Slowly the shape of a new set of prudential controls over home lending, are emerging and will soon see the light of day as the country’s key banking regulator, APRA, prepares to issue a new set of rules.
The most likely change will be the introduction of an interest rate stress test for new borrowers, especially investors (the current area of concern for regulators), rather than quantitative restrictions on the level of leverage allowed in loans (such as loans with high loan to valuation ratios).
APRA is known to be discussing new guidelines with banks and other authorised deposit taking institutions which lend on housing.
The ANZ may have something to say on the issue at its interim results announcement on Thursday.
The move comes as concern grows within APRA and the Reserve Bank about the direction some of the current lending is taking especially among investors, with RBA Governor, Glenn Stevens warning investors several times this year about the amount of leverage investors could be taking on in their property dealings.
The February housing finance data earlier this month revealed the extent of the surge in investor interest in housing – it jumped more than 37% in the year to February to $10.75 billion, which was much faster than the 21.7% rise (to $16.46 million) in owner-occupier home finance.
That surge is why investor borrowing, especially among self managed super funds, is the area of most concern for regulators. Investors and self managed super funds have emerged as the fastest growing cohort of property investors, especially in Sydney, and now in Melbourne.
In its first Financial Stability report of 2014, issued in late March, the Reserve Bank warned banks to be more vigilant about risk management in housing. The warning included the disclosure that APRA is soon to issue a new set of prudential guidelines for lenders to the housing sector.
"It is important for banks’ risk management that they are vigilant in maintaining prudent lending standards, given that a combination of historically low interest rates and rising housing prices could encourage speculative activity in the housing market and encourage marginal borrowers to increase debt.
"APRA’s forthcoming Prudential Practice Guide, which will outline its expectations for prudent housing lending practices, should assist banks in this regard," the RBA added without going further. In fact the central bank’s warning to property lenders was quite specific and singled out what it obviously sees problem areas – with much of those centred on the booming lending to property investors and self managed super funds.
"Although aggregate bank lending to these higher-risk segments has not increased, it is noteworthy that a number of banks are currently expanding their new housing lending at a relatively fast pace in certain borrower, loan and geographic segments. There are also indications that some lenders are using less conservative serviceability assessments when determining the amount they will lend to selected borrowers.
"In addition to the general risks associated with rapid loan growth, banks should be mindful that faster-growing loan segments may pose higher risks than average, especially if they are increasing their lending to marginal borrowers or building up concentrated exposures to borrowers posing correlated risks.
"As noted above, the investor segment is one area where some banks are growing their lending at a relatively strong pace. Even though banks’ lending to investors has historically performed broadly in line with their lending to owner-occupiers, it cannot be assumed that this will always be the case.
"Furthermore, strong investor lending may contribute to a build-up in risk in banks’ mortgage portfolios by funding additional speculative demand that increases the chance of a sharp housing market downturn in the future."
APRA issued a prudential guideline 16 months ago setting out requirements for lenders to take when lending on residential mortgages and asset valuations. But there were no quantitative or qualitative restrictions issued, such as liming loans with high loan to valuation ratios (usually above 80%). These have received considerable publicity since the Reserve Bank of NZ issued rules to control high LVR loans in 2013.
The RBNZ has since claimed this rules have helped cool activity in parts of the property market – although it was forced to issue new rules earlier this year exempting high LVR loans for the purposes of new home construction.
That was done because the LVR restrictions threatened to crimp the rebuilding of housing in earthquake damaged Christchurch.
It also threatened to choke off new home building elsewhere in the country, so the high LVR restriction is not the ‘golden bullet’ many Australian property bears have claimed it is.
That is the last thing the RBA wants to do in Australia – it is depending on home building to be a major source of investment and growth as the economy transitions from the mining investment boom.
That has left the NZ restrictions on loans to buy existing homes. The RBNZ has subsequently published a paper linking high macro-economic policies (such as high LVR loan restrictions) to monetary policy.
But a 10% fall in new home sales across New Zealand in March has started concerns that the RBNZ’s move might be too successful and that the slide in new lending for high LVR loans is starting to crimp overall activity in housing (except in the rebuilding of Christchurch).
In his appearance before a Federal Parliamentary Committee in March, Mr Stevens made it clear the RBA had been talking to APRA about new rules.
"I said somewhere a few months ago that we had thought about this, we had had some preliminary discussions with APRA, which we had, and we promptly had a flood of FOIs for all the documents. That will all come out in due course. So we have thought about macroprudential tools. My view on them is they are a useful adjunct, but if we do use them we should go into this with a bit of realism," he said.
And rather than restricting certain loans (say with a high LVR), Mr Stevens nominated an interest rate stress test:
"The most effective tool could be that when banks test people for an interest rate, so you are supposed to be able to make the payments not just at the current rate but, say, 200 points higher, APRA could insist that the test be made 300 higher, or 400, or whatever, so that people do not get overcommitted."
And Deputy Governor, Phil Lowe told the committee that the benefit of an interest rate test was that "it allows lower interest rates to feed through into lower servicing costs for both new and existing borrowers, but it does not mean that lower interest rates keep on increasing the size of the loan that people can get access to, because the bank is applying a bigger buffer to the actual interest rate you pay. I think there is quite a lot of merit in exploring that. I know APRA is discussing that at various levels with the bank lenders."
Interest rate stress tests would valuable, but the question is whether they would have the impact APRA wants.
After all plenty of existing homeowners started with their first and second loans with high LVRs, but rising home prices and incomes have seen millions of mortgagees maintain their repayments at levels well above existing home loan interest rates.
That has seen mortgagees build up substantial buffers with overpayments reaching around two years of repayments according to the latest figures from regulators.
Interest rate stress tests would have to acknowledge that, plus the favourable impact of wage and home price rises and factor those into any stress test.
That would then involve regulators and banks in a high stakes guessing competition – estimating home loan and wage rises could become self-fulfilling over time and add to inflation and other pressures, as well as house prices.
And with investors, how do you work out an interest rate stress test when many investors take fixed rate term home loans (so they know their interest cost) and are really only interested in the size of the loss on the house for negative gearing purposes?
But the banks will have to be more careful in making loans.
