The public statements from the Reserve Bank suggests they are monitoring the situation, and working with APRA on potential measures should the need arise. However, the recent freedom of information request reveals a significant and important dialogue within the bank about the potential impact of investor loans. A highly restricted document from 2014 makes the following points. Two concerns on increase in investor lending:
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%.
In addition there were concerns about the 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).
… and on 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.
Then, we noted the Reserve Bank of NZ view that the risks in investment loans are different from owner occupied loans and should have different capital rules applied.
We continue to stress the fact the lending for investment property is unproductive, we need more finance for business, which can create productive growth.
Finally, we note the capital regulatory discussions on forthcoming changes to the capital rules under Basel IV, and where investment loans fit in.
Put all this together, and the risks to the broader economy, and the banking system from higher investment property loans, at a time of low interest rates, and high prices are significantly higher than acknowledged in public by the regulators in Australia. In addition, the recent interest rate cut makes even less sense.
