David Whitburn

Archive for the ‘Interest Rates & Loans’ Category

Unfortunately there have been another round of earthquakes in Christchurch earlier this afternoon.  The media coverage I use to track this Twitter, NZ Herald, Stuff, TVOne and TV3 news have all reported no deaths, but a lot more damage.  The eastern suburbs have again experienced severe liquefaction, and tens of thousands of people have had drains broken, freshwater mains break and power cut to their homes.  Below is a photo of some kitchen damage that incurred in today’s 5.5 Richter magnitude earthquake at 1:00pm (11km deep, 10km east of Christchurch) followed up with a 6.0 Richter magnitude earthquake at 2:20pm (9km deep, 10km south-east of Christchurch), and nine 3.5 or higher Richter magnitude earthquakes to hit Christchurch in the 6 hours since up to the time of writing.

This will be the final straw for many more proud Cantabrians who will move to Timaru, Ashburton, Auckland, Wellington, Nelson, Dunedin, Queenstown, Invercargill and other New Zealand regional centres, and a few who perceive the grass to be greener in Australia. What happened was money markets reacted by selling down the NZ Dollar, which is likely to be temporary.  Leading bank economists are predicting that the OCR will now rise later.  It may have been raised in late 2011, or early 2012.

As a result floating and short term fixed interest rates are far more likely to stay low longer.  This will help the rebuild of Christchurch and investors and home-owners alike all around the country.

Whilst this months OCR announcement and Monetary Policy Statement stated inflation is the fear, and the OCR is the tool the Reserve Bank of NZ will use to combat the effects of inflation.  It is hard place to be in the RBNZ as exporters are concerned about the historically high NZ dollar.

The Official Cash Rate (OCR) remains unchanged at 2.50%.  Interestingly the Reserve Bank noticed signs of a recovery particularly with commodity prices remaining strong and stated that inflation is a concern.  Since the OCR is the tool to fight inflation, this will rise, and the speed of the OCR rise will broadly match the speed of our great nation’s economic recovery.

Reserve Bank Governor Dr Alan Bollard said:

The outlook for the New Zealand economy has improved since the publication of the March Statement.

Economic activity has been significantly disrupted by the Christchurch earthquake. However, while many firms and households – particularly within Canterbury – continue to be adversely affected, it appears the negative confidence effect of the earthquake on economic activity throughout the rest of the country has been limited.

The early signs of recovery noted in the March Statement have continued. Despite some continuing signs of weakness in the world economy, commodity prices remain very strong and firms expect to increase their hiring and capital investment. Reconstruction in Canterbury is projected to add about 2 percentage points to GDP growth over 2012, and boost the level of activity for several years thereafter.

Despite the strong outlook for export earnings, household expenditure is expected to grow only modestly. Household debt remains very high and is expected to constrain retail spending and the housing market for some time. Continued fiscal consolidation will also act to dampen activity.

The New Zealand dollar has appreciated substantially over the past two months. This appreciation, supported by high export prices for primary producers, is negatively affecting other parts of the tradable sector, constraining rebalancing of the New Zealand economy.

Headline inflation is currently being boosted by recent increases in indirect taxes, food and petrol prices, and surveyed expectations of future inflation have edged up. Despite this, indicators of capacity usage and core inflation suggest underlying inflation remains constrained.

As GDP growth picks up, underlying inflation is expected to rise. A gradual increase in the OCR over the next two years will be required to offset this, such that CPI inflation tracks close to the midpoint of the target band over the latter part of the projection. The pace and timing of increases will be guided by the speed of recovery, but for now the OCR remains on hold.”

 

I have been preparing this week for the NZ Wealth Mentor Property Masterclass Event is on this weekend at our Newmarket, central Auckland offices.  It will be another great event, with very useful information for those looking to invest in property and those with property looking for further direction and wanting to accelerate their path towards financial freedom.

Residential Loan Expiry Dates at 31 March 2011

This is not a graph of NZ political parties in Parliament.  The excel doughnut chart I used to plot the data from the Reserve Bank gave me these colours as a default.  For the first time in a great many years there is a higher value of residential loans ($84.6 billion) on floating rates, than residential loans ($83.1 billion) on fixed rates.

There were only $35.9 billion of residential floating loans 2 years earlier in March 2009, and fixed interest loans with greater than two years to expire amount to less than $10 billion.  This will please the Reserve Bank hugely as the OCR will have much faster effect when it eventually rises (which in my opinion will not happen within at least the next 6 months).  The OCR is exceptionally strongly correlated to floating rates and short term (say < 18 months) interest rates.

Whilst the OCR was held at 2.50% by the Reserve Bank Governor, Dr Alan Bollard as was widely anticipated, the accompanying comments indicate that this rate will not change for quite some time (most economists are predicting early in 2012 for the OCR to rise, with a few picking a rise late this year).  The truth is that it is simply too far out in this turbulent economic climate to predict this correctly.

The Consumers Price Index (“CPI”) for the March 2011 quarter rose to 4.5%.  This is seen as being high in light of the Reserve Bank’s target inflation range set in 2002 of 1 – 3% over the medium term. In the 1990s the average inflation was 2.4% and in the 2000s the average inflation was 2.7%.

How much of an issue is this?

High inflation erodes savings (term deposits, cash) and causes harm by eroding the purchasing power of money itself.  Inflation at just 2.5%, causes your purchasing power to half in just 30 years. Those in retirement or approaching retirement typically suffer the most as their retirement nest egg loses its purchasing power, with future income struggling to match it.  For those working it is less of an issue since wages generally keep rise with inflation.  As inflation rises usually interest rates do too.  This can impact property investors and business owners with higher interest costs.  The underlying value of the assets we property investors and business owners however rise though.

Lets have a look at inflation from 1970 onwards – a period which includes the high inflation 1970s and 1980s.

If you have all of your assets in cash and are approaching retirement, perhaps you should seek some expert advice on whether to include into your asset mix a prudently geared or freehold property, or perhaps some exposure to the commodities boom.  If inflation keep rising with fuel, power, rates, water, food, beverages etc all increasing in price (as is housing, but this is conveniently excluded from the CPI calculations), what is your plan to combat this for the future?

Me in yesterday's Herald Homes, Ask an Expert section

I was asked by the NZ Herald to assist as a property investment expert in the Herald Homes supplement this week.  The question was:

With interest rates so low at the moment, we are considering buying a couple of units in Auckland as an investment. Is now a good time to enter the market?  What sort of returns should we be looking for?

I think that it is a good time to enter the Auckland property market right now.  This is because the property market moves in cycles and we are well in the downturn phase of this cycle.  Properties can be purchased below true value with good cashflow.  I am a passionate believer in buying for cashflow, equity and growth.

The returns that an investor can expect do differ widely, including upon which market you are looking at.  In my property coaching business NZ Wealth Mentor, one of the things I teach my clients is the importance of cashflow. This is because interest rates are at emergency low levels so you need to have a buffer for when they rise.  In terms of the various submarkets in Auckland, there are a number of very high-yielding inner-city freehold apartments.  Whilst the cashflow is very high I don’t foresee the capital growth to be spectacular.  If you are looking for positive cashflow there is an abundance of this in South Auckland, and a number of positive cashflow properties in West Auckland, as well as parts of Central Auckland. David Whitburn

Source: New Zealand Herald, Herald Homes supplement 30 March 2011.  Ask an Expert – David Whitburn

In the wake of the devastating earthquake where it looks like around 240 New Zealanders and global citizens will have sadly been killed, and many more injured, there is going to be some financial damage too.  Costs are likely to come in at over $10 billion. Fortunately this doesn’t appear that it will be against New Zealand’s Sovereign Credit Rating, nor the big 4 Australian banks (Commonwealth Bank of Australia – owner of ASB, National Australia Bank – owner of BNZ, ANZ – owner of ANZ and National Bank, and Westpac).  This would have been disastrous for Cantabrian home-owners in negative equity situations as a result of the earthquake, and also for home-owners struggling in what looks like a double dip recession (certainly it appears this way when inflation is backed out of the equation too).  This blog acknowledges the devastation on the great people of Canterbury arising from this second massive and larger giant earthquake, but focuses in on the financial impacts for property investors which include:

1. Interest rate changes
2. Insurance premium increases
3. Government policy/tax changes

1) Interest rate changes

Looking at the latest home loan rates at http://www.mortgagerates.co.nz/ you will note that there have been price movements this afternoon.  ANZ and their sister bank National Bank were the first to cut rates reducing one-year rates by 50 basis points, 18-month rates have dropped by 26 points and its two and three-year rates have fallen by 16 and 11 points respectively.  This was followed by cuts to short and medium term interest rates by ASB and their boutique sister bank, Bank Direct, Westpac and TSB Bank. This earthquake is a game changer and all previous predictions are off.  Our GDP forecast for the year was 2.3% now it has been reduced to a tiny 0.3%.  The Canterbury region which Christchurch dominates is responsible for 15% of New Zealand’s GDP. It will struggle to be anywhere like as productive as it should be, and massive Government subsidies will be required. I now predict the OCR will be lowered by 0.50% on 10 March as an emergency measure to return it to its lowest point in 40 years.  This is what the market is predicting anyway, with the flow off into short and medium term interest rates.  Take a look at the following table:

Source: Interest.co.nz - Interest Rates at 1 March 2011

2) Insurance Costs

EQC Levies

Firstly I need to tidy up the misconception that after a natural disaster everyone is entitled to a payout from the Earthquake Commission (“EQC”).  This government body was set up under the Earthquake Commission Act 1993, to provide a natural disaster fund for homeowners and tenants who hold insurance.  The levies are 5 cents (plus GST) for every $100 insured, raised from landlord’s taking out building cover and tenant’s taking out contents cover.  The most you can pay a year for one dwelling and its contents is $67.50 including GST. This will give you the maximum cover of $100,000 (+ GST) for your home and $20,000 (+ GST) for personal belongings. EQC pays the value of  damaged land at the time of the earthquake or natural disaster, or the repair cost, whichever is lower.

Dwellings are covered on a replacement value basis. Personal property is insured on the same basis as the household insurance policy covering the same property.  Some retaining walls are covered, but on an indemnity basis.

Clearly this is going to be a massive claim on the EQC and although costs have not been calculated with claims deadlines for aftershocks to the 4 September 2010 not being closed yet.  It may well be the the EQC war chest is emptied and that the Government needs to borrow funds to top it up.  Going forwards EQC levies are likely to triple and you need to budget for this cost increase.

Insurance Premiums

Private insurers and their re-insurers are going to get hit hard in the pocket.  This is concerning to property investors as insurance costs were already going up in light of GST rises and increased claims in New Zealand as a result of the 4 September 2010 Canterbury earthquake – now general property insurance premiums will be much higher too.

3) Downstream costs from Government Policy

There has been talk by the Minister of Finance Dr Bill English today of removing the middle class tax relief that is Working for Families tax credits; and removing interest-free student loans. This will restore the policy to how I had in the 1990s at Auckland University where I could get my fees and course costs paid with a low interest rate (from memory it was just under the banks floating rates).  If we borrow too much it will put our plan to get to a Government surplus by 2014/15 into jeopardy prejudicing further Government spending or tax cuts.

No surprises here that Dr Alan Bollard, the NZ Reserve Bank Governor left the official cash rate unchanged at 3.0%.  He noted in question time a slight improvement for future forecasts.  We need to remember that the Reserve Bank has three major functions:

• operating monetary policy to maintain price stability;
• promoting the maintenance of a sound and efficient financial system; and
• meeting the currency needs of the public.

In terms of monetary policy the overall goal is price stability, which is laid out in the Reserve Bank Act 1989 and defined and specified by a Policy Targets Agreement. Currently the Reserve Bank must keep CPI inflation between 1–3 percent, on average, over the medium term. This is a good thing on the whole as inflation is rising prices, meaning money is losing its value.

Today’s announcement:

Dr Alan Bollard said:

The outlook for the New Zealand economy remains consistent with the projections underlying the December Monetary Policy Statement.

Domestic economic activity was weaker than forecast through the second half of 2010. September quarter GDP declined unexpectedly, and retail spending appears to have fallen in the December quarter.

Forward indicators of activity have firmed somewhat. Trading partner activity continues to expand and New Zealand’s export commodity prices have increased further. Within New Zealand, business confidence, across a range of industries, has picked up and imports of capital equipment have grown. Furthermore, there are tentative signs that housing market activity has stabilised, after having trended lower for some months.

The recent increase in the rate of GST has caused headline CPI inflation to spike higher as expected, but underlying inflation remains comfortably inside the target band.

As noted previously, while interest rates are likely to increase modestly over the next two years, for now it seems prudent to keep the OCR low until the recovery becomes more robust and underlying inflationary pressures show more obvious signs of increasing.”

My prediction

On looking at the data and the monetary policy targets of the Reserve Bank, I think that they will defer raising the OCR until September 2011.  What this means for you is that you should consider floating, or if you get a good fixed interest rate discount a 1 – 3 year rate offers good value.  I am an advocate of an interest rate averaging strategy, to hedge future interest rate rises (or falls).

On a stunning summer’s day yesterday at the well appointed Exhibition Hall in Waipuna Conference Centre, overlooking the Panmure lagoon, I was the keynote presenter at Property Masterclass run by NZ Wealth Mentor.

David Leon - Property Masterclass Master of Ceremonies on 27 November 2010

I covered a lot of topics as the keynote presenter, and those attending particularly enjoyed my take on the market, drawing attention to where we are at in this current stage of the property cycle and my predictions for the future in terms of the various Auckland sub-markets.  I gave a thorough analysis of all of the key market drivers, showing and interpreting graphs from the economics and research of the major trading banks, Reserve Bank of New Zealand, Statistics New Zealand, Quotable Value and the Real Estate Institute.

In another segment on stage I talked about how we as investors are running a property business and the fact that we have to wear a number of hats.  One of the leading property educators in the United Kingdom Gill Fielding talked about the importance of being skilled in a number of different disciplines wear you have a number of buckets to control or hats to wear.  I love this analogy so I talked about the various hats we have to wear as property investors in terms of the CEO hat – managing everything in our business; CFO hat checking our bank statements, keeping accounts, monitoring the financial performance of our portfolio, paying taxes, Renovations/Maintenance hat – looking at how we maintain our very valuable assets and renovating to increase our cashflow and equity; Legal hat – when doing due diligence on properties, looking at legislation changes and ownership structures; and Property Management hat on – where you have to manage your tenants or your property manager, to ensure you minimise vacancies, charge market rent and collect your rent and take the appropriate action when tenants are not behaving,  I also covered ownership structures, including the key changes in light of LAQCs losing their potency in that they lose the ability to offset losses against personally earned income.  The new tax structure the Look Through Company (“LTC”) was introduced too, with Chartered Accountant and my colleague from Deloitte Tax many years ago Amanda Macdonald (Tasman Tax and Accounting Services based in Albany) also presented on this topic being the tax and accounting expert she is.

Finally I gave covered my opinions on US tax deeds and liens that have been promoted in New Zealand heavily over the past couple of years, and I covered the good, the bad and the ugly things about lease options, giving an example of the massive win-win situation created in my last lease option deal that resulted in my tenant buyers settling the property and giving me a giant hug as they achieved their dream of being home owners in New Zealand, as well as the sheer joy of meeting their goal.  I also enjoyed presenting on the strategies I am using in today’s market and covered my revamped and intense mentoring programme where I take my mentoring clients out to do deals with me.  I have some new clients from this event and am looking forward to training them shortly.

Other speakers

Senior Resource Management lawyer Andrew Braggins talked about the spatial plan for Auckland the Supercity, which highlit the growth areas in the Auckland region, major infrastructure and planning thoughts from the head planner and CEO at Auckland Council, who are in Andrew’s network.  This presentation was enjoyed by attendees who were impressed with Andrew’s knowledge and communication skills, as he enlightened them about the hot spots in Auckland.

Andrew also briefly covered how to dispute council fees, levies and contributions both under the Building Act (including seeking a determination from the Department of Building & Housing) and also the Resource Management Act (including a judical review application he recently did on a property he rents out).

Jan Galloway then gave a masterclass in property management, including listing out the issues in relation to the Residential Tenancies Amendment Act with the fines for unlawful acts by Landlords and Tenants all covered – luckily these were included in the comprehensive bound manual we gave our event attendees.

Renovations expert Mark Trafford told attendees about a number of ways not to do renovations in a photo driven presentation.

Gary Hey, a director and shareholder of large mortgage broking firm, Mortgage People, then address the property cycle from a finance perspective.  He talked about how lenders’ criteria are changing and it is much easier to get finance for property now (compared to say 6 months, 1 and 2 years ago).

International Rating Agency Standard & Poor’s (“S&P”) has lowered the outlook on NZ’s AA+ sovereign credit rating to “negative” from “stable”. This is not great news for New Zealand borrowers as if New Zealand’s sovereign rating were actually downgraded to only AA our interest costs would rise.  This would have an impact on business owners and struggling home owners and property investors, as we continue to navigate our way out of this cyclical downturn slowly but surely.

S&P Sovereign ratings credit analyst Kyran Curry stated:

The outlook revision on the foreign currency ratings reflect our recognition of the risks stemming from New Zealand’s projected widening external imbalances in the context of the country’s weakened fiscal flexibility…

New Zealand’s vulnerability to external shocks, arising from its open and relatively undiversified economy, also raises risks to the country’s economic recovery and credit quality.”

Standard & Poor’s stresses, however, that these weaknesses are mitigated by New Zealand’s fiscal and monetary policy flexibility, strong institutions, economic resilience, and its actively traded currency.

The main risk to the ratings would be a significant weakening in the credit quality of New Zealand’s banking sector, which is largely owned by the Australian banks.  That said, however, a range of factors ameliorates some of these risks, including a high degree of foreign-currency-debt hedging and an actively traded currency. New Zealand has independent and effective monetary policy settings with a highly traded and free-floating currency that allows external imbalances to adjust. A large portion of the nation’s external debt is denominated in New Zealand dollars, while much of the remainder finances companies with revenues in foreign exchange or is hedged. In sum, we view New Zealand’s financial and capital markets as supportive of the rating.”

The negative outlook on the New Zealand foreign currency ratings reflects the possibility of a ratings downgrade if New Zealand’s external position does not improve. Rising public savings will be an important component of such an improvement.

The rating could fall, too, if New Zealand’s current account weakens because of any higher real cross-border funding costs within its banks. On the other hand, the ratings could stabilize at the current levels upon a sharper-than-expected improvement in the external accounts, led by stronger export performance and higher public savings.

New Zealand needs to tackle its growing government deficit in the light of softening international prospects.  We are still borrowing over $200 million a week, which is over $10 billion per year.  This has a significant interest servicing cost and the potential to place a noose on future generations of taxpayers.

A major issue is that together New Zealanders always want to borrow a lot more than other New Zealanders are willing to lend.  As a result the difference has to be imported, which means that the net international liabilities of New Zealand (note that this is private and not Government debt) at 30 June 2010 was NZ$164 billion.

The private debt our economy has is akin to that of Portugal, Ireland, Greece and Spain (the “PIGS” countries that are stressing global financial markets) and has long been pointed to by the credit rating agencies as a significant problem.

John Key’s thoughts on this

Our Prime Minister John Key thinks that Prime Minister the downgrade in outlook by S&P is because of NZ’s high private indebtedness and S&P’s reassessment of risks following the Irish banking crisis, where a bailout up to $100 billion Euros may be required (similar to the bailout Greece had).  Concerns are mounting on Portugal’s debt and to a lesser extent Spain too.  As a result S&P felt they had to put us on a negative outlook. John Key said:

In fact the Finance Minister (Bill English) met with Standard and Poor’s two weeks ago, (and) there were no specific issues raised at that point.

With the position in Ireland, that has had an impact on their (S&P’s) assessment of countries that have an over-reliance on debt.

What I will say though is the way it’s been positioned by S&P and other rating agencies to us is, if your [public] gross debt to GDP or net debt to GDP is less than 30%, then you are in a small group of countries for which the rating agencies have no concerns in that regard.

That was absolutely where New Zealand was positioned, with a very small group of other countries – Korea, Australia and one or two others”.

Bill English – Minister of Finance’s View

Bill English issued the following press release to explain the situation and he points out it is private debt and not Government debt which is the issue (as John Key did), and he re-iterated the Government’s commitment to balance the books and return to surpluses by 2016.

Standard and Poor’s decision to put New Zealand’s foreign currency rating on negative outlook highlights the need to reduce our heavy reliance on foreign debt. This is a long-standing problem for New Zealand and has left us vulnerable as a country. The Government is taking steps to reduce this external vulnerability and to move the economy towards savings and exports.

They include the tax changes in the Budget this year and work currently underway with the Savings Working Group. From here, it’s important that our economic programme continues.

Standard and Poor’s praised the New Zealand Government’s commitment to get back to budget surplus by 2016, and it noted that New Zealand had outperformed most other advanced economies in the past two years.

However, it said the negative outlook on New Zealand’s AA+ foreign currency rating reflected risks stemming from its widening external imbalances and relatively low levels of national savings.

As Standard and Poor’s notes, New Zealand’s household liabilities – at about 156 per cent of disposable income – are 50 per cent higher than 10 years ago.

Banks and the Government, which are borrowing in volatile international financial markets, face higher interest costs on their increasing debt. In the past 10 years alone, New Zealand’s net foreign liabilities have jumped from about $90 billion to more than $160 billion.

Bill English also pointed out that, despite the negative outlook on its AA+ rating with Standard and Poor’s, New Zealand still enjoys the highest possible Aaa (stable) rating with Moody’s (another International Rating Agency).

I think we have to watch this space and the international events we are faced with that create an environment of uncertainty.  Also consider negotiating some good interest rates on 2 and 3 year fixed rate periods with your lender, as I just don’t see these rates getting materially cheaper (the odd cut up to 0.1% for competition reasons aside may happen) and I don’t see the floating rate being decreased in the short or medium term.