Tag: Macroprudential

Australian Household Loan To Income Ratios Are Worse Than In The UK

As we highlighted recently, the Bank of England is supporting the imposition of loan to income (LTI) ratios on banks in the UK, as a way to manage risks in the housing sector. So today, we start to explore loan to income data in Australia, captured though our rolling programme of household surveys. We start with some average national data, then look at the NSW picture in more detail. The UK recommendation, was to ensure that mortgage lenders do not extend more than 15% of their total number of new residential mortgages at Loan to Income ratios at or greater than 4.5. This recommendation applies to all lenders which extend residential mortgage lending in excess of £100 million per annum.

So whats the Australian data? We start by looking at the average LTI by postcode. The histogram shows the average LTI by household, calculated at a postcode level, and including all households with a mortgage. Income means the gross annual income, before tax or other deductions. We see that the LTI varies between 2.25 and 8. This is the ratio of household income to the size of the mortgage. We see a peak around 4.25-4.5 times, and a second peak at 6.25. Newer loans are more represented in this second peak.

Loan to income is a good indicator, because it isolates movements in house prices altogether from the data. The rule of thumb when I was working in the bank as a lender was to take 3 times the first income, and add one times the second income as a measure of the loan which was available to a household. Although rough, it was not too bad. Since then, lending rules have changed and criteria stretched. This ability to lend more has in turn led to higher house price inflation, thanks to supply/demand dynamics.

Australia-LTI-Average The current data from the UK shows that LTI’s there are spread between 0 and 6. Interestingly, we see that in their forward scenarios they suggest an emerging second peak around an LTI of 5 times. So LTI’s in Australia are more stretched than in the UK. The regulators here do not report LTI data regularly. This is a significant gap. LTI2We can map relative LTI average to post code. Here is the Sydney example, which highlights that there is a significant geographic concentration of high LTI loans in the western suburbs of Sydney.

Sydney-LTIThere is, further, a correlation between higher LTI loans and Mortgage Stress. Here is the stress data for Sydney.

NSW-Mortgage-StressThese are concerning indicators. In addition as we dig into the data we find that the second peak in the LTI data relates to younger buyers, often first time purchasers. They are highly leveraged into the property market, and are surviving thanks to the very low interest rates available today. If rates rise, this could be a problem. This suggests that the loan to income situation in Australia is more adverse than the UK scene. Whilst we note the UK regulator is acting, there is no macro-prudential intervention in Australia.  There should be.

Later we will present additional data across the other major centres, and examine in more detail those who are recent purchasers.

UK To Cap High Loan To Income Mortgage Loans

The UK Financial Policy Committee is is charged with taking action to remove or reduce systemic risks with a view to protecting and enhancing the resilience of the UK financial system. In their June 2014 report they highlighted that the recovery in the UK housing market has been associated with a marked rise in the share of mortgages extended at high loan to income multiples. Increased household indebtedness may be associated with a higher probability of household distress, which can cause sharp falls in consumer spending. Falls in consumption can in turn weigh on wider economic activity, increasing macroeconomic volatility in the face of shocks to income and interest rates. Furthermore, rapid growth in aggregate credit – which could be associated with a sharp increase in highly indebted households – is strongly associated with subsequent economic instability and the risk of financial crisis. Acting against excessive indebtedness will make the financial system more stable.

As a result, the FPC decided at its June meeting to recommend to the Prudential Regulatory Authority (PRA) and the Financial Conduct Authority (FCA) that they take steps to ensure that lenders constrain the proportion of new lending at loan to income (LTI) ratios at or above 4.5 to no more than 15% of the total number of new mortgage loans. This is because they believe the the aggregate effect of many firms undertaking such lending could pose a risk to financial stability.

They recommend:

“The PRA and the FCA should ensure that mortgage lenders do not extend more than 15% of their total number of new residential mortgages at Loan to Income ratios at or greater than 4.5. This recommendation applies to all lenders which extend residential mortgage lending in excess of £100 million per annum. The recommendation should be implemented as soon as is practicable.”

The PRA have now released a detailed consultation paper on implementing this recommendation. They are intending to implement the recommendation as soon as practicable. The proposed implementation date for these rules is 1 October 2014. The proposed rules would have the effect of limiting to no more than 15% of the total the number of mortgage loans completed by each lender at or greater than 4.5 times LTI. The limit is intended to restrict but not halt the extension of mortgage lending at such LTIs and can thus be thought of as a limit on the flow of very high LTI lending. The measure is designed to capture risks associated with excessive household indebtedness. Lenders will be required to report on this dimension. This relates to mortgages written, not offers made, or decisions in principle. Remortgages are buy-to-let mortgages are excluded. They provide data on the split by LTI in the UK, showing the trends.LTIThey also show scenarios for the potential impact of the policy. If house prices and mortgage approvals grow in line with the central scenario, the impact of the policy action is likely to be minimal. However, if there is more underlying strength in the housing market than in the central scenario, the proposed rule would be likely to restrict the availability of very high LTI mortgages to some households. The proposed policy might then reduce the level of GDP in the short term to the extent that it acts as a binding constraint on mortgage lending. However, even in the upside scenario considered in the June 2014 FSR, the size of the effect would be small (roughly 0.25%). The main benefits of the policy will be to reduce macroeconomic volatility and the likelihood and severity of financial instability.LTI2Two observations for the Australian market. First, we have no macro-prudential policies here despite the fact that they are recommended by several global bodies. Second, the LTI metric is recommended as the policy of choice, and in Australia we do not see regular reporting of LTI data from the banks via APRA or ABS.  Given the high income multiples here, we should be following the UK. In addition the regulators should start to capture and report LTI data.