The Wrap: Tax, Housing, Trade And Banks

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Weekly Broker Wrap: Corporate tax cut; house prices; trade wars; and banks.

-Proposed tax cut to have minimal impact in short-medium term
-Property market uncertainty to continue over 2018
-Governments expected to be wary of escalating trade wars
-Higher levels of due diligence on mortgages likely to be asked of the banks
 

By Eva Brocklehurst

Corporate Tax Cut

The Australian government's proposed corporate tax cut, to 25% from 30%, will be far less influential than the recently implemented US tax cuts, UBS suggests.

It is materially smaller, delayed and staggered, and to be phased in from 2023 to 2027. Moreover, Australia's imputation system arguably also makes a corporate tax rate cut less relevant, although the broker points out it is not irrelevant.

In the long run a corporate tax cut is likely to have a net positive impact on the economy but the immediate impact on the forecast horizon is considered minimal. UBS believes tax cuts are supportive for business investment and overall GDP because, historically, shifts in company profits are a key driver of business investment.

If there is a change of government the broker concedes it possible there could be a lower tax rate co-existing with the Australian Labor Party's proposed imputation rebate. The impact of both pieces of legislation would be to make the pre-payment of excess franking balances more attractive.

House Prices

House prices fell for a sixth consecutive month in March and are now down -3.5% annualised. While there appears to be little flow through to broader conditions, Morgan Stanley believes risks are building over 2018.

Building activity has held up versus expectations, so far, while consumer confidence also remains slightly above trend, even in housing-specific indicators. Meanwhile regulatory scrutiny for the banking system, and by association the mortgage market, is likely to remain elevated for much of 2018.

Further regulatory tightening of credit, and and increasing stock of properties to be settled amid uncertainty regarding government housing policy are all factors that are likely to be challenging over 2018. This makes Morgan Stanley cautious regarding the broader economy in 2018, giving the leveraged exposure to the property market.

Protectionism

Escalating trade wars between the US and China could lead to stagflation for the global economy, although Citi suggests risks appear contained with regard a full-blown trade war.

The real-time response of financial markets to the erecting of trade barriers, including sharp falls in share prices, provides a signal for governments to be wary of escalating measures.

Tariff increases by the US, China and the EU of 10 percentage points would result, in the broker's calculations, in a reduction to global GDP of -2% from the base-line level after one year, moderating to -1.5% after three years. The impact on Australia's GDP would be a reduction of -0.5% after one year and -1.25% after three years.

The Productivity Commission has looked at the consequences for Australia of a trade war, including a 15 percentage point increase in tariffs globally. In this pessimistic scenario, economic activity is calculated to be more than -1 percentage point lower while employment would be reduced by -100,000 and almost 30% of households would experience a drop in purchasing power of at least -4%.

Citi believes these modelled results represent a worst-case scenario because the current trade battle is largely between the US and China and does not include the EU, and Australia still has access to both markets.

Banks

The latest financial aggregates data from the Reserve Bank indicates credit growth is still being buoyed by housing. Housing credit increased by 0.5% in February and 6.2% over the 12 months to February.

System credit growth is tracking slightly ahead of Credit Suisse' projections, reflecting very resilient housing credit. Business credit increased by 0.1% and 3.6% over the 12 months while personal credit fell by -0.2% and contracted by -1.1% over the 12 months.

Morgan Stanley observes investor mortgages slowed further in February and the latest quarterly approvals show interest-only loan flows are just 16% versus the 30% threshold. Both trends are negative for margins, the broker asserts. Morgan Stanley expects around 4% growth in mortgage volumes for the major banks in 2018 despite efforts to lift both investor property lending and interest-only loans.

Meanwhile, the ACCC has released its interim report on residential mortgage price competition. The report finds that idiosyncratic discounting by banks makes it hard for price discovery for prospective borrowers and poses this as one of the reasons for the prevalence of mortgage brokers.

The inquiry concluded that the "no-frills" residential mortgages are not always the cheapest. A lack of vigorous price competition was also noted. Credit Suisse believes increased transparency is a likely outcome of this inquiry but recommendations are likely to fall short of regulated pricing.

The first round of the Royal Commission into Financial Services was more severe than UBS anticipated. Irresponsible lending was a key finding. The broker expects a higher level of due diligence will be recommended for banks. In particular, banks may need to undertake a detailed assessment of each customer's living expenses and over-stated income will require extra validation.

UBS has estimated the impact of higher household living expenses on borrowing ability, using bank home loan calculators and benchmarks. The calculation is then re-run using what the broker considers are more realistic living expenses. UBS found borrowing limits provided by the bank calculators fell by -35% as a result.

Bank returns on equity are nearly -2 percentage points lower than they were 20 years ago. Credit Suisse notes, while there is similar leverage, there are substantially lower income contributions, offset by better expense ratios.

With bad debts at cyclical lows the broker believes the banks will need to focus on capital optimisation and expenses if they are going to hold current margins. In this environment, the broker prefers banks with established productivity programs and National Australia Bank ((NAB)) is the top pick.

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