NZ Bankers' Association completes about face on 'weak tool with low welfare gains', but is wary of RBNZ move towards debt-to-income ratio limits & making banks hold more capital against housing loans

By Gareth Vaughan

The New Zealand Bankers' Association (NZBA) "fully supports" the Reserve Bank's plans to beef up its restrictions on banks' high loan-to-value ratio (LVR) residential mortgage lending. However, the bank lobby group is much more cautious about the possibility of the prudential regulator introducing the additional macro-prudential tools of debt-to-income ratio limits and capital overlays.

In mid-July the Reserve Bank announced plans to ramp up the existing LVR restrictions. It proposed that, from September 1, no more than 5% of bank lending to residential property investors across New Zealand would be permitted with an LVR of greater than 60%, i.e. a deposit of less than 40%. And no more than 10% of lending to owner-occupiers across NZ would be permitted with an LVR of greater than 80%, i.e. a deposit of less than 20%. Loans exempt from the existing LVR restrictions, including loans to construct new dwellings, would continue to be exempt.

In its submission on the Reserve Bank's plans NZBA says; "LVR restrictions are an appropriate macro-prudential measure to help mitigate risks around the current New Zealand housing market environment, and [NZBA] fully supports the proposed further adjustments to high-LVR residential mortgage lending."

Change of tune

This shows a major change of tune within the banking industry since the Reserve Bank first introduced LVR restrictions in 2013. Prior to that move NZBA questioned whether there was any need for the Reserve Bank to use macro-prudential tools at all. And of the four tools then under consideration by the Reserve Bank, NZBA said LVR restrictions were its least favoured option, describing LVR restrictions as a "weak tool with low welfare gains from a policy perspective," and difficult and costly for banks to implement.

However, NZBA's only real beef with the Reserve Bank's latest plans for high LVR restrictions are that the start date ought to be pushed out a month to October 1 from September 1.

"The proposed LVR restrictions apply a consistent approach across New Zealand, removing the distinction between Auckland and the rest of the country. NZBA welcomes this simplified approach as it will reduce system and process complexity of administering differing geographical limits (noting that some complexity will be retained for reporting the Auckland buckets)," NZBA says.

Banks get their wish

And banks have got their wish. The Reserve Bank announced on Friday that the start date for its new LVR restrictions will indeed be pushed back to October 1.

“Banks have indicated through their submissions that more time is required to enable them to meet the new restrictions that apply to investor loans nationwide, given the pipeline of loan pre-approvals made prior to our announcement in July. We understand that banks have been applying the new LVR restrictions to new loan applications since the LVR changes were announced. On that basis we will defer the formal introduction of the changes to 1 October in order to accommodate the backlog of pre-approvals,”  Reserve Bank Deputy Governor Grant Spencer said.

Currently Auckland rental property investors borrowing from banks are limited to a 70% LVR, with banks having a 5% speed limit on any lending above 70%. And currently the limit for non-Auckland owner-occupiers borrowing more than 80% is 15% of banks' new lending flows (it's 10% in Auckland). 

NZBA does argue, however, that the current LVR construction exemption is too restrictive.

"Given the intention of this exemption is to support the supply of new residential property to the market, NZBA submits the current restrictions limiting the exemption to 'off the plans' or early stage of construction should be extended to include buildings that are further advanced in the building phase. In short, if the property being acquired is adding to the housing stock, it should be exempt from the LVR regime," NZBA argues.

"The present settings that impose restrictions to the early stage of a build, such as foundations or framing, may be considered arbitrary and are difficult for developers, customers, and banks to navigate."

Existing exemptions to stay

Spencer said after a number of queries related to exemptions, the existing range of exemptions to LVR restrictions will continue to apply. Exemptions apply where:

 · Owner-occupiers or investors are constructing or purchasing a new dwelling (provided the loan commitment occurs prior to, or at an early stage of, construction of the dwelling). 

· Owner-occupiers or investors require bridging finance to complete the purchase of a residential property on a date prior to the completion of a sale of another property. 

· Owner-occupiers or investors are re-financing an existing high LVR loan, or shifting an existing high LVR loan from one property to another (provided the total value of the new loan does not increase). 

· Owner-occupiers or investors are borrowing to fund extensive repairs or remediation that is not routine or deferred maintenance. This includes events such as a fire, natural disaster, weather tightness issues or seismic strengthening).

· A loan is made under Housing New Zealand’s Mortgage Insurance Scheme, including the Welcome Home Loans scheme. 

· Borrowers with owner occupied and investor collateral can use the combined collateral exemption to obtain finance up to 60% of the value of the investment properties and 80% on their owner occupied property.

 “It is important to emphasise that these exemptions are permissive but do not create an obligation on the banks to make such loans. The banks will still apply their own lending criteria to individual borrowers and may choose to not provide finance in these circumstances or to provide it only at lower LVRs. The consultation process closed on 10 August and we are continuing to analyse submissions. Further adjustments to the proposals, including the exemptions, are still possible and we expect to publish a final policy position later this month,” Spencer said. 

'Significant work required to define what constitutes debt and what constitutes income'

The Reserve Bank's also looking at potentially introducing limits to high debt-to-income ratio lending, and/or making banks hold more capital against housing loans through a counter-cyclical capital buffer or capital overlay. NZBA is much more circumspect about these concepts than it is about the tweaks to high-LVR restrictions. The bank lobby group suggests the Reserve Bank should work closely with banks to carefully consider "the relevance and operational implications" of debt-to-income ratios as a macro-prudential tool. Furthermore, the full effect of the high LVR restrictions should be assessed before any additional tools are implemented. And, NZBA suggests, a debt-to-income ratio framework presents a significant design and implementation challenge.

"For example significant work will be required to define what constitutes debt and what constitutes income," NZBA says.

"Loan-to-income and debt-to-income are completely different concepts. A significant amount of time will be required to devise a methodology that can take into account customer lifestyles, spending habits etc."

Additionally NZBA suggests consistency of application across banks would be challenging, as significant variation currently exists such as for the treatment of income values and income types.

"Debt-to-income measures would add a substantial level of complexity for both customer and staff understanding, and design and delivery of effective education and communication would take considerable effort."

NZBA goes on to say for debt-to-income measures to be effective, changes to the Credit Reporting Privacy Code would be required to allow the sharing of customer loan balance.

"As any debt-to-income rules will be public, there is a risk that customers will not fully disclose, or choose not to disclose, such information on application forms and banks would have limited ability to identify this (for customers who do not otherwise bank with them). This would further encourage split banking." NZBA says. 

Governor Graeme Wheeler said on Thursday the Reserve Bank was close to sending a report to Finance Minister Bill English formally requesting the inclusion of a new debt-to-income multiple limit in the central bank's macro-prudential tool kit. However, Wheeler cautioned the tool was unlikely to be introduced this year.

'Banks are well capitalised'

In terms of the potential for the Reserve Bank to enforce capital overlays on bank's home loans, NZBA says any capital response ought to be proportionate, taking into account that banks are "well capitalised", and that the LVR restrictions have resulted in healthier risk profiles in bank loan books.

"As with debt-to-income ratios, NZBA submits that the full effect of the LVR restrictions should be assessed before any capital overlays are implemented. The introduction of capital overlays before such time would be premature," NZBA says.

(There are alternative views on bank capital levels here and here).

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