The peak LVR’s on investment mortgage transactions is down according to a speech today given by Heidi Richards, General Manager, Industry Analysis APRA, which developed further the information published yesterday relating to mortgage underwriting standards. This is important because 62% of bank lending is mortgage related (a high). Whilst much of the information in the speech covered the same ground, which we discussed yesterday, there was a striking piece of data on the LVR’s of investment loans.
More recently, APRA’s initiative to rein in growth in the investor segment of the market has prompted a number of ADIs to use LVR caps as a lever to reduce loan approvals in this segment. Although many ADIs traditionally required more equity for investment loans, some ADIs reduced maximum LVRs for investors significantly over the course of 2015. Note the actual distribution of loans approved for investors is much lower than these maximum levels, and overall, LVRs for investors on average tend to be lower than for owner-occupiers.
Two observations. First different lenders clearly had – and have different policies relating to LVR limits, and second LVR limits have been reduced, by some in recent times. For example, a maximum from 92.5% down to 65%! Others have not changed their maximum ratios (though may not be lending to the maximum of course).
Towards the end of her speech she brings together the various steps taken to reduce lending, and referring to the hypothetical borrower model summaries:
…the hypothetical borrower exercise illustrated a material tightening of lending standards that we believe is appropriate and reflects more sensible risk assessment practices. Between 2014 and 2015, the maximum loan sizes that could have been extended to our four hypothetical borrowers declined by, on average, around 12 per cent for investors and 6 per cent for owner-occupiers. The actual change for individual ADIs was greater, up to 25 per cent in some cases. This should not be interpreted as an indication that actual loan sizes are shrinking, however, only that the maximum allowable loan for a given borrower income profile is now more conservative.
The next two charts illustrate the key drivers of this result. For owner-occupiers, the largest impact has come from the use of more realistic estimates of living expenses. For investors, interest-rate buffers that ADIs now apply more consistently to the borrower’s other debts are most significant. I should mention that there are also changes to standards at some ADIs that are yet to be implemented, due to systems constraints or other hurdles, so these results will continue to evolve and we will most likely conduct additional exercises in the future.
These changes reflect the policies of each lender, but it is always possible that practice may be divergent from policy. Lenders generally allow some scope for the standard credit criteria to be overridden by experienced lending staff. APRA would clearly be concerned if these tighter policies were being undermined in practice to any material degree.
As a result, we are taking a hard look at loans approved outside serviceability policy. Many loans are approved or declined based on automated criteria. In some cases, however, an application might be referred for a manual decision because it marginally fails a serviceability test. The loan might ultimately be approved by a lending officer with appropriate delegation if there is other evidence that the borrower can service the loan—this might be, for example, because there is other income that was not captured in the decisioning tool, the borrower is on maternity leave with temporarily lower income, or for bridging finance. However, there is also the potential for weaker loans being approved, and in our view ADIs need to have good oversight and monitoring of these approvals. APRA data shows a recent uptick in loans approved outside serviceability; anecdotal evidence indicates much of this relates to loans in the pipeline that were preapproved under older, looser criteria now being settled. So we expect to see this volume taper off.
Another way to look at the situation is that there are tranches of loans which were written under more generous underwriting terms, for at least the last 2-3 years. These loans may well have a higher probability of default down the track (after all why else would APRA want to tighten the criteria), so it will be interesting to see if indeed defaults rise higher than average in these loan pools. Across the board defaults are up, if only a little. For the major bank issuers, the 30 day delinquency rate increased to 1.15 per cent at December also up from 0.94 per cent at September according to Moody’s.
