As on 20th May 2020, there were 4.89 million confirmed cases & 323k deaths, which shows health shock around the world. Australia, however, is in a much better spot. Thanks to the timely measures, the number of confirmed cases are at 7,069 of which just about ~10% are active. With the number of fatalities limited to 100, Australia is clearly winning this war. However, there is one more battle left before they claim victory, the Economic Fallout.
This paper takes the focus of the pandemic’s impact on the most crucial segment of the Australian economythe housing market and analyses it from a lender’s perspective. It tracks how the lockdown restrictions and pandemic stricken economic environment are affecting the market activity. While the housing segment is generally slow to react, the early effects are already visible. We see three emerging threats that would affect lenders – increasing defaults, a surge in refinancing and flattening book growth. In light of these emerging risks for lenders, it becomes pertinent to devise a robust strategy for responding to these challenges. The final section answers a few of the responses to these threats.
1. Increasing Defaults
Exhibit 1: Labour Statistics April 2020
Exhibit 2: Number of people on Job Seeker payments
Australia went into stage 3 lockdown by late Mar’20. Lockdown restrictions have immediately brought some industries like aviation & hospitality to a standstill, resulting in layoffs. The looming economic uncertainty has forced people to cut back non-essential spending, resulting in falling aggregate demand and further layoffs. As per the latest labour statistics released by Australian Bureau of Statistics, the unemployment rate jumped by 100 bps over the previous month to reach 6.2% in April while underemployment rate jumped by 490 bps to reach 13.7%. This rise along with the jump in the number of people on Job Seeker wages are both testimonials to rising stress in the labour force. In credit risk models as per our experience, rising unemployment is often a leading indicator of rising delinquencies. With the governmentsponsored payment holiday, the risk of defaults will increase further. To prepare the same, we saw the Big 4 banks and others deferring or cutting dividends to retain cash and creating provisions for bad debt.
2. Increased Refinancing Risk
Exhibit 3: Cash rate target from RBA
Exhibit 4: Owner-occupied variable housing rate
With RBA’s reduction in the cash rate, the interest rates are at an all-time low at 0.25%. Banks have swiftly slashed their lending rates and flooded the market with lucrative refinance offers to keep the economic engine running. The present economic conditions also present an opportune time for refinancing. In this market scenario, the firstmover advantage will play a critical role from the lender’s perspective. As per the recent data released by CoreLogic, refinancing constituted over 75% of all the property valuations requested from mid-March to mid-April. ANZ bank recently announced its half-year results for the 2020 financial year. While speaking to investors, the CEO acknowledged that most of the home loan applications the bank has received in the last six weeks were for refinancing. This clearly highlights the rising interest in the market for refinancing and presents a threat to those lenders who have not been agile enough to adapt. Thus, those who adapt quickly can retain their share of the portfolio and can take a bigger pie of the market re-shuffle.
Since refinancing requests are not straight forward, the lenders may need to ramp up operations to match demand. Any gap in servicing customers will quickly translate into customer attrition. There is scope for banks to tie up with consulting and analytics partners to understand differences in operations, analytical models and priorities.
3. Flattening Book Growth
Exhibit 5: New loan commitments for housing (in million AUD)
Exhibit 6: Monthly volume of dwellings approved
Exhibit 7: Aggregate Home Value Index for 5 Capital Cities from CoreLogic
As per the latest housing finance data compiled by the Australian Bureau of Statistics, new loan commitments have started to plateau since Jan’20. The trend is consistent with the slowdown in dwelling approvals and also Home Value Index from CoreLogic
The reason behind this decline is due to the loss of purchasing power and economic uncertainty, a drop in immigration, leading to a reduction in housing demand. We might see potential trade tensions with China creating further dents in housing demand. Fall in rental demand is leading to distress selling of investment properties, which in turn is leading to the decline of housing prices too. In the worst-case scenario of a ‘prolonged downturn’, CBA predicts that the house prices will crash by 32% over the next three years from the current level. However, this might change with the focus shifting to recovery and ease of restrictions, thanks to the limited Covid-19 cases in Australia.
What Can Lenders Do?
1. Comprehensive Customer Lifetime Value Engine
The engine captures the value generated from lifetime 360-degree engagement with the customer enabling a lender to look at a customer holistically and from longterm relationship perspective
Exhibit 8: Comprehensive CLTV View
Exhibit 9: Advantages of Comprehensive CLTV
There is a growing risk that the existing CLTV models might not be sufficient in the COVID climate. This is observed in our interactions with lenders, as CLTV is usually misconstrued to be a simple summation of product cash flows or not thorough enough to look beyond the current value of the customer. These masqueraded versions of CLTV are bound to fail. The need of the hour is a comprehensive CLTV engine, which is exhaustive enough to capture aspects of credit risk, purchasing power, crossselling and upselling, product level weights and forwardlooking dimensions.
2. Proactive Retention & Prospect Acquisition Strategy
While lenders generally acknowledge attrition late, the best practice is to be ‘pro-active’ than ‘reactive’. This is because the attrition prediction model is usually late to highlight attrition, which captures the moment at which the customers begin to “fade” before they attrite.
On strategy, an immediate application of CLTV is to prioritise the operational support if the lender is not able to ramp-up to cater to the pressing demands of hardship support, EMI holidays and other support initiatives. This would ensure that customers ranked higher on CLTV are supported first. Other applications include using CLTV in driving engagement campaigns and allocating inbound requests from valuable customers to experienced staff.
Client prospects can also be evaluated using the engine, and the acquisition efforts can be customised accordingly.
We have observed that financial institutions are increasingly looking to analytics partnerships to develop best in class CLTV engines and gain a competitive edge.
3. Data-Driven Collections Strategy
The need for a data-driven collection strategy is higher than ever. As collections are overwhelmed with defaulters, a unique segmentation is needed to segregate temporarily stressed customers from permanent ones. This is in addition to existing segmentations to drive collections strategies for order, allocation and testing of competing actions. There is further scope of optimisation where the selected set of accounts can be outsourced to external debt collection agencies and offloaded as part of debt sale.
4. Loss Forecasting to Avoid Surprises
The immediate need for lenders is to calibrate existing expected credit loss calculations for adequate provisioning. While available regulatory guidance should be ingested, it is crucial for lenders to look beyond compliance for effective risk management. Robust stress testing is also the need of the hour to test capital adequacy and provisioning levels.