Aussie regulator heightens oversight of banks' interest-only mortgages, property investor lending, serviceability metrics and mortgage securitisation

In a widely anticipated move, the Australian Prudential Regulation Authority (APRA) is tightening the leash on banks' residential mortgage lending.

In a move that will impact the Australian parents of ANZ NZ, ASB, BNZ and Westpac NZ, APRA is targeting interest-only lending, lending to residential property investors, and increasing oversight of debt serviceability metrics and mortgage securitisation.

APRA wants to limit the flow of new interest-only lending to 30% of banks' total new residential mortgage lending. It notes interest-only lending represents almost 40% of the stock of residential mortgage lending in Australia, which is "quite high by international and historical standards."

In New Zealand Reserve Bank figures show interest-only lending comprises 28.5% of existing residential mortgage lending, and made up 33% of new lending during February. These figures include revolving credit. S&P Global Ratings warned last August that the growing use of interest-only loans by New Zealand borrowers could prove "particularly problematic" if house prices fall.

APRA also says the 10% benchmark for growth in lending to investors per individual bank, which was established in late 2014, continues to provide an appropriate restraint. It wants banks to "comfortably remain below" the 10% benchmark.

Meanwhile, credit rating agency Fitch points out APRA's mention of increased scrutiny of warehouse lending suggests the regulator has concerns about mortgage lending shifting from banks to the non-bank sector to avoid the stricter underwriting standards. Fitch notes many non-bank lenders use warehouse funding from banks to cover their mortgage lending until growing a big enough pool of loans to support external securitisation.

APRA's full statement isbelow.

APRA announces further measures to reinforce sound residential mortgage lending practices

31 March 2017

The Australian Prudential Regulation Authority (APRA) is today initiating additional supervisory measures to reinforce sound residential mortgage lending practices in an environment of heightened risks. 

The latest measures build on those communicated to authorised deposit-taking institutions (ADIs) in December 2014 aimed at improving the quality of new mortgage lending generally and moderating the growth of investor lending in particular. As was the case previously, these latest measures have been developed following discussions with other members of the Council of Financial Regulators (CFR). 

Since December 2014, APRA, together with CFR members, has closely monitored residential mortgage lending trends and the resulting impacts on the resilience of lenders, as well as the household sector more broadly. This increased scrutiny has been in response to an environment of heightened risks, reflected in an environment of high housing prices, high and rising household indebtedness, subdued household income growth, historically low interest rates, and strong competitive pressures. 

Given this environment, APRA has concluded that further steps to address risks that continue to build within the mortgage lending market are appropriate. 

- APRA has written to all ADIs today advising, in summary, that APRA expects ADIs to:

*limit the flow of new interest-only lending to 30 per cent of total new residential mortgage lending, and within that:

place strict internal limits on the volume of interest-only lending at loan-to-value ratios (LVRs) above 80 per cent; and
ensure there is strong scrutiny and justification of any instances of interest-only lending at an LVR above 90 per cent;

*manage lending to investors in such a manner so as to comfortably remain below the previously advised benchmark of 10 per cent growth;

*review and ensure that serviceability metrics, including interest rate and net income buffers, are set at appropriate levels for current conditions; and

*continue to restrain lending growth in higher risk segments of the portfolio (e.g. high loan-to-income loans, high LVR loans, and loans for very long terms).

APRA Chairman Wayne Byres said APRA believes the 10 per cent benchmark for growth in lending to investors continues to provide an appropriate constraint in the current environment, balancing the need to continue to moderate new investor lending with the increasing supply of newly completed construction which must be absorbed in the year ahead. 

“APRA expects ADIs to target a level of investor lending growth that allows them to comfortably manage normal monthly volatility in lending flows without exceeding this benchmark level.”  

However, additional supervisory measures, particularly in relation to the high level of interest-only lending, are warranted. Mr Byres said: “Our objective with these new measures is to ensure lenders are recognising the heightened risk in the lending environment, and that their lending standards and practices appropriately respond to these conditions.”  

Mr Byres said lending on interest-only terms represents nearly 40 per cent of the stock of residential mortgage lending by ADIs – a share that is quite high by international and historical standards. 

“APRA views a higher proportion of interest-only lending in the current environment to be indicative of a higher risk profile. We will therefore be monitoring the share of interest-only lending within total new mortgage lending for each ADI, and will consider the need to impose additional requirements on an ADI when the proportion of new lending on interest-only terms exceeds 30 per cent of total new mortgage lending. 

“APRA has chosen not to set quantitative limits in relation to serviceability assessments at this point in time. However, APRA considers it important that borrowers retain some level of financial buffer to allow for unexpected events, especially for borrowers that have high levels of indebtedness. 

“APRA will therefore continue to scrutinize serviceability assessments, and ADIs continue to need to advise APRA should they propose to change their existing methodologies or policies,” Mr Byres said.  

APRA has advised ADIs that it is also monitoring the growth in warehouse facilities provided by ADIs to other lenders. These facilities allow lenders to build a portfolio of loans that will eventually be securitised. “APRA would be concerned if these warehouse facilities were growing at a materially faster rate than an ADI’s own housing loan portfolio, or if lending standards for loans held within warehouses are of a materially lower quality than would be consistent with industry-wide sound practices,” Mr Byres said. 

He said that APRA also continues to monitor the prevalence of higher risk mortgage lending more generally, including lending at high loan-to-income ratios, lending at a high loan-to-valuation ratios, and lending at very long terms or with long interest only periods (e.g. beyond 5 years). 

APRA will continue to observe conditions in the residential mortgage lending market, and may adjust the above measures, or implement additional ones, should circumstances warrant it. 

A copy of the letter sent to ADIs today is available here: www.apra.gov.au/adi/Publications/Pages/other-information-for-adis.aspx

An incentive for investors to maximise their loan amount

Credit rating agency Fitch says APRA's new measures don't go as far as many commentators, including Fitch, had expected.

"House price growth could still remain high and some risks may continue to build, which might lead the regulator to tighten restrictions again later in the year. APRA has left the cap on annual growth of investor mortgages at 10%, but has indicated that banks should operate comfortably below this limit. The regulator appears sensitive as to the risks of tightening the market too much - given the supply of new builds that is expected to enter the market towards the end of 2017 and beyond," Fitch says.

"The main change is to lower the proportion of banks' new mortgage lending that can be in the form of interest-only loans to 30%. Previous regulatory tightening in 2015 brought down growth in interest-only lending, but this has accelerated again over the last year and accounted for 37.5% of new housing loans in 4Q16. Banks that lend heavily in the form of interest-only mortgages could be more exposed to non-payment risks in the event that interest rates rise or house prices fall."

Fitch notes investors can deduct interest payments from tax, providing an incentive for such borrowers to maximise their loan amount.

Meanwhile, Fitch says APRA's mention of increased scrutiny of warehouse lending suggests the regulator has concerns about mortgage lending shifting from banks to the non-bank sector to avoid the stricter underwriting standards.

"Many non-bank lenders use warehouse funding from banks to cover their mortgage lending until they develop a large enough pool of loans to support an external securitisation," says Fitch.