Banks pull the broker lever as APRA pressures mount

From The Adviser.

In addition to rate hikes and policy changes, brokers are proving to be a convenient lever for the banks to pull as they strive to meet APRA’s limits on mortgage lending.

Banks are now approaching broker clients with owner-occupier home loans to refinance as they look to rebalance their mortgage portfolios and limit investor and interest-only lending.

In a recent The Adviser survey, brokers who had experienced channel conflict were asked which type of loan their clients had been approached by their bank to refinance.

Almost 74 per cent of brokers said clients with owner-occupier mortgages had been targeted. The survey also found that 84 per cent of the 766 brokers surveyed claimed the major banks and their subsidiaries had directly approached their clients to refinance over the last 12 months.

The figures come as Australian banks face ongoing pressure from the prudential regulator to cap investor lending growth at 10 per cent and limit the interest-only loans as a proportion of all new lending to 30 per cent.

Commenting on The Adviser’s channel conflict survey results, Digital Finance Analytics principal Martin North said banks are currently “powering up” their acquisition of owner-occupier loans to offset a reduction in investor and interest-only lending. He said this is being done through their proprietary channels “at the expense of brokers”.

Earlier in the year, CBA stopped refinancing investor mortgages through the third-party channel. Any CBA customers with an investor home loan looking to refinance would have to visit the bank directly.

“Two or three months ago, CBA said they were really looking to drive more momentum through their branch channels and offset the volumes through brokers. Westpac also showed in their latest results a little bit of a fall in broker momentum,” Mr North told The Adviser.

“There is a change of strategy from these lenders. They are less willing to take business from third-party channels for that particular category because they are trying to control the volume of those particular loans at the moment, thanks to the imposed speed limits and the need to reduce interest-only loans. It is a way of giving priority to their own channels,” he said.

Morningstar expects that a change in the broker strategies of Westpac and CBA in recent months could have a detrimental impact on broker market share.

“Changes in mortgage distribution strategy by Australia’s two largest mortgage banks CBA and Westpac will over time likely slow the growth rate of home loans sourced through brokers,” Morningstar analyst David Ellis said in a recent research note.

Over the last year 84 per cent of brokers have had one or more of their clients approached directly by their lender to refinance. Over 47 per cent of brokers admitted they had lost commission through clawback as a result of a client being refinanced by the lender directly.

However, despite these findings, MoneyQuest managing director Michael Russell is adamant that channel conflict is not a systemic issue.

“Under no circumstances have I witnessed any systemic channel conflict condoned by a lender,” Mr Russell told The Adviser. “I just have not witnessed it.”

Brokers slam APRA’s ‘sledgehammer’ approach to IO loans

From The Adviser.

The Australian Prudential Regulation Authority has been castigated by brokers for its nationwide “sledgehammer” crackdown on interest-only loans, which have been labelled as “myopic” and “devastating” for regional Australia.

Damian Collins, managing director of Momentum Wealth in Perth, told The Adviser that APRA’s moves to limit the flow of new interest-only loans were based on a “sledgehammer” approach that neglected to consider the impact on areas outside of Sydney and Melbourne.

He added that “everyone outside of Sydney and Melbourne should be feeling fairly aggrieved” by the measures.

Mr Collins said: “We got told in WA [in April], that for investor refinances, [lenders] are not doing them… so, you can tell APRA is definitely putting the pressure on the banks to manage their loan book growth, which is strange because in WA there aren’t a lot of investors doing anything at the moment.

“So, I guess [APRA] aren’t really looking at it state by state, they’re just looking at it as a global pull and finding any way they can to make changes.”

The Momentum Wealth MD went on to say that some of his clients in WA had previously been able to borrow around $2 million and, within a couple of months of the macroprudential measures being announced, that figure dropped down to $700,000.

“We used to have some lenders that, for our clients that had three or four properties already, would have assessed existing debt at actual rate, so they might be paying 4.5 per cent. But, pretty much all the lenders now have switched to servicing everything at 7.5 or 7.25 per cent, so for existing investors with a decent portfolio, it’s certainly made it a lot tougher.”

Mr Collins lamented that the regulator had not taken a state-by-state approach.

He said: “It is quite staggering… Maybe they should say: ‘Right, for investor growth in [postcodes] 3,000-3,200 or 2,000-2,200 (or whatever those postcodes are [in Melbourne and Sydney]) any properties secured by IO loans in those postcodes we’re restricting’. But, there is just a blanket ban nationally, it’s crazy. And it has certainly affected not just Perth but pretty much everything outside of Sydney and Melbourne.

“It’s like taking a sledgehammer to the problem and certainly has affected investors across the country… You’d think [APRA] would be able to do it better, but they haven’t,” he added.

Touching on the crackdown on interest-only loans in particular, Mr Collins said that the penalties now made this type of loan practically redundant for investors. According to the Momentum Wealth managing director, the repayments on some interest-only loans are the same now as P&I.

He said: “It’s at the stage now where, for a lot of our investor clients, we’re saying: ‘Get a P&I loan, it’s just not worth paying that premium for paying interest-only.’”

However, while Mr Collins said he expects interest-only loans to go “back to normal” in the future, he was “struggling to see how it’s worthwhile to pay that higher rate for interest-only at the moment”.

‘The most devastating manifestation in the financial sector since the GFC’

Roger Ward, director at Cairns Mortgage Brokers, agreed, labelling lenders’ response to APRA mandates as “city-centric” and “damaging” to investment in regional Australia.

He said: “It should be stated that there is no housing bubble in almost all of the rest of Australia. These lending restrictions are being applied nationally and already are driving down investment in regional Australia, an area which needs additional investment, not less.

“Most places in regional Australia have not experienced the growth in real estate asset values like Sydney and Melbourne and look to be casualties to this developing panic in the financial sector over the Sydney and Melbourne ‘housing bubble’.”

Condemning the “myopic” APRA policies, he said the recent changes to interest-only lending policies look to be “the most devastating manifestation in the financial sector since the GFC and is already costing investment dollars in regional Australia”.

He continued: “It’s my professional opinion that APRA and the banks are going to crush investment in regional Australia, all for fear of a housing bubble in our capital cities.”

Echoing Mr Collins, Mr Ward argued that APRA should have called on lenders to address the “hyper-investment issue” in Sydney and Melbourne on a postcode basis.

For example, he suggested that that investors buying in Melbourne and Sydney should have to provide at least a 20 per cent deposit, and that there should be foreign investment restrictions on certain postcodes in Sydney and Melbourne.

He suggested that these measures “would have dealt with the core issue” without affecting the regions, and could even potentially benefit regional Australia as the “frustrated appetite of investors” would lead them to invest elsewhere.

APRA Wriggles In Senate Probe On Housing Risk

From our friends at MacroBusiness, quoting Nathan Lynch, Asia-Pacific bureau chief, financial crime and risk, Thomson Reuters.  The video is essential viewing!

It was only the devoted, the desperate or the sleep deprived who remained in the chamber last night in Canberra when Wayne Byres, APRA chairman, buckled under a sustained line of questioning. For almost two-and-a-half hours the Senate Economics Legislation Committee had been firing questions like mortars at the country’s chief prudential regulator. By the end, Byres looked understandably fatigued.

Are Australian capital city house prices sustainable? Do they pose a systemic risk to the broader economy? Is APRA concerned that Australian households are vying with Switzerland to claim a gold medal in the global consumer-debt-to-GDP sweepstakes?

The recent data from the Bank for International Settlements is alarming, showing Australian households carrying an average of 123% debt-to-GDP.

In the measured language so well honed by prudential regulators, Byres said the risks in the Australian property market were among APRA’s highest priorities.

He said Australian housing had entered a high-risk phase due to a range of factors, including capital city house prices, household debt levels, record low interest rates and anaemic wages growth. APRA, ever vigilant, was taking action to intervene in the market to ensure that banks were not taking on excessive risks and exposing the broader economy to unnecessary systemic risks.

“The whole issue of housing and property is a big issue on our agenda. There’s a lot of discussion at APRA and a lot of discussion at the Council of Financial Regulators (with Treasury, the RBA and ASIC) about the risks. We’ve never hidden behind the fact that we are in an environment of heightened risk. Prices are high, household debt is high, interest rates are at historical lows, interest rates are low and competitive pressure is strong in the housing market. So everyone needs to be fairly careful about how they operate in this environment,” Byres said.

Nick Xenophon, the South Australian senator, wasn’t having any of it. With supportive grenade lobs from Greens senator Peter Whish-Wilson, he pressed Byres for a concrete answer to one simple question: at what point will housing debt levels trigger alarm bells at APRA?

“Do you consider that there is a point where at which the ratio of household debt to GDP becomes problematic in this country?” Xenophon asked. “Is it 200%?”

Earlier in the week John Fraser, Treasury secretary, had refused to provide a number.

“He’s a wise man,” quipped Byres, realising where this was heading.

The truth is, though few want to admit it, APRA’s alarm bells have been ringing for years. It would be an imprudent prudential regulator who suggested otherwise. The regulator’s responses simply haven’t worked.

More than two hours into the appearance Byres finally said it: alarm bells were ringing, albeit “softly”, over the accumulation of risks in the banking system.

“I’d say they’re [alarm bells] going off softly. That’s why we’ve been intervening in the sense that …” Byres said, before being cut off by questions from a feverish chamber.

It was the committee’s gotcha moment. And it went largely unnoticed.

Macroprudential mayhem

In recent years APRA has taken a number of tentative steps, jokingly referred to in the industry as “macroprudential lite”, to constrain the irrational exuberance in the property market. It’s imposed higher interest rate buffers for loan serviceability assessments, set benchmarks for year-on-year growth in investor lending and most recently took steps to constrain interest-only investor loans.

The regulator has been hamstrung, however, as these measures apply on a nationwide basis and APRA is reluctant to cripple lending in resources-linked markets such as Perth and Darwin. Behind the scenes it’s also worried about driving borrowers into the shadow banking sector, which takes lending activity outside APRA’s regulatory remit.

Despite these challenges, the message from the handful of bellicose senators last night was clear: something needs to be done about housing market risks and APRA needs to be a core part of the solution.

Some of the tools that need to be considered are hard macroprudential caps (the type the major Australian banks have been operating under in New Zealand) and lending controls targeted at specific geographical areas. APRA already has powers to impose the former and, in the wake of the latest Budget, it will soon have explicit powers to do the latter.

The politically unpalatable subtext to this discussion is that, if there is a “property calamity” in Australia, taxpayers are ultimately on the hook for these long-term regulatory shortcomings.

Bank Mortgage Up To $1.55 Trillion

The latest data from APRA, the monthly banking statistics for April 2017, shows that mortgage book growth is still well above inflation and income growth, at 0.5% in the month. Total loans are now $1.55 trillion, up from $1.54 trillion last month and 4.5% across the 12 months.

An additional $8 billion of net loans were added, with owner occupied loans accounting for $5.8 billion and investment loans $2.1 billion.

Investment loans are 35% of the portfolio.

Looking at the monthly trends, we see that the growth in investment loans slowed slightly, rising by 0.39%, whilst owner occupied lending accelerated, rising by 0.59%. Overall growth was 0.5%.

Looking at the lending profiles, CBA grew their book the most, followed by ANZ. Members Equity Bank and AMP Bank also grew quite fast and above portfolio.

CBA still leads the owner occupied market, and is continuing to chase down Westpac in the investment sector, though has not yet overtaken.

Finally, looking at 12 month portfolio growth for investment loans, the majors are well under the APRA limit. Some smaller players are still speeding.

So, whilst we see some adjustment in terms of risks in the market, growth remains strong, which explains why the auction clearance rates remain strong.

Analysis of the RBA market figures, which includes the non-banks will follow.

APRA Reinforces The Mortgage Fog

APRA released their quarterly property exposure statistics today to end March 2017.

We see a fall in interest only loans, a fall in over 90% LVR loans and a fall in out of serviceability approvals.  Third Party volumes from the majors fell, though offset by momentum from foreign banks.

Except they put a health warning on the data which says in essence, the numbers they are using to managed the banks interest only exposures are different from those reported.  They caution that loans approved may not necessarily be funded, and they are measuring funded loans, which are not disclosed. In the public data on approved loans, we see a small fall, but offset by a rise in interest only loans offered by foreign banks.

The below-the-waterline conversations continue away from public gaze, despite the material implications of changes being made. Once again disclosure in Australia is shown as faulty and myopic. They also stopped reported credit unions and regional banks separately, last year as the number of entities fell, which is another issue.

This is what they said:

APRA recommends that users of the publication exercise caution analysing and interpreting the statistics to monitor sound residential mortgage practices. APRA initiated additional supervisory measures to reinforce sound residential mortgage lending practices in an environment of heightened risks on 31 March 2017.

These measures included an expectation that ADIs limit the flow of new interest-only lending to 30 per cent of new residential mortgage lending.

The data used by APRA to monitor ADIs’ new interest-only lending is not the same as the source data for the statistics in this publication. First, APRA monitors ADIs’ new interest-only lending using data on loans funded; statistics is this publication show loans approved. Loans approved is a broader definition than loans funded; loans approved may not necessarily be funded. Second, APRA monitors new interest-only loans funded by all ADIs; interest-only mortgage statistics in this publication are based on data reported by 31 ADIs with over $1bn in residential term loans.

APRA currently collects data on ADIs’ new interest-only loans funded in an ad-hoc data collection.  APRA has introduced a new reporting form, Reporting Form ARF 223.0 Residential Mortgage Lending (ARF 223.0) to better enable APRA’s supervisory monitoring and oversight of residential mortgage lending, and reduce the reliance on ad hoc information requests.

APRA will consider publishing statistics sourced from ARF 223.0 in the future.

Having got that out of the way, lets see what the public data does say.

Total ADIs’ residential term loans increased by $107.8 billion from march 2016, to $1.51 trillion as at 31 March 2017. This is an increase of 7.7 per cent on 31 March 201.

Of these, owner-occupied loans were $985.8 billion (65.1 per cent), an increase of $78.9 billion (8.7 per cent) from 31 March 2016; and investor loans were $528.7 billion (34.9 per cent), an increase of $28.8 billion (5.8 per cent) from 31 March 2016. Note: ‘Other ADIs’ are excluded from all figures.

ADIs with greater than $1 billion of residential term loans held 98.7 per cent of all such loans as at 31 March 2017. These ADIs reported 5.8 million loans totalling $1.49 trillion. Of these the average loan size was approximately $259,000, compared to $250,000 as at 31 March 2016 and   $583.3 billion (39.0 per cent) were interest-only loans.

ADIs with greater than $1 billion of residential term loans approved $383.7 billion of new loans in the year ending 31 March 2017. This is an increase of $13.8 billion (3.7 per cent) on the year ending 31 March 2016.

Of these new loan approvals, owner-occupied loan approvals were $249.7 billion (65.1 per cent), an increase of $7.6 billion (3.1 per cent) from the year ending 31 March 2016 and investment loan approvals were $134.0 billion (34.9 per cent), an increase of $6.2 billion (4.8 per cent) from the year ending 31 March 2016.

$54.0 billion (14.1 per cent) had a loan-to-valuation ratio (LVR) greater than 80 per cent and less than or equal to 90 per cent, an increase of $2.7 billion (5.4 per cent) from the year ending 31 March 2016 (chart 8),      $30.8 billion (8.0 per cent) had a LVR greater than 90 per cent, a decrease of $4.2 billion (12.0 per cent) from the year ending 31 March 2016 and      $141.6 billion (36.9 per cent) were interest-only loans, a decrease of $5.3 billion (3.6 per cent) from the year ending 31 March 2016.

The number of over 80% under 90% LVR loans rose.

Offset by a fall in over 90% loans.

We see a fall in the over 90% LVR across the banks. So there is some lowering of risk from an LVR perspective, but affordability standards are still too lax in places (in our view).

Third party loans from the majors fell from over 47% to 46%, reflecting a change in emphasis we have already discussed, as some lenders push business via their branch channels.

Loans outside servicability fell as a proportion of loans, other than from foreign banks, where it is on the rise, though from a lower base.

Finally, investment loans are highest via the major banks and we see a rise in investment lending from the foreign banks, as some local lenders dial back their loan availability to meet regulatory constraints.


APRA Tweaks New Mortgage Reporting Requirements

APRA has delayed the commencement of new mortgage reporting standards, and watered down some requirements. On the other hand they are seeking to introduced the requirement for lenders to report on debt-to-income ratios for the first time, or at least looking at the cost benefit.  Some would say, about time too, but many would not be able to comply, so do not hold your breath! Meantime, APRA says ad hoc requests will continue.

APRA received six submissions to their proposals to revise residential mortgage lending requirements. No submissions objected to the proposals, but some did raise concerns with timelines, data availability and specific definitions.

So APRA has revised the requirements.

Specifically, the start date has been delayed.  APRA has deferred the first reporting period for the new reporting requirements to: for ADIs that currently report on ARF 320.8, the period ending 31 March 2018; and for ADIs that do not report on ARF 320.8, the period ending 30 September 2018.

APRA will accept data submitted for the first two reporting periods from these dates on a best endeavours basis. However, APRA expects ADIs will be able to provide accurate, reliable information from the first reporting period. All information provided on ARF 223.0 must be subject to processes and controls developed by the ADI for the internal review and authorisation of that information. These systems, processes and controls are to assure the completeness and reliability of the information provided.

The requirements to classify owner-occupied and investor loans based on security, and to report loans to household trusts has been removed.

Based on feedback, APRA believes the costs of reporting loans to household trusts outweighs the benefits, and has removed the concept.

APRA says it expects that a prudent ADI with material exposures to residential mortgage lending would invest in management information systems that allow for appropriate assessment of residential mortgage lending risk exposures.

They warn that as part of its supervisory monitoring, APRA requests information from ADIs regarding residential mortgage lending on an ad hoc basis. Four submissions to the consultation asked if these requests will continue. ARF 223.0 is designed to replace these data requests, and APRA intends to either significantly reduce or cease the regular requests for individual ADIs once reporting on ARF 223.0 commences. However, given the risks identified in the housing market, ad hoc requests will continue to be a necessary part of APRA’s prudential supervision from time to time.

On the upside (in terms of reporting), in March 2017, APRA noted heightened industry risks relating to residential mortgage lending, and the need to monitor residential mortgage lending more generally. APRA therefore proposes including additional data items to ARF 223.0 regarding:

  • borrower’s debt-to-income ratios;
  • additional information on increases in lending; and
  • lending to private unincorporated business.

These items are highlighted on the updated ARF 223.0. To improve the quality of regulation, the Australian Government requires all proposals to undergo a preliminary assessment to establish whether it is likely that there will be business compliance costs. In order to perform a comprehensive cost-benefit analysis, APRA welcomes information from interested parties.




APRA To Supervise The Non-Banks

APRA will be given new powers over the non-bank sector according to the budget. Currently non-banks are outside of APRA’s control and fall within ASIC’s remit. This is an important change.

Also we note that APRA will be encouraged to use geographic-based restrictions on the proivision of credit. This could for example be setting capital to different levels in different geographies, or setting different loan to income or loan growth levels.

Both these developments are significant!

Improving regulator tools to address housing risks

The Government is ensuring that the Australian Prudential Regulation Authority (APRA) is able to respond flexibly to financial and housing market developments that pose a risk to financial stability. This includes giving APRA new powers over the provision of credit by lenders that are outside the traditional banking sector.

The Government also recognises that housing pressures and risks may not be the same in markets across Australia. For this reason, the Government will make it clear that APRA has the ability to use geographically-based restrictions on the provision of credit where APRA considers it appropriate.

Mortgage Reclassification Still An Issue

The RBA said recently, when they released their credit aggregates to end March, that $51 billion of loans have been switched from investor to owner-occupier, with $1.2bn in March.

Following the introduction of an interest rate differential between housing loans to investors and owner-occupiers in mid-2015, a number of borrowers have changed the purpose of their existing loan; the net value of switching of loan purpose from investor to owner-occupier is estimated to have been $51 billion over the period of July 2015 to March 2017, of which $1.2 billion occurred in March 2017. These changes are reflected in the level of owner-occupier and investor credit outstanding. However, growth rates for these series have been adjusted to remove the effect of loan purpose changes.

With the current balance of investor loans sitting at a record $577 billion, nearly 10% of the book has been switched to lower owner occupied rates. We of course cannot tell if this switching is legitimate, or opportunistic to get a lower interest rate and helpfully reduce the bank exposure to investor loans. The RBA data shows strong “corrected” investor growth of 7.1%, higher than owner occupied loans.

According to a report in the Australian today:

Responding to questions on notice from a Senate economic committee hearing, APRA said the switching “highlighted that some (lenders) have not had ­sufficiently robust practices” for monitoring the status of their borrowers and the data previously submitted to the regulator was “incorrect”.

APRA forced several banks to upgrade their reporting capabilities and, as a result, “some have strengthened their procedures”.

Tasmanian senator Peter Whish-Wilson, who asked APRA if its data was accurate, said the ­reclassification of loans was “concerning, whether it’s deliberate or not”.

He said: “I’d be loathe to see if any sort of systemic changes by the banks to loan classification were made to continue to grow loans to investors when it’s clear APRA is trying to crack down on what is potentially a very serious issue.”

The Affordability Conundrum

We have highlighted the rise in mortgage stress. We identified rising mortgage rates, underemployment, higher costs of living and flat incomes as causes of stress. But we need to stop and ask how come more households are under mortgage pressure than ever?

After all, lenders should have been operating with at least a 2.5% buffer between the mortgage rate offered and the rate they use for affordability assessment, and they should be looking at the household spending to ensure they can afford the loan. Failure to do this would make the loan “unsuitable” and under the lending provisions if loans were not made in compliance with the responsible lending provisions, the borrower can dispute the loan.

Mortgage stress should just not be as high as it is these guidelines were followed. Whilst interest rates have moved from their lows, thanks to out of cycle rises, (which in sum for owner occupied borrowers amount to around 30-40 basis points, whereas interest only loans, and investor loans are now 75-100 basis points) are still well within the 2.5% mortgage affordability rate buffer.

To try and unpick this, we have been looking at real household expenditure budgets from our core market model (using our surveys and other data), and comparing this with the standard Household Expenditure Measure (HEM) used by the banks.

HEM is based on more than 600 items in the ABS Household Expenditure Survey (HES). The HEM is calculated as the median spend on absolute basics (food, utilities, transport, communications, kids’ clothing) and the 25th percentile spend on discretionary basics, which includes expenses like alcohol, eating out and childcare. Non-basic expenses, for example overseas holidays, are excluded from calculations.

The National Consumer Credit Protection Act regulations say that whilst banks may use a HEM to guide the analysis, they must still do more complete analysis and validate the expenditure profile by looking at statements and other evidence. Relying on HEM is not sufficient.

Whats interesting about this is that APRA said last year:

On the expense side, the major differences across ADIs seen in the original exercise related to whether the ADI used a benchmark living expenses measures, such as the Household Expenditure Measure (HEM), the customer’s own reported expenses, or a more targeted calculation of the benchmark.   Most people have a hard time actually estimating their own living expenses, so the customer-declared figure may not be particularly accurate. However, the basic benchmark measures are also simplistic; scaling expense assumptions to the borrower’s income level (and potentially other factors including geography) is a more realistic and prudent approach.

About half of the ADIs in our exercise were still using the basic HEM, but others have moved to implement more sophisticated approaches or are in the process of doing so. At a minimum, all ADIs now reflect the customer’s declared living expenses where these are higher than the benchmark.

A strong alignment between the HEM calculation and the final expenses assessment might be a warning of expenses being understated.

Regulators said recently that there was often a “coincidental” alignment between HEM and actual costs, especially for more affluent purchasers.

So we obtained some HEM data for a typical household in our survey, and compared the HEM output with the data on real expenditure, using the same basis of calculation as HEM.

We found that in all states except SA, the standard HEM understated household expenditure significantly, net of mortgage payments, many were more than 10% higher. ACT, WA and NSW had the highest divergence. So did lenders make sufficient allowance to actual spending in the current low growth, higher cost of living environment?

If not, or if HEM had been used, households might have obtained a larger mortgage than could comfortably be serviced.

So, we need to ask – why the variation between HEM and reality? We suggest it may be a combination of:

  1. Households incomes being squeezed as costs rise and underemployment rises (households are not generally reassessed in flight by the banks)
  2. Banks were too generous in their initial affordability assessments and did not take actual spending sufficiently into account.
  3. Households did not fully disclose costs and banks did not fully check them out. HEM became the default.

Finally, we also looked across our household segments, and found that (no surprise) expenses of more affluent households were significant higher.

This helps to explain why we are seeing more affluent households getting into mortgage stress territory.

Should banks be obliged to review household spending patterns on a recurring basis, rather than at mortgage underwriting time? Is there  merit in the regulators looking in more detail at the extent to which all lenders (including non-banks) are compliant. We suspect some lenders have been too willing to operate on lower spending buffers to enable a deal to be done.

Borrowers of course should not borrow just because the bank says they are willing to lend to a certain level. Households should prepare their own budgets and include allowance for higher mortgage rates and rising living costs. They may get a smaller loan as a result, but they will be more secure in a rising market.

Our industry contacts suggest that many lenders are reviewing their spending assessment, and that more details and granular information is now been used. However, this may nor help those who got bigger loans in easier conditions as affordability bites.

Prudential perspectives on the property market

Wayne Byers APRA  Chairman spoke at  CEDA’s 2017 NSW Property Market Outlook in Sydney  today.  Of note, he explains the reason why the 10% investor speed limit was not reduced, because of the potential impact on commercial propery construction!

My remarks today come, unsurprisingly, from a prudential perspective. Property prices and yields, planning rules, the role of foreign purchasers, supply constraints, and taxation arrangements are all important elements of any discussion on property market conditions, and I’m sure the other speakers today will touch on most of those issues in some shape or form. But I’ll focus on APRA’s key objective when it comes to property: making sure that standards for property lending are prudent, particularly in an environment of heightened risk.

Sound lending standards

Our recent activity in relation to residential and commercial property lending has been directed at ensuring banking institutions maintain sound lending standards. Our ultimate goal is to protect bank depositors – it is, after all, ultimately their money that banks are lending. Basic banking – accepting money from depositors and lending to sound borrowers who have good prospects of repaying their loans – is what it’s all about. Of course, banking is about risk-taking and it is inevitable that not every loan will be fully repaid, but with appropriate lending standards and sufficient diversification, the risk of losses that jeopardise the financial health of a bank – and therefore the security offered to depositors – can be reduced to a significant degree. The banking system is heavily exposed to the inevitable cycles in property markets, and our goal is to seek to make sure the system can readily withstand those cycles without undue stress.

Our mandate goes no further than that. We also have to take many influences on the property market – tax policy, interest rates, planning laws, foreign investment rules – as a given. And there are credit providers beyond APRA’s remit, so a tightening in one credit channel may just see the business flow to other providers anyway. For those reasons, there are clear limits on the influence we have. Property prices are driven by a range of local and global factors that are well beyond our control: whether prices go up or go down, we are, like King Canute, unable to hold back the tide.

Of course, that is not to ignore the fact that one determinant of property market conditions is access to credit. We acknowledge that in influencing the price and availability of credit, we do have an impact on real activity – and this may feed through to asset prices in a range of ways. But I want to emphasise that we are not setting out to control prices. Property prices will go up and they will go down (even for Sydney residential property!). It is not our job to stop them doing either of those things. Rather, our goal is to make sure that whichever way prices are moving at any particular point in time in any particular location, prudentially-regulated lenders are alert to the property cycle and making sound lending decisions. That is the best way to safeguard bank depositors and the stability of the financial system.

Residential property lending

APRA has been ratcheting up the intensity of its supervision of residential property lending over the past five or so years. Initially, this involved some fairly typical supervisory measures:

  • in 2011 and again in 2014, we sought assurances from the Boards of the larger lenders that they were actively monitoring their housing lending portfolios and credit standards;
  • in 2013, we commenced more detailed information collections on a range of housing loan risk metrics;
  • in 2014, we stress-tested around the largest lenders against scenarios involving a significant housing market downturn;
  • also in 2014, we issued a Prudential Practice Guide on sound risk management practices for residential mortgage lending; and
  • we have conducted numerous hypothetical borrower exercises to assess differences in lending standards between lenders, and changes over time.

These steps are typical of the role of a prudential supervisor: focusing on the strength of the governance, risk management and financial resources supporting whatever line of business is being pursued, without being too prescriptive on how that business should be undertaken.

But from the end of 2014, we stepped into some relatively new territory by defining specific lending benchmarks, and making clear that lenders that exceeded those benchmarks risked incurring higher capital requirements to compensate for their higher risk. In particular, we established quantitative benchmarks for investor lending growth (10 per cent), and interest rate buffers within serviceability assessments (the higher of 7 per cent, or 2 per cent over the loan product rate), as a means of reversing a decline in lending standards that competition for growth and market share had generated.

I regard these recent measures as unusual, and not reflective of our preferred modus operandi. We came to the view, however, that the higher-than-normal prescription was warranted in the environment of high house prices, high household debt, low interest rates, low income growth and strong competitive pressures.  In such an environment, it is easy for borrowers to build up debt. Unfortunately, it is much harder to pay that debt back down when the environment changes. So re-establishing a sound foundation in lending standards was a sensible investment.

Since we introduced these measures in late 2014, investor lending has slowed and serviceability assessments have strengthened. But at the same time, housing prices and debt have got higher, official interest rates have fallen further and wage growth remains subdued. So we recently added an additional benchmark on the share of new lending that is occurring on an interest-only basis (30 per cent) to further reduce vulnerabilities in the system.

Each of these measures has been a tactical response to evolving conditions, designed to improve the resilience of bank balance sheets in the face of forces that might otherwise weaken them. We will monitor their effectiveness over time, and can do more or less as need be. We have also flagged that, at a more strategic level, we intend to review capital requirements for mortgage lending as part of our work on establishing ‘unquestionably strong’ capital standards, as recommended by the Financial System Inquiry (FSI).

Looking at the impact so far, I have already noted that our earlier measures have helped slow the growth in investor lending (Chart 1), and lift the quality of new lending. Serviceability tests have strengthened, although as one would expect in a diverse market there are still a range of practices, ranging from the quite conservative to the less so. Lenders subject to APRA’s oversight have increasingly eschewed higher risk business (often by reducing maximum loan-to-valuation ratios (Chart 2)), or charged a higher price for it.

For example, there is now a clear price differential between lending to owner-occupiers on a principal and interest basis, and lending to investors on an interest-only basis (Chart 3). And as a result of our most recent guidance to lenders, we expect some further tightening to occur.

Looked at more broadly, the most important impact has been to reduce the competitive pressure to loosen lending standards as a means of chasing market share. We are not seeking to interfere in the ability of lenders to compete on price, service standards or other aspects of the customer experience. We do, however, want to reduce the unfortunate tendency of lenders, lulled by a long period of buoyant conditions, to compete away basic underwriting standards.

Of course, lenders not regulated by APRA will still provide competitive tension in that area and it is likely that some business, particularly in the higher risk categories, will flow to these providers. That is why we also cautioned lenders who provide warehouse facilities to make sure that the business they are funding through these facilities was not growing at a materially faster rate than the lender’s own housing loan portfolio, and that lending standards for loans held within warehouses was not of a materially lower quality than would be consistent with industry-wide sound practices. We don’t want the risks we are seeking to dampen coming onto bank balance sheets through the back door.

Commercial real estate lending

For all of the current focus on residential property lending, it has been cycles in commercial real estate (CRE) that have traditionally been the cause of stress in the banking system. So we are always quite interested in trends and standards in this area of lending. And tighter conditions for residential lending will also impact on lenders’ funding of residential construction portfolios – we need to be alert to the inter-relationships between the two.

Overall, lending for commercial real estate remains a material concentration of the Australian banking system. But while commercial lending exposures of APRA-regulated lenders continue to grow in absolute terms, they have declined relative to the banking system’s capital (partly reflecting the expansion in the system’s capital base). Exposures are now well down from pre-GFC levels as a proportion of capital, albeit much of the reduction was in the immediate post-crisis years and, more recently, the relative position has been fairly steady (Chart 4).

The story has been broadly similar in most sub-portfolios, with the notable exception of land and residential development exposures (Chart 5).

These have grown strongly as the banking industry has funded the significant new construction activity that has been occurring, particularly in the capital cities of Australia’s eastern seaboard. At the end of 2015, these exposures were growing extremely rapidly at just on 30 per cent per annum, but have since slowed significantly as newer projects are now being funded at little more than the rate at which existing projects roll off (Chart 6).

(As an aside, this is one reason why we opted not to reduce the 10 per cent investor lending benchmark for residential lending recently. There is a fairly large pipeline of residential construction to be absorbed over the course of 2017, and there is little to be gained from unduly constricting that at this point in time.)

In response to the generally low interest rate environment, coupled with relatively high price growth in some parts of the commercial market, low capitalisation rates and indications that underwriting standards were under competitive pressure, we undertook a thematic review of commercial property lending over 2016. We looked at the portfolio controls and underwriting standards of a number of larger domestic banks, as well as foreign bank branches which have been picking up market share and growing their commercial real estate lending well above system growth rates.

The review found that major lenders were well aware of the need to monitor commercial property lending closely, and the need to stay attuned to current and prospective market conditions. But the review also found clear evidence of an erosion of standards due to competitive pressures – for example, of lenders justifying a particular underwriting decision not on their own risk appetite and policies, but based on what they understood to be the criteria being applied by a competitor. We were also keen to see genuine scrutiny and challenge that aspirations of growth in commercial property lending were achievable, given the position in the credit cycle, without compromising the quality of lending. This was often being hampered by inadequate data, poor monitoring and incomplete portfolio controls. Lenders have been tasked to improve their capabilities in this regard.

Given the more heterogeneous nature of commercial property lending, it is more difficult to implement the sorts of benchmarks that we have applied to residential lending. But that should not be read to imply we have any less interest in the quality of commercial property lending. Our workplan certainly has further investigation of commercial property lending standards in 2017, and we will keep the need for additional guidance material under consideration.

Concluding remarks

So to sum up, property exposures – both residential and commercial – will remain a key area of focus for APRA for the foreseeable future. Sound lending standards are vital for the stability and safety of the Australian banking system, and given the high proportion of both residential mortgage and commercial property lending in loan portfolios, there will be no let up in the intensity of APRA’s scrutiny in the foreseeable future. But despite the fact the merit of our actions are often assessed based on their expected impact on prices, that is not our goal. Prudence (not prices) is our catch cry: our objective is to make ensure that, whatever the next stage of the property cycle may bring, the balance sheet of the banking system is resilient to it.