Could the RBNZ and FMA or Commerce Commission follow APRA and ASIC's one-two combination attack on risky home lending?

By Gareth Vaughan

Could Tuesday's one-two punch combination from Australian regulators on residential mortgage lending practices be followed by their New Zealand counterparts?

The Australian Prudential Regulation Authority (APRA) has warned lenders it's "dialling up the intensity" of its supervision to reinforce sound residential mortgage lending practices. And the Australian Securities and Investments Commission (ASIC) will "conduct a surveillance" into the provision of interest-only loans.

Given the same four banks dominate the residential mortgage market on both sides of the Tasman, with similar lending standards and practices, what chance APRA and ASIC's New Zealand counterparts will make similar announcements?

They have the perfect opportunity as soon as Thursday. The Reserve Bank of New Zealand (RBNZ) has its final Official Cash Rate review for the year on Thursday morning and is due to issue a Monetary Policy Statement. And the Financial Markets Authority is due to hold a strategic risk outlook briefing in Auckland.

The latest Real Estate Institute of New Zealand monthly data shows a fresh record high national median price - powered by Auckland which accounted for 64% of the national increase - and the REINZ Stratified Median Housing Price Index is also at a record high. As REINZ CEO Helen O'Sullivan put it an "element of buoyancy" has returned to the real estate market.

But there's unlikely to be such a co-ordinated regulatory response on this side of the ditch, at least not yet.

APRA's restrictions 'not hard limits'

APRA says specific areas of concern for it as prudential regulator are;

Higher risk mortgage lending - for example, high loan-to-income loans, high loan-to-valuation (LVR) loans, interest-only loans to owner occupiers, and loans with very long terms;
strong growth in lending to property investors - portfolio growth materially above a threshold of 10% will be an important risk indicator for APRA supervisors in considering the need for further action; loan affordability tests for new borrowers - in APRA’s view, these should incorporate an interest rate buffer of at least 2 per cent above the loan product rate, and a floor lending rate of at least 7 per cent, when assessing borrowers’ ability to service their loans. Good practice would be to maintain a buffer and floor rate comfortably above these levels.

However, APRA has stopped short - at least for now - of introducing RBNZ style macro-prudential tools such as the 10% "speed limit" on banks' high LVR - or low equity - residential mortgage lending. APRA says neither the 10% figure for growth in property investor lending, nor the 2% interest rate buffer are "hard limits." Rather they're intended as trigger points for more intense supervisory action.

APRA says RBNZ style high LVR limits or Bank of England type debt serviceability limits "are not necessary or appropriate at this stage."

Here the RBNZ has made the LVR 'speed limit" a condition of banks' registration meaning, in theory at least, banks can lose their banking licence if they breach it. And the RBNZ is also working on plans to make banks hold more capital against loans to owners of multiple rental properties. Deputy Governor Grant Spencer says the RBNZ is looking at how to categorise a borrower as a residential investor, noting it could be based on the proportion of their total income that's coming from their investment portfolio. This could make loans more expensive for property investors, and potentially harder to obtain.

Lending responsibly?

ASIC, meanwhile, will probe how banks and other lenders are complying with consumer protection laws such as their responsible lending obligations as it surveys the provision of interest-only lending. ASIC is concerned about higher-risk lending, after strong house price growth in Sydney and Melbourne.

Interest only loans, as a percentage of new housing loan approvals by Australian banks, reached a record high of 42.5% in the September quarter.

Here we don't yet have publicly available date on what percentage of banks' new home lending is interest only. The RBNZ says it has been collecting data on bank interest only loans for a few months and plans to start publishing this sometime next year. However, we do know that the big four banks here have about a quarter of their mortgage books paying interest only.

As ASIC notes, although interest only loans can be appropriate in the right circumstances, they can raise a number of risks, including; Whether the borrower can only afford a loan because it is interest-only, whether the borrower can afford principal and interest repayments at the end of the interest-only period, and whether the borrower understands the impact of not making principal and interest repayments.

It's interesting to note ASIC specifically mentioned lenders' responsible lending obligations. In New Zealand the Responsible Lending Code is still under development, and expected to come into force in June next year. The Australian equivalent has been in place for some time.

The Commerce Commission, which is currently charged with enforcing the Credit Contracts and Consumer Finance Act, will also be responsible for enforcing the new lender responsibility principles when they come into force, although the Code itself won't be legally binding. The FMA is likely to be focused on bedding in the behemoth that is the Financial Markets Conduct Act.

So rather than any co-ordinated regulatory approach in NZ, the heavy lifting on watching bank lending practices and any additional actions to rein in Auckland's runaway train of a housing market are likely to fall to the RBNZ - at least for the time being. In a global environment of low interest rates and low inflation, hiking the OCR appears off the table for now. This means there's potential for additional macro-prudential action.

However, the quandary the RBNZ is in is nicely summarised by ASB senior economist Jane Turner below.

The RBNZ and the impact of high-LVR lending vs interest rate impact

The RBNZ has concluded that the high-LVR lending restrictions were a significant contributor slowing the housing market. And yes, there was a very pronounced overnight impact when the restrictions took effect. The new tools were rushed in. Banks had to change their lending practices dramatically in a short space of time. The impact of this abrupt shift is evident in the data.

High LVR-lending (after exemptions) initially dropped to just 3.6% of total lending, substantially lower than the RBNZ’s intended speed limit of 10%. Over time, most banks have been able to fine-tune their monitoring and internal processes and this has allowed market conditions to become less restrictive. In October, high-LVR lending (before exemptions) was 7% of new lending.

The high-LVR lending restrictions had the most impact in the lower end of the housing market, as it effectively locked out many first home buyers. This still appears to be the case.

The restrictions had little impact on the million dollar mansion market, and only a temporary one on the proportion of houses sold for over $600k. Over the past few months, house sales have lifted and are nearly back to levels pre-dating the LVR lending restrictions. However, the proportion of high-LVR lending has remained broadly unchanged. What has changed in recent months is mortgage rates. In a competitive banking environment, mortgage rates have declined due to lower global interest rates and as the market speculates on the removal of the RBNZ’s tightening bias.

Based off ASB’s ‘special’ rates for those with more than 20% equity, 2-year borrowing rates are actually lower than was the case before the RBNZ started its 100 basis points of OCR increases. This is stimulating housing demand (or at the least not holding it back) at a time when demand is already pretty strong due to population and income growth.

And herein lies the RBNZ’s quandary going forward. The high-LVR lending limits do not solve the fundamental of under supply of houses in Auckland. Auckland population growth, owing to strong net migration inflows, is outpacing new construction in Auckland. Demand for houses in Auckland is stronger than supply and there will continue to be upward pressure on Auckland’s house prices.

The RBNZ is investigating finessing macro-prudential tools, but until these are in place interest rates are the only other tool the RBNZ has. But lifting the OCR right now does not feel appropriate with inflation still at the bottom of the target band.

Does it matter for inflation? Traditionally strong housing market cycles produce a wealth impact that is stimulatory for the economy. However, arguably, this housing cycle is much more unevenly distributed, favouring those that are already wealthy or have high incomes. This segment has a much lower propensity to spend on increased wealth/incomes. Hence, this house prices cycle may not be as inflationary. It will still pose concern on the financial stability front, however.

Implications
The RBNZ will be uncomfortable with recent housing market developments, but may continue to focus on macro-prudential tools to try rein in pressures. However, the recent declines in lending rates appear to have stimulated demand and suggest that macro-tools aren’t as powerful without complementary interest rate settings. We expect the RBNZ to leave the OCR on hold until it can see inflation pressures starting to pick up on a more generalised basis. This will not occur until late next year. We continue to expect two further rate hikes, one in December 2015 and one in March 2016.