Investment Mortgages, a 10-Year View

Continuing our series on the 10-year data from our household surveys, today we look at the investment mortgage portfolio. We find some interesting variations compared with the owner occupied borrowing segments, which we discussed recently.

In value terms, 28% of the portfolio is held by exclusive professionals, 15% to suburban mainstream, 14% mature stable families, 10% to young affluent, 9% to rural and 5% to young growing families.  19% of the portfolio was written in 2016.

In 2016, 23% of the loans were to the exclusive professional segment, 14% to young affluent, 11% to rural, 17% to mature stable families, 12% to suburban mainstream, and 5% to young growing families.  Young affluent households were more active last year, than across the entire portfolio.

In 2016, the average value of the mortgage to exclusive professionals for investment purposes was $982,360 compared with $536,193 for young affluent, $652,812 for mature stable families and $412,924 for young growing families.

The analysis shows the penetration of investment properties touches most segments, but is also shows a skew towards more affluent groups.

Is Business Lending Momentum On The Turn?

The latest data from the ABS, Lending Finance for October 2016, shows total credit flows in October were $68.1 billion, up 0.72% compared with last month, in the more reliable trend terms. Within that, the total value of owner occupied housing commitments excluding alterations and additions fell 0.5% in trend terms, to $19.7 billion. Alterations and additions, fell 0.5%.

The trend series for the value of total personal finance commitments fell 1.2%. Revolving credit commitments fell 3.5%, while fixed lending commitments rose 0.1%. Total personal finance flows fell to $6.6 billion.

The trend series for the value of total commercial finance commitments rose 1.7% to $40.9 billion. Fixed lending commitments rose 2.0% to $32.8 billion and revolving credit commitments rose 0.4% to $8.1 billion

The trend series for the value of total lease finance commitments rose 0.1% in October 2016 and the seasonally adjusted series fell 11.8%, after a rise of 10.1% in September 2016.

What is possibly significant is that within the fixed business lending category, we have a combination of lending for investment property and lending for other business purposes. We are beginning to see a rise in other business lending, alongside lending for investment property. We need to see more of the former, and less of the latter.

Lending for investment property rose 1.5% to $12.5 billion, whilst lending for other business purposes rose 2.3% to $20.3 billion. As a result, the share of lending for business (other than for investment property) rose, whilst the share of commercial lending for investment property fell from 38.2% to 38%.

Looking at the investment property data, investors were hot to trot in Sydney, and Melbourne. Much of the investment property remains in these two centres.

ANZ Lifts Variable Investment Property Rates

ANZ today announced its variable Residential Investment Property Loan Index Rate would increase by 0.08%pa to 5.60%pa in response to rising funding costs and changing market conditions.

There is no change to ANZ’s standard variable rate for owner-occupier home loans.

Fixed rates remain unchanged for both investors and owner occupiers.

ANZ Group Executive Australia Fred Ohlsson said: “Despite residential investor rates remaining at historic low levels, this was a difficult decision that took into account increases in our funding costs and our regulatory obligation to manage a balanced portfolio.

“There are no changes to our variable rates for owner-occupier home loans. Customers concerned about the long-term direction of interest rates are able to take advantage of our competitive fixed rates that remain unchanged for both investors and owner-occupiers,” Mr Ohlsson said.

ANZ will also increase its Equity Manager Account rate by 0.15%pa to 5.82%pa. All changes are effective 16 December.

NAB residential investor home loan variable interest rates to change

NAB has said it will increase its variable rates on new and existing residential investor home loans by 0.15% per annum, effective from Monday 12 December 2016.


This will mean NAB’s Variable Rate for Residential Investment Home Loans will be 5.55% per annum.

There is no change to NAB’s Variable Rate for Home Loans (Standard Variable Rate) for owner occupier customers, which remains at 5.25% p.a.

NAB Chief Operating Officer, Antony Cahill, said NAB takes a disciplined approach to managing its entire portfolio, and needs to make adjustments to ensure it continues to lend responsibly and sustainably to all customers.

“We don’t make these decisions lightly, and these changes reflect the increasingly challenging environment we are currently operating in as we seek to meet the needs of all our customers and our shareholders,” Mr Cahill said.

“As was evident during the recent bank reporting season, net interest margins – the difference between what we pay to borrow funds to lend to our customers and what our customers pay – are down, particularly in home lending, and they remain under pressure.

“A low-rate environment poses considerable challenges to all lenders, and we must respond to what is happening in the economy and the market. In doing so, we have to consider a range of factors including the ongoing need to hold longer-term stable sources of funding, continued elevated funding costs, regulatory requirements, and the competitive pressures at play.

“We will continue to regularly review our products and pricing, and make decisions that enable us to achieve a balance for all stakeholders – borrowers wanting to buy a home or grow their business, depositors and investors seeking a return on their investment, and our shareholders who rely on our dividends.”

Earlier this year, NAB made changes to the way it prices its home loans based on loan purpose and repayment type.

“We can now be more specific in how we manage our entire home lending portfolio in line with economic conditions and regulatory requirements,” Mr Cahill said.

He said the investor segment continues to be important to NAB, and interest rates for all home buyers are around their lowest levels in more than 50 years.

“NAB is committed to providing customers with great value and service, and home loan products that suit their needs at a competitive price,” Mr Cahill said.

NAB continues to offer highly competitive fixed rate terms, and borrowers seeking certainty about their repayments may want to consider fixing part or all of their home loan.

“Switching to a fixed rate loan is a straightforward and easy process, and I encourage borrowers to speak with their banker or broker to find out more about what’s available, and if a fixed rate home loan might be right for their circumstances.

“We’re here to help our customers as they make choices about which product may best suit their needs,” Mr Cahill said.

Conditions, fees and eligibility criteria apply to NAB’s products. Customers who want to know more about these changes are encouraged to contact their banker about what works best for them.

Investment Home Lending Is Where It Is At

The data from the ABS of lending finance for May 2016 shows an overall fall of 0.8% in borrowing flow of all types, or $885 million, compared with the previous month. Within this, there was a relative rise in the proportion of new loans for investment housing (16.% of all lending flows), whilst the relative proportion of lending to business, net of investment housing, fell, to 53.8% of all lending in the month, down from a maximum of 61% of all flows in Match 2015.

Trend-Lending-Flows-May-2016This is not a good outcome when lending to business can translate to productive growth, whilst lending for investment housing continues to stoke up home prices and bank balance sheets. No surprise the banks are cutting mortgage rates to try and attract more business, but at the expense of business lending.

The total value of owner occupied housing commitments excluding alterations and additions fell 0.6% in trend terms to $20.5 billion. Investment lending volumes, which are included in the business volumes, were similar to the previous month, showing a relative swing towards investment loans at $11.6 billion.

The trend series for the value of total personal finance commitments rose 0.9%, or $65 million to $7.3 billion. Revolving credit commitments rose 1.8% and fixed lending commitments rose 0.3%. The seasonally adjusted series for the value of total personal finance commitments fell 4.6%. Revolving credit commitments fell 7.8% and fixed lending commitments fell 2.3%. Households are borrowing more on personal credit, including making up the difference on deposits for housing, as lending criteria get tighter.

The trend series for the value of total commercial finance commitments fell 1.2% to $28.4 billion, net of investment housing. Revolving credit commitments and Fixed lending commitments both fell 1.2%. The seasonally adjusted series for the value of total commercial finance commitments fell 4.1%. Fixed lending commitments fell 4.4% and revolving credit commitments fell 3.2%.

The trend series for the value of total lease finance commitments fell 3.9% in May 2016 and the seasonally adjusted series fell 14.2%, following a fall of 0.6% in April 2016 to $517 million.



Housing Lending Keeps The Ship Afloat

The final data from the ABS for March lending finance includes data on all the flows, including commercial. Trend finance for owner occupied housing flows fell 0.7% to $20.9 billion in the month, personal finance rose 0.5% to $6.9 billion and commercial finance fell 1% to $41.9 billion (which includes investment housing lending of $11.7 billion).

All-Lending-Mar-2016-FlowsLooking at the overall lending trends, we see on a 3 month rolling average, credit flows fell by 0.73% and have been falling since October 2015.

Data on commercial lending for the purchase of existing investment properties shows an uptick, based on the original data by selected states. After the slowing around the summer, it is now trending higher, especially in NSW  (before the cash rate cut).


We can also look at some of the other ratios which are important. First, total housing lending – including owner occupation and investment made up 46.7% of all lending flows. This is a record, and shows that the banks are reliant on housing lending to keep their ships afloat. The proportion of commercial lending not investment property related to all lending was 42.7%, and has been falling since October 2015.    The proportion of commercial lending which was for investment property related, to all commercial lending rose to 28.1%, the highest it has been for six months.

All-Lending-Mar-2016-Flows-Ratios So do not be fooled by talk of the home lending market stalling, it is not so. Even before the RBA’s cash rate cut at the start of May, housing lending of all flavours was significant, and demand will likely rise as  lower rates flow through, especially as the stock markets look shaky in May (sell in May and go away…?) and deposit interest rates are being killed.

Economically though, more home lending does not solve our economic growth problem.

Where Did The 10% Investor Mortgage Growth Speed Limit Come From?

An interesting FOI disclosure from the RBA tells us something about the discussions which went on within the regulators in 2014 and beyond, as they considered the impact of the rise in investor loans. Eventually of course APRA set a 10% speed limit, and we have see the growth in investment loans slow significantly and underwriting standards tightened.

Back then, they discussed the risks of investment lending rising, especially in Melbourne.

Macroeconomic: Extra speculative demand can amplify the property price cycle and increase the potential for prices to fall later. Such a fall would affect household spending and wealth. This effect is likely to be spread across a broader range of households than the investors that contributed to the heightened activity.

Concentration risk: Lending has been concentrated in Sydney and Melbourne, creating a concentrated exposure in these cities. The risk could come from a state-based economic shock, or if the speculative upswing in demand brings forth an increase in construction on a scale that leads to a future overhang of supply. In Sydney, the risk of oversupply appears limited because of the pick-up in construction follows a period of limited new supply and it has been spread geographically and by dwelling type. While the unemployment rate has picked up a little over the past 18 months, the overall economic environment in NSW is in a fairly good state. In Melbourne, there has been a greater geographic concentration of higher-density construction in inner-city areas. Some developments have a concentration of smaller-sized apartments that may only appeal to some renters, or purchasers in the secondary market. Economic conditions are not as favourable in Victoria and the unemployment rate is 6.8%.

Low interest rate environment: While a pick-up in risk appetite of households is to some extent an expected outcome given the low interest rate environment, their revealed preference is to direct investment into the housing market.  Historically low interest rates (combined with rising housing prices and strong price competition in the mortgage market) means that some households may attempt to take out loans that they would not be able to comfortably service in a higher interest rate environment. APRA’s draft Prudential Practice Guide (PPG) emphasises that ADIs should apply an interest rate add-on to the mortgage rate, in conjunction with an interest rate floor in assessing a borrower’s capacity to service the loan. In order to maintain the risk profile of borrowers when interest rates are declining, the size of the add-on needs to increase (or the floor needs to be sufficiently high).

Lending standards: In aggregate, banks’ lending standards have been holding fairly steady overall; lending in some loan segments has eased a little, while lending in some other segments has tightened up a bit. The main lending standard of concern is the share of interest-only lending, both to owner-occupiers and investors. For investors, 64% of banks’ new lending is interest-only loans and for owner-occupiers the share is 31%. The typical interest-only period is 5 years, but some banks allow the interest-only period to extend to 15 years. During this period, the loan is amortising more slowly than a loan that requires principal and interest (P&I) payments. If housing prices should fall, this increases the risk that the loan balance may exceed the property value (negative equity). There is some risk that the borrower could face difficulty servicing the higher P&I payments when the interest-only period ends, although this is typically mitigated by banks assessing interest-only borrowers on their ability to make P&I payments.

Of course the regulators found underwriting standards were more generous than they thought, at times in 2015 more than half of all new loans were investment loans, and recently banks have reclassified loans, causing the absolute proportion of investment loans to rise. Things were whose than they thought.

Next they discussed how to set the “right” growth rate:

How to calibrate the benchmark growth rate?  Household debt has been broadly stable as a share of income for about a decade. National aggregate ratios are not robust indicators of a sector’s resilience because the distribution of debt and income can change over time. But as a first pass, it is reasonable to expect that the current level of the indebtedness ratio is sustainable in a range of macroeconomic circumstances. Therefore there does not seem to be a case to set the benchmark growth rate significantly below the rate of growth of household income, in order to achieve a material decline in the indebtedness ratio. With growth in nominal household disposable income running at a little above 3 per cent, this sets a lower bound for possible benchmarks at around 3 per cent. Current growth in investor credit, at nearly 10 per cent, suggests an upper bound around 8 per cent to achieve
some comfort about the leverage in this market. Within this range, there are several options for the preferred benchmark rate for investor housing credit growth (including securitised credit).

a) Around 4½ per cent, based on projected household disposable income growth over calendar 2015. This could be justified as being consistent with stabilising the indebtedness ratio. However, it would be procyclical, in that it would be responding to a period of slow income growth by insisting that credit growth also slow. It would also be materially slower than the current rate of owner-occupier credit growth, which so far has not raised systemic concerns.

b) Around 6 per cent, based on a reasonable expectation of trend growth in disposable income, once the effects of the decline in the terms of trade have washed through. It is also broadly consistent with current growth in owner-occupier housing credit, which as noted above has not been seen as adding materially to systemic risk.

c) 7 per cent, consistent with the system profile for residential mortgage lending already agreed as part of the LCR/CLF process. Unless owner-occupier lending actually picks up from its current rate, however, the growth in investor housing credit implied by the CLF projections would be stronger than this. It is therefore not clear that these projections should be the basis for the preferred benchmark.

Staff projections suggest that only a moderate decline in system investor loan approvals would be required to meet a benchmark growth rate for investor housing credit in the 5–7 per cent range for calendar 2015. The exact size of the decline depends partly on assumptions about repayments through churn, refinancing and amortisation in the investor housing book. For a reasonable range of values for this implied repayment rate, and assuming that investor housing credit growth remains at its current rate for the remainder of 2014, the required decline in investor approvals is of the order of 10–20 per cent. This would take the level of investor housing loan approvals back to that seen a year ago. It is worth noting that investor loan approvals would have to increase noticeably from here to sustain the current growth rate of investor housing credit, even though the implied repayment rate is a little below its historical average. Since credit is not available at a state level, the benchmark can only be expressed as a national growth rate. The flow of loan approvals at a state level can be used as a cross-check to ensure that the benchmark incentive has had its greatest effects in the markets that have been strongest recently.

When the 10% cap (note this is higher than those bands discussed above) was announced, some Q&A’s provide some insights into their thinking.

Isn’t 10 per cent a bit soft?  We are not trying to kill the market stone dead. Investor housing credit is currently running at a bit under 10 per cent. Some lenders will have investor credit growth well below this benchmark anyway, so if all lenders do end up at least a little under this benchmark, which we hope they will, then aggregate growth in investor credit will be noticeably below 10 per cent. Setting a benchmark for individual institutions is not the same thing as setting it for an aggregate, and APRA has allowed for that.

Where did the 10 per cent benchmark come from?  This was a collective assessment by the Council agencies. We took the view that we did not want to clamp down on the market excessively. We also took the view that in the long run, household credit can expand sustainably at a rate something like the rate of trend nominal household income growth, maybe a bit more or less in shorter periods. Trend income growth is below 10 per cent, more like 6 per cent or thereabouts. But it was important to make an allowance for the fact that some lenders will undershoot the benchmark, so the aggregate result will likely be slower than that.

But isn’t household income growth likely to be below average in the next few years, because of the end of the mining boom?  Maybe, but we don’t want to be procyclical and clamp down on credit supply more when the economy growing below trend.

This of course confirms the regulators were wanting to use household debt as an economic growth engine (interesting, see the recent post “Why more-finance-is-the-wrong-medicine-for-our-growth-problem” )

We also see a significant slow down in household income growth, yet credit growth, especially housing has been stronger, creating higher risks if interest rates or unemployment was to rise. Raises the question, were the regulators too slow to act, and did they calibrate their interventions correctly? We will see.


Lending Finance To Dec 2015 Shows Business Loans Up Ex. Investment Housing

The ABS data to December 2015 of total lending by category shows that the total flow value of owner occupied housing commitments excluding alterations and additions rose 1.3% in trend terms (to $21.9 bn), and the seasonally adjusted series rose 0.9%.

The trend series for the value of total personal finance commitments fell 0.7% (to $6.9 bn). Fixed lending commitments fell 1.0% and revolving credit commitments fell 0.3%. The seasonally adjusted series for the value of total personal finance commitments rose 2.1%. Fixed lending commitments rose 2.6% and revolving credit commitments rose 1.5%.

The trend series for the value of total commercial finance commitments fell 0.3% (to $44.1 bn). Revolving credit commitments rose 2.4%, while Fixed lending commitments fell 1.2%. The seasonally adjusted series for the value of total commercial finance commitments fell 7.3%. Revolving credit commitments fell 18.3% and fixed lending commitments fell 3.3%.

The trend series for the value of total lease finance commitments rose 0.1% in December 2015 (to $602m) and the seasonally adjusted series rose 1.7%, after a fall of 3.8% in November 2015.

All-Lending-Trends-Dec-2015Commercial finance includes lending to individuals and other for investment property purchase. We see that lending for investment property purchase slid to 15% of all lending in December, having reached a high of nearly 20% in late 2014. In addition, the proportion of commercial lending which related to investment property purchase fell to 25% of all commercial lending, having reached a peak of 31.4% in late 2014.

However, bearing in mind total commercial lending fell in the month, we see that owner occupied lending is now growing considerably faster (1.3%), compared with investment lending (down 2.4% and $11.4 bn) and commercial lending in aggregate is down 0.34%, but the non-investment housing segment rose 0.38% (to $32.7 bn).

If investment lending continues to slow, this will put more pressure on commercial lending growth, or create space for other lending to business, depending on your point of view. Or will the banks simply continue to chase owner occupied refinancing, the easy option? That said, lending to business ex. investment housing did grow, if but a little in the month. We need much stronger movement here to drive productive growth.

Lending Finance Shows NSW Investment Property Momentum Falling

The last piece of the finance data, from the ABS shows lending finance for October 2015. Two things of note (despite the noise in the data, as we have already discussed), first, investment housing lending is on the slide (down 3%), offset by a rise in owner occupied lending (up 2%), so overall lending for housing contained to rise a little. Second lending for business rose (up 1.3%). Investment loans were down to 36% of all housing, and lending for commercial (other than for property investment) rose from 43.8 to 44.2%.

All-Lending-Oct-2015Data for NSW, which is original data (no adjustments for trend or seasonality), showed a 5% rise in construction finance for investors, offset by a 33% fall in investment for existing property.  From this, it looks like the investment property party may just be over.


Many Eastern States Investment Properties Are Underwater

We have had the opportunity to do a deep dive on investment property loans, using data from our household surveys. We have looked at gross rental returns, net rental returns (after the costs of mortgage servicing are included) and net equity held (current property value minus mortgage outstanding). The results are in, and they make fascinating reading, especially in the context of up to 40% of all residential property loans being for investment purposes, according to the RBA. Whilst we will not be sharing the full results here, one chart tells the story quite well.

We show the average gross rental yield on houses by state, (the blue bar), net rental yields before tax (the orange bar) and the net gross average capital gain (the yellow line). Gross yield is annualised rental over current value, assuming full occupancy;  net rental is annual rental less annual mortgage repayments; and capital value is the current marked to market price less current outstanding mortgage. The first two are shown as a percentage, the last as a dollar value. The chart below only covers houses, we have separate data on other property types but won’t show that here.

Rental-SnapshotWe found that investment property which were houses in VIC were on average losing money at the net rental level (and this is before any maintenance or other costs on the property). Those in NSW were a little better, but still in negative territory. The other states were in positive ground – some only just – and of course this is at current interest rates, before the latest uplifts were applied by the banks. We accept that the pre-tax position does not tell the full story, but as a stand-alone investment, many property investors are from a cash flow perspective underwater. Indeed, they are banking on prospective capital gains, and at the moment, they do have a cushion, but if prices were to slip, many would find this eroded quickly.

Our take is that the property investment sector contains considerable risks for banks, and investors, and these are not well understood at the moment. The more detailed analysis we did also showed that some specific customer segments, regions and postcodes were more at risk. Running scenarios on small interest rate rises shows that things get worse very quickly, especially for higher LVR loans.

We concur with analysis from Ireland and New Zealand, that the risks in the investment loan portfolios, despite the apparent historic low rates of default, are higher, and under Basel IV we expect investment loans to carry a higher capital rating, meaning that interest rates on investment loans are likely to rise more in the future, relative the the cash rate.