Macroprudential Bites in the UK – Bank of England

The Bank of England (BoE) recently published their Q3 Credit Conditions Survey. This is the first edition since the recent Mortgage Market reforms were introduced, and the macroprudential controls were tabled. Looking specifically at secured lending to households they report that demand for credit has eased, and the proportion of higher loan to value loans has reduced. In other words macroprudential is biting!

After eight consecutive quarters of expansion, lenders reported that the availability of secured credit to households fell significantly in the three months to early-September.

BoECreditOct2014The contraction in overall availability was reported to be driven by a changing appetite for risk and lenders’ expectations about house prices. Many lenders noted that operational issues associated with the implementation of the Mortgage Market Review had pushed down on credit availability over the summer. And some lenders commented that they had tightened availability a little in response to the recommendations made by the Financial Policy Committee to mitigate risks stemming from the housing market.

Credit availability was reported to have fallen in Q3 both for borrowers with loan to value (LTV) ratios below 75% and for borrowers with LTV ratios above 75%.  Lenders also reported that they had become less willing to lend at LTV ratios above 90% for the first time since the question was introduced in 2013, and some noted that they had introduced policies which restrict lending at high loan to income (LTI) ratios.

Consistent with a tightening in credit availability, credit scoring criteria for granting household loan applications were reported to have tightened in Q3 and the proportion of household loan applications being approved fell.

Ireland Joins The Macroprudential Bandwagon

In the paper released by the Central Bank of Ireland, it is clear they have gone macroprudential! According to the Irish Times new rules will be applied to mortgage lenders in Ireland from 1 January 2015. A 2 month consultation period now starts, so they may get tweaked before implementation. The UK had announced parallel measures earlier.

New mortgage rules published today mean that most house buyers will have to have a 20 per cent deposit when applying for a home loan. The regulations come into force on January 1st.

The Central Bank is proposing that no more than 15 per cent of all new mortgages for private dwelling homes should have a loan to value (LTV) ratio above 20 per cent. This means that most first-time buyers are now going to be expected to have at least a 20 per cent deposit when buying a home.

In addition, it has also decided that just one-fifth of new mortgages should be issued above a level of three and a half times income (LTI).

In the case of buy-to-let properties, no more than 10 per cent of the value of all new loans should have an LTV above 80 per cent.

The Central Bank’s deputy governor said these measures should help to avoid another property crash in Ireland and dampen the rate of price rise currently being experienced in the market.

“Our research has shown there is strong evidence that mortgage losses are much higher where borrowers have a high LTV or LTI rate,” he said. “We believe that measures such as these are a standard part of a well regulated financial system and introducing these precautionary measures should contribute to a stable and well-functioning mortgage lending market.”

The regulator said the income caps would be “more binding” than the LTV ratios in a period of boom as pay levels could never keep pace with soaring property prices.

The LTV caps are not “completely counter-cyclical” as loan values will rise in line with property prices.

Certain exemptions are proposed to the new rules. These cover residual debt from home loans in negative equity, switcher mortgages, and home loans in arrears. Buy-to-let borrowers will also be exempt from the income restrictions.

Here is the Economist’s comparison chart, showing UK, Ireland and Australia – and we thought we had a problem!


IMF On Macroprudential – It Works!

In the just release IMF World Economic Outlook, as well as revising down growth estimates, they discuss macroprudential, highly relevant in the light of RBA comments. The main observations are:

  1. there is evidence that macroprudential can assist in manage house price growth, and credit growth. Different settings should be applied to different types of purchases, e.g. differentiate first time buyers from multiple investors, but
  2. it is less effective if the cause of extended price rises stems from overseas investors, who bypass local controls and credit policy, so specific separate measures may need to be used to target foreign investors
  3. need to make sure business is not simply redirected to the non-bank sector, and
  4. supply side issues also need to be addressed.

RBA please note! The comments in full from the IMF are below, and worth a read. In particular they cite a number of success stories, so macroprudential is perhaps more proven than many would like to admit.

Many countries—particularly those in the rebound group—have been actively using macroprudential tools to manage house price booms. The main macroprudential tools employed for this purpose are limits on loan-to-value ratios and debt-service to-income ratios and sectoral capital requirements. Such limits have long been in use in some economies, particularly in Asia.

IMFSurveyMacroPrudOct2014For example, Hong Kong SAR has had a loan-to-value cap in place since the early 1990s and introduced a debt-service-to-income cap in 1994. In Korea, loan to-value limits were introduced in 2002, followed by debt-service-to-income limits in 2005. Recently, many other advanced and emerging market economies have followed the example of Hong Kong SAR and Korea. In some countries, such as Bulgaria, Malaysia, and Switzerland, higher risk weights or additional capital requirements have been imposed on mortgage loans with high loan-to-value ratios. Empirical studies thus far suggest that limits on loan-to-value and debt-service-to-income ratios have effectively cooled off both house price and credit growth in the short term.

Implementation of these tools has costs as well as benefits, so each needs to be designed carefully to target risky segments of mortgage loans and minimize unintended side effects. For instance, stricter loan-to value limits can be applied to differentiate speculators with multiple mortgage loans from first-time home buyers (as in, for example, Israel and Singapore) or to target regions or cities with exuberant house price appreciation (as in, for example, Korea). Regulators also should monitor whether credit operations move toward unregulated or loosely regulated entities and should expand the regulatory perimeter to address the leakages if necessary. For example, when sectoral macroprudential instruments are used to limit mortgage loans from domestic banks, they can be circumvented through a move to nonbanks (as in, for example, Korea) or foreign banks or branches (as in, for example, Bulgaria and Serbia). Macroprudential tools may also not be effective for targeting house price booms that are driven by increased demand from foreign cash inflows that bypass domestic credit intermediation. In such cases, other tools are needed. For instance, stamp duties have been imposed to cool down rising house prices in Hong Kong SAR and Singapore. Evidence shows that this measure has reduced house demand from foreigners, who were outside the loan-to-value and debt-service-to-income regulatory perimeters. In other instances, high house prices could reflect supply bottlenecks, which would need to be addressed through structural policies such as urban planning measures.


RBA Leaves Rates On Hold, Again

At its meeting today, the Board decided to leave the cash rate unchanged at 2.5 per cent.

Growth in the global economy is continuing at a moderate pace. China’s growth has generally been in line with policymakers’ objectives, though some data suggest a slowing in recent months. Weakening property markets there present a challenge in the near term. Commodity prices in historical terms remain high, but some of those important to Australia have declined further in recent months.

Volatility in some financial markets has picked up in recent weeks. Overall, however, financial conditions remain very accommodative. Long-term interest rates and risk spreads remain very low. Markets still appear to be attaching a low probability to any rise in global interest rates or other adverse event over the period ahead.

In Australia, most data are consistent with moderate growth in the economy. Resources sector investment spending is starting to decline significantly, while some other areas of private demand are seeing expansion, at varying rates. Public spending is scheduled to be subdued. Overall, the Bank still expects growth to be a little below trend for the next several quarters.

Labour market data have been unusually volatile of late. The Bank’s assessment remains that although some forward indicators of employment have been firming this year, the labour market has a degree of spare capacity and it will probably be some time yet before unemployment declines consistently. Growth in wages has declined noticeably and is expected to remain relatively modest over the period ahead, which should keep inflation consistent with the target even with lower levels of the exchange rate.

Monetary policy remains accommodative. Interest rates are very low and have continued to edge lower over recent months as competition to lend has increased. Investors continue to look for higher returns in response to low rates on safe instruments. Credit growth is moderate overall, but with a further pick-up in recent months in lending to investors in housing assets. Dwelling prices have continued to rise over recent months.

The exchange rate has declined recently, in large part reflecting the strengthening US dollar, but remains high by historical standards, particularly given the further declines in key commodity prices in recent months. It is offering less assistance than would normally be expected in achieving balanced growth in the economy.

Looking ahead, continued accommodative monetary policy should provide support to demand and help growth to strengthen over time. Inflation is expected to be consistent with the 2–3 per cent target over the next two years.

In the Board’s judgement, monetary policy is appropriately configured to foster sustainable growth in demand and inflation outcomes consistent with the target. On present indications, the most prudent course is likely to be a period of stability in interest rates.

This was in line with expectation, despite some calling for a rise to signal the markets in relation to speculative housing. However, these ultra-low rates cannot last for ever, and the average mortgage rate is closer to 7% rather than the current 4.75%.



RBA Highlights Housing Supply Issues And Lending Regulation

The RBA made a statement today to the Inquiry into Affordable Housing. Several points to note:

1. They recognise the high price to income ratio we currently have, but also state that low rates make larger mortgages affordable.

  • the ratio of housing prices to incomes is at the top of its historical range; but
  • over time, this has been more than offset by falls in financing costs, so that the typical repayment burden as a share of income is not particularly high. This of course does not rule out affordability problems in particular market segments or for particular types of households.

The recent data from the Economist shows the relative data of prices against average income in different countries.EconomistAug2014-IncomeTrend2000s

2. Supply of mortgages is not a constraint

there is no shortage of housing finance in Australia. Housing loan interest rates are currently as low as they have been in a generation, and households are not artificially constrained from borrowing as much as they can reasonably be expected to repay. I have already made the point that perceptions of affordability will differ across different types of households; but, if there is a perceived affordability problem in Australia, it is not due to a lack of finance.

3. There are property supply problems

It is the supply response that determines the extent to which additional demand results in higher prices over time. Our submission highlights that Australia faces a number of longstanding challenges in this area, including regulatory and zoning constraints, inherent geographical barriers and the cost structure of the building industry. There are also obstacles to affordable housing created by Australia’s unusually low-density urban structure, though this is gradually changing.

4. Lending practice reinforcement and other measures are on the cards

the Bank said in its Financial Stability Review last week that the composition of housing and mortgage market activity is becoming unbalanced. The review also indicated that we are discussing with APRA steps that might be taken to reinforce sound lending practices, particularly for investor finance, though not necessarily limited to that.

I want to emphasise that the banks in Australia are resilient, and mortgage lending in this country has historically been relatively safe. APRA has, however, noted a trend to riskier lending practices, and over the past couple of years has been seeking to temper these through its supervisory activities. There are also broader concerns with the macroeconomic risks associated with excessive speculative activity, since this activity can amplify the property price cycle and increase risks to households.

Our discussions with APRA and other agencies on these matters are ongoing, and there will be more to say about them in due course

Total Housing Lending Hits Another High At $1.39 Trillion – RBA

The monthly Financial Aggregates from the RBA for August are out, and shows yet another growth in housing lending. Total housing credit grew at an annual 6.7%, business credit at 3.2% and personal credit 1.1%. Total housing was $1.39 trillion, and now represents 60.7% of all bank lending, the highest it has ever been. In 1990, housing lending was 23% of all bank lending. The red area chart shows the relative proportion of housing lending, compared with all lending. The difference between the APRA number of $1.28 trillion represents the non-bank sector.

TotalHousingPCLendingAugust2014Here is the lending mix data right back to 1990 showing the proportion of the banks books in housing finance, as a total of all lending.

LendingTrends1990August2014Looking at the mix of housing loans, investment lending makes up 33.9% of all housing lending, it has never been higher. Owner occupied lending was worth $919 billion, and investment lending, $471 billion.  These are all seasonally adjusted numbers. The red area chart shows the relative proportion of investment housing lending, compared with all housing lending.

TotalHousing-LendingAugust2014Looking at the relative growth, we see that investment lending grew 0.8% last month, whilst owner occupied loans grew 0.4%, seasonally adjusted.

MonthlyHousing-LendingAugust2014The 12 month averages, which smooth some of the noise in the data shows strong investment growth, at 9.2%, the strongest for several years, (the all time high was in the credit fueled heights of 2003. when it reach more than 25%). Owner occupied growth was slower at 5.4%, but still the strongest since 2012.

12MonthHousing-LendingAugust2014Looking at business lending, we see it falling as a proportion of all lending, to 33%, and worth $760 billion. The red area chart shows the relative proportion of business lending, compared with all lending.

TotalBusinessLendingAugust2014Personal credit (other than housing) fell to 6% of all lending, and worth $142 billion. The red area chart shows the relative proportion of other personal lending, compared with all lending.

TotalPersonalLendingAugust2014Our banks are more and more reliant on housing lending, raising questions about concentration risks, should housing take a negative turn. We encourage the FSI to consider seriously the steps needed to re-balance the equation.

Deja Vu Housing Data For August From APRA

APRA published their monthly banking statistics for August 2014 today. The trend remains set, with investment lending running ahead of owner occupied lending. Further evidence that the RBA should react to the hot market. Total lending was up by $7.4 billion to a total of $1.28 trillion. Owner Occupied loans grew at 0.48% from last month, whilst investment loans grew at 0.78%. 65.4% of loans were for owner occupation, the rest investment. This data excludes the non-bank sector, which will be reported separately.

Looking at the bank specific data, Westpac leads the way on Investment Loans, with CBA continuing to grow its relative share of investment lending. Should the rules of the game change, thanks to RBA intervention, then WBC and CBA (the Sydney based banks) are likely to feel the heat more than the others. Competition amongst the big players is hot, with significant discounts and special offers available to lure prospective borrowers. Lending growth is still well behind property price rises in most centres.

HomeLoanBanksAugust2014In terms of relative market share, WBC has 32% of all Investment loans, and CBA 26.9%. On the Owner Occupied loans, CBA has 27.2% of the market and WBC 21.4%.

HomeLoanSharesAugust2014Looking at portfolio movements, in the past month, WBC has been lending the most, note also Macquarie is active as it continues its strategy to grow its retail business.

HomeLoanPortfolioAugust2014Another way to look at this growth pattern is by month on month percentage movements. Relatively, Macquarie is the most aggressive, followed by AMP bank.

HomeLoanPortfolioMOMAugust2014Turning to the other data in the statistics, on the deposit side, balances grew by 0.75%, to $1.749 trillion. This is a slowing from the previous 1.02%, perhaps reflecting falls in average deposit rates relative to other investments.

DepositTrendsAugust2014In terms of monthly movements, nab has been the most aggressive amongst the larger banks, together with HSBC from the smaller players. Relatively speaking, Suncorp, Rabobank and Bendigo went backwards.

DepositMovementsAugust2014Looking at relative shares, CBA has 24.2%, WBC 21.0% and nab 17.6%. This chart highlights the concentration in the big four, with a combined 78.4% of all deposits. With deposits backed by the government guarantee, these might be viewed as government back funds, and this helps to prop up the credit ratings of the major players. The Australian Government has guaranteed deposits up to $250,000 in Authorised Deposit-taking Institutions at the momentThere is a case to review this, and we wonder if the FSI report, due soon will mention it.

DepositSharesAugust2014Finally, Cards. The balances on cards are at $40 billion, just $130m up from last month.

CardTrendsAugust2014CBA has 27.9% of the market, Westpac 22.9% and ANZ, 19.6%. The big four have combined 84%, and with Citigroup’s 10%, the five have close to 95%.

CardSharesAugust2014So, in summary, deja vu. Hot investment lending, industry concentration, and large deposit balances guaranteed.


Household Incomes And Property Segmentation

In the current discussions about macroprudential, stimulated by the RBA comments last week and likely to be stoked further as the RBA appears before the Senate Banking Committee on Thursday, many are claiming that household balance sheets and incomes are supporting the growth in house prices, and so no intervention is needed. The chair of the Banking Committee Sam Dastyari is “concerned about the unanticipated consequences of the Reserve Banks’s view-change on the sustainability of the housing boom and whether it needed to interfere with bank lending”.

The debate has shifted to first time buyers, and not wishing to put further barriers in the way of the small number able to enter the market at prices which are already too high. They may be missing the point. First, the increase in household wealth is directly linked to the rise in house prices (a weird piece of feedback here, as prices rise, households are more wealthy, so can accommodate higher prices – spot the chicken and egg problem?). In addition, wealth is growing thanks to stock market movements (though down recently) driven partly by the US and European low rates and printing money strategies. This will reverse as rates are moved to more normal levels later. Superannuation, the third element is of course savings for retirement, so cannot be touched normally (there are exceptions, and no, first time buyers should not be allowed to use their super to get into the property market). More first time buyer incentives won’t help.

But, we have been looking at household incomes, after inflation, at a segment level. We segment based on property ownership, and you can read about the DFA segments here. On average, across all households, income growth is falling behind inflation. This is the ABS data from June 2014. In the past few months, real income is going backwards, before we consider rising costs of living.

AdjustedIncomeGrowthAllHowever, at a segment level, the situation is even more interesting, and diverse. Those wanting to buy, but unable to enter the market are seeing their incomes falling sharply, inflation adjusted, making the prospect of buying a house more unlikely. We are seeing the number of households in this group rising steadily, see our Property Imperative Report.

AdjustedIncomeGrowthWantToBuysFirst time buyers, those who have, or are purchasing for the first time, are also seeing income falling in real terms, more sharply than the average. This is why we are predicting a higher proportion of first time buyers will get into mortgage stress, especially if interest rates are increased. This is one reason why loan to income ratios for this group are high.

AdjustedIncomeGrowthFirstTimeBuyersThen looking at holders, their incomes are moving closer to the average. Holders have no plans to change their property, many have mortgages.

AdjustedIncomeGrowthHoldersRefinancers, are hoping to lock in lower rates, though we note the forward rates are now higher than they were, which may suggest the lowest deals are evaporating. One of the prime motivations for switching in this segment is to reduce outgoings, not surprising when we see incomes falling faster than the average in real terms.

AdjustedIncomeGrowthRefinanceNow, looking at Up Traders, we find their incomes are rising more quickly than the average. Up Traders have been active recently. They have the capacity to service larger loans. They will be purchasing primarily for owner occupation.

AdjustedIncomeGrowthTradingUpDown Traders have incomes rising more quickly, thanks to investment income, and there still about one million households looking to sell and move into a smaller property, releasing capital in the process. They are also active property investors, directing some of their released capital in this direction, either direct, or via super funds.

AdjustedIncomeGrowthDownTradersInvestors also have incomes which are rising faster than the average, so no surprise they are active in the market, seeking yields higher than deposits, and taking advantage of negative gearing. We continue to see a small but growing number of investors using super funds for the transaction.

AdjustedIncomeGrowthInvestorsSo, the segmental analysis highlights how complex the market is, and that there are no easy fixes. Any rise in interest rates would hit first time buyers very hard. Demand from investors (the foreign investment discussions is only a sideshow in my view) will be sustained, with the current policy settings. Raising interest rates will not help much on this front, because interest will be set against income. So macroprudential controls on investment loans makes more sense.

One option would be to differentially increase the capital buffers the banks hold for investment loans, making their pricing less aggressive, and the banks more willing to lend to suitable owner occupiers and businesses, which is what we need. Trimming demand for investment properties may help to control prices.

The bottom line though is that many years of poor policy are coming home to roost, on both the supply and demand side. A number of settings need to be changed, as discussed before.

My Recent Thoughts On House Prices

I did an interview for the ABC, on the RBA Financial Stability Review. Here is the transcript, courtesy of the ABC. The link to the interview, and my longer interview can be found at the ABC site.

By way of context, a quick reminder of current house price trends from the Economist:

EconomistAug2014-Trend2000sCHRIS UHLMANN: The Reserve Bank (RBA) has given its strongest warning yet that a dangerous property price bubble in Sydney and Melbourne could destabilise the economy.

It’s now ramping up talks with other regulators to introduce lending controls to head off the risk of a damaging correction in prices.

With more I’m joined by our business editor, Peter Ryan.

And Peter, these warning have been around for the past year. Is the Reserve Bank starting on the back foot?

PETER RYAN: Well, this was certainly very strong language from the RBA yesterday that investment in Australian property is now becoming “unbalanced” and that the speculation increases the potential for current stellar prices to fall.

Now the RBA is now worried about the broader impact of any correction or a hard landing and how that would hurt not just the speculators but average Australians whose biggest single investment is usually the family home.

The property analyst Martin North says unless the RBA intervenes with tighter controls, there could be a correction in the range of 20 to 25 per cent and that some borrowers could find themselves overwhelmed in debt – in other words facing negative equity.

MARTIN NORTH: Property prices have been high for a long period of time so this is not just a little bubble. This is a long term systemic issue.

So what’s been happening is it’s been sucking a lot of money from people’s pockets out to pay the mortgage, right? Secondly, people have been committing to buy at the top of the market and so if prices were to move down, a lot of people who’ve bought relatively recently would be out of the money and that’s very significant.

A lot of those are investors – and investors will change their tune quite quickly, you know, particularly if capital growth is no longer in the sector. So yeah, this is a very unstable situation.

Also, the banks have a huge exposure to property, probably one of the highest exposures in the world and that means that whatever happens to the property market is going to impact not only individuals but also the banks as well.

PETER RYAN: If there was a correction and those property speculators decided to sell while they could and the market was flooded with properties, what impact would that have on the general market?

MARTIN NORTH: We will probably see a downward swing and that downward swing would gain quite a lot of momentum. I wouldn’t be surprised to see prices slipping by 20 to 25 per cent. It will probably self-correct a little bit beyond that but it’s that, it’s that sort of slide down and then up which is the problem.

PETER RYAN: And that of course is a huge problem for borrowers who bought at the top of the market, borrowed too much and are now over their heads in debt.

MARTIN NORTH: The real issue there of course is all the people will find that they’re in negative equity at a point. In other words, they can’t then sell. So we could find the situation where people are trying to sell, are being forced to sell. That will tend to drive prices further down, probably languish for quite some time because we have to correct back to long term averages between income and property prices in my view.

So this is more like I think the early signs of some of the things that happened in the US prior to the GFC.

CHRIS UHLMANN: Property analyst Martin North.

So Peter, can we expect to see action on lending controls from the Reserve Bank?

PETER RYAN: Well, the RBA governor Glenn Stevens is speaking in Melbourne later today and as always his comments will be scrutinised on perhaps when and how the RBA might intervene to prevent any property bubble bursting.

CHRIS UHLMANN: Business editor Peter Ryan, thank you.

Macroprudential Tools could prove useful – RBA

In a speech in Melbourne, the RBA governor, Glenn Stevens said macroprudential tools could prove useful in helping to control the exuberant housing market. That said, he was still skeptical about their effectiveness.

He made the point that whilst monetary policy can’t solve every problem (i.e. interest rates alone)  and there may be a need to take other steps if “at the margins they are helpful,”he didn’t consider macroprudential tools a simple solution to the problem, referred to in yesterdays Stability Review of strong investment lending. A reminder of the latest data, which we discussed recently.

InvestmentLendingByStateJuly2014He reiterated his concerns about the risks of investment loans, and highlighted the potential risks later, echoing yesterdays report.

No mention of macroprudential as a fad this time, which I guess is a step in the right direction. The IMF and OECD seem more convinced of the effectiveness of macroprudential. DFA’s view is we need them, and soon, alongside changes to negative gearing, and increased capital buffers.

It is interesting to note that U.S. regulators have announced that large banks will be required to hold more liquid capital to ensure they do not get into difficulty in a downturn. According to Reuters the eight biggest U.S. banks must boost capital levels by a total of $68 billion under these new rules. These rules are stricter than those under Basel III, and the banks have complained they will be put at a competitive disadvantage. They will need to hold tier one assets of 5%.