Opinion: A year on from their introduction, the RBNZ's controversial high LVR home loan speed limits are working

By Gareth Vaughan

The Reserve Bank's "speed limits" on banks' high loan-to-value ratio (LVR) residential mortgage lending kicked in one year ago.

We know the banks, real estate agents and Prime Minister John Key didn't want the restrictions. But Reserve Bank Governor Graeme Wheeler, who witnessed the US housing market crash of 2008-10 whilst living there, held firm, announcing the introduction of the restrictions on August 20 last year.

"Today we are announcing the introduction of speed limits on high LVR lending with an implementation date of 1 October 2013. These are designed to help slow the rate of housing-related credit growth and house price inflation, thereby reducing the risk of a substantial downward correction in house prices that would damage the financial sector and the broader economy," Wheeler said in a speech.

Wheeler went on to say; "While the primary purpose of the restrictions is financial stability, they will also provide the Reserve Bank with more degrees of freedom in conducting monetary policy. In particular, they will provide the Bank with greater flexibility in considering the timing and magnitude of any future increases in the OCR. This flexibility around the need for interest rate adjustments is especially useful in light of the over-valued New Zealand dollar and the international monetary conditions currently facing New Zealand."

The Reserve Bank initially estimated the LVR restrictions would lower house sales by 3-8%, house price inflation by 1-4 percentage points, and housing credit growth by 1-3 percentage points over the first year the restrictions were in place.

The question I'm going to focus on in this article is are the LVR restrictions working based on what Wheeler said he wanted them to achieve?

Focusing on Wheeler's explanation above for what the Reserve Bank wanted the LVR restrictions to accomplish, I've broken this down into four key points set out below.

1) Help slow the rate of housing-related credit growth;

2) Help slow house price inflation;

3) Reduce the risk of a substantial downward correction in house prices. And;

4) Provide the Reserve Bank with greater flexibility in considering the timing and magnitude of any future increases in the OCR.

To recap this is what the rules actually are; Banks must limit their lending at LVRs above 80% (where borrowers don't have a deposit or equity of at least 20%) to no more than 10% of total new mortgage lending. This 10% limit excludes high LVR loans made under Housing New Zealand’s Welcome Home Loans scheme, the refinancing of existing high-LVR loans, bridging finance or the transfer of existing high-LVR loans between properties, and new residential construction loans.

Criteria One

From 25.1% of total new mortgage commitments (before exemptions) in September 2013, high LVR lending (after exemptions) hasn't got near the Reserve Bank imposed 10% limit since. It fell to 11.5% in October last year, then 7% in November, bottomed out at 3.6% in January and March this year, and most recently was 6.5% in August.

Total new commitments in September last year were $4.735 billion. They've only topped that level  in one month since, reaching $4.797 billion in May. But even then just $328 million, or 6.8%, was high LVR lending before exemptions. The latest Reserve Bank sector credit data shows, although housing debt topped $194 billion for the first time in August, it grew at an annualised rate of 4.9%, its slowest rate since April 2013.

So in terms of helping slow the rate of housing-related credit growth, the LVR restrictions are working.

Criteria Two

 In its May Financial Stability Report the Reserve Bank pointed out national house sales fell 11% between October 2013 and March 2014, with the drop evenly spread across regions. And it argued if the LVR restrictions hadn't been in place, house sales would've increased.

The latest monthly housing market figures we have are for August 2014. Quotable Value's August figures had nationwide residential property values up 6.9% year-on-year, and up 1.7% in the three months to August. For Auckland the figures were an annual increase of 11.4%, and a rise of 1.8% over three months.

Jumping back a year, in August 2013 QV had nationwide values up 8.5%, and a three month rise of 2.9%. For Auckland the figures were an rise of 13.1%, and a three month rise of between 3.3% and 3.6% depending on what part of Auckland you were in.

So although values are still rising, they're rising at a slower rate. And sales volumes are down significantly.

The Real Estate Institute of New Zealand's August 2014 figures show national sales volumes down 16.3% to 5,481 versus August last year, but the national median price up $30,000, or 8%, to $420,000. In Auckland the August 2014 median price was $51,000, or 9.1%, higher than a year earlier at $614,050. Auckland sales volumes were down 541, or 20.2%, this August compared to last August at 2,136.

For those who prefer the REINZ Stratified Housing Price Index, which removes some variations that can impact on the median price, it was 4.8% higher this August than last August at 3926.5. The Auckland Index was up 5.8%, Christchurch Index up 11.0% and the Wellington Index up 2.8%.

REINZ pointed out the volume of sales below $400,000 fell by 24.8% in August 2014 versus August 2013, adding to a 21.8% drop in sales of houses for less than $400,000 between July 2013 and July 2014. Although REINZ said this may be indicative of fewer sales in the lower price brackets since the introduction of the LVR restrictions, it also cites a lack of listings as a factor.

Here's what the Reserve Bank itself said on house price inflation in its September Monetary Policy Statement;

"House price inflation has moderated further in the past three months, despite continued strong immigration. Rising mortgage interest rates and the introduction of LVR restrictions in October last year have helped restrain rising housing demand. From a peak of 9.8% in November last year, annual house price inflation on a three-month moving average basis eased to 6.2% in July 2014. The moderation in nationwide house price inflation has been led by Auckland. Monthly house sales in the three months to July were 12% lower than last year and have stabilised, suggesting that house price inflation may also stabilise through the middle of 2014.".

In terms of number two - helping slow house price inflation - the LVR restrictions do appear to be having an impact.

Criteria Three

Credit rating agency Moody's certainly believes the LVR restrictions are reducing the risk of a substantial fall in house prices.

In a report on the New Zealand banking system released in July, Moody's Sydney-based analyst Daniel Yu said the risk of a significant house price correction was slowly moderating thanks to steps taken by the Reserve Bank and efforts to boost housing supply.

"The risk of a significant house price correction is slowly moderating, as a result of Reserve Bank restrictions on high LVR lending, higher capital requirements on such loans, the tightening of monetary policy, and the coming measures to boost housing supply. All these are helping to cool down the market, as evidenced by a slowing of house sales and price growth," Yu said.

Nonetheless, with median house prices having risen 8% nationally and 9% in Auckland in the year to August, those are still decent increases in anyone's language. And the Bank for International Settlements, the central bank's bank, recently highlighted that at almost 140%, New Zealand's house prices to disposable income ratio is one of the highest from a range of countries surveyed.

My view is the jury's still out on this one.

Criteria Four

In terms of providing the Reserve Bank with greater flexibility in considering the timing and magnitude of any increases to the Official Cash Rate, this is perhaps the most difficult of the four criteria to judge.

In a March speech Reserve Bank Deputy Governor Grant Spencer said the LVR restrictions were worth up to 50 basis points of OCR hikes. So does that mean without the LVR restrictions the OCR would now be at 4%? That's hard to believe given we've had 100 basis points worth of OCR hikes this year.

And Wheeler's strongly implying there are more to come in the current tightening cycle to get to what he deems a "neutral" rate of about 4.5%.

So it may be we have to wait until the end of the current tightening cycle to judge whether the LVR speed limits have given the Reserve Bank greater flexibility in considering the timing and magnitude of OCR hikes.

A pass mark, but how long will they remain? 

With two ticks and two wait and sees to the four questions posed, the LVR speed limits are working. They're also undoubtedly achieving something else Wheeler said they would in that they're reducing the riskiness of bank loan portfolios. In the nine months to June 30 the big five banks' combined residential mortgages with LVRs above 80% fell by a net $5.5 billion, or 14%, to a shade under $33 billion.

That leaves one more question. When will the Reserve Bank remove them? Both Wheeler and Reserve Bank Deputy Governor Grant Spencer have steadfastly maintained they are temporary.

Spencer told me in a July interview the Reserve Bank was likely to comment on its plans for the LVR restrictions in its November 12 Financial Stability Report. He went on to say it would be late this year at the earliest before the Reserve Bank begins removing the speed limits, with them potentially being "phased off rather than taken off holus-bolus."

Spencer also acknowledged the Reserve Bank had been surprised at just how low high LVR lending had fallen.

"We have been a bit surprised that it has been 5%, 6% territory. We knew that banks would set their internal buffers to make sure they don't go over 10%. So we thought maybe more around 8% or that sort of territory, would be where they would end up. And they may still get back to that," Spencer said. 

"But we have been surprised that they've been relatively lower than that. Part of it seems to be the lack of demand. In other words a lot of people out there saying 'there's no point going to the bank if I haven't got at least 20% deposit.' That's the general feeling out there, people don't even broach the subject with their bank."

"I'd add though that the overall impact of the LVRs in terms of lower house price inflation, low rates of credit etc, is pretty well in line with our expectations in terms of the impact of the policy  on the housing market as opposed to the actual number of high LVR loans," Spencer said.

 And below is what the Reserve Bank said in May's Financial Stability Report.

"It is the Reserve Bank’s intention to remove LVR restrictions when there is a better balance of supply and demand in the housing market. The timing of removal will depend on a range of criteria. A key condition for removal is a sustained moderation in house price inflation. In particular, house prices should be rising more closely in line with growth in household incomes. It will also be important that household credit continues to grow in line with household incomes."

"The impact of the LVR restriction, by itself, may not be great enough to meet the conditions for removal. However, the effects of the LVR policy are expected to be reinforced by rising interest rates and, over the longer term, by improvements in the supply of housing. Before removing the LVRs, the Reserve Bank will want to be confident that the housing market is responding to interest rate increases, and that immigration pressures are not causing a resurgence of house price pressures."

 My hunch is LVR speed limits, in some shape or form, will be around for some time yet. And even if and when they're gone completely, the Reserve Bank will undoubtedly emphasise it can reintroduce them with as little as two weeks notice.

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