Investment Lending – Page 5 – Digital Finance Analytics (DFA) Blog

UK Budget Emasculates Negative Gearing

This week the UK Chancellor, George Osborne delivered his latest budget. One strong theme was the need to reduce the bias towards buy-to-let property investors against owner occupied purchasers. Currently, landlords can claim tax relief on monthly interest repayments at the top level of tax they pay of 45 per cent. Mortgage interest relief is estimated to cost £6.3billion a year. Buy-to-let lending has accounted for more than 15% of mortgages taken out – compared with 50% of new mortgages in Australia. The UK has seen the proportion grow by 8% in recent years.

“First, we will create a more level playing-field between those buying a home to let, and those who are buying a home to live in. Buy-to-let landlords have a huge advantage in the market as they can offset their mortgage interest payments against their income, whereas homebuyers cannot. And the better-off the landlord, the more tax relief they get. For the wealthiest, every pound of mortgage interest costs they incur, they get 45p back from the taxpayer. All this has contributed to the rapid growth in buy-to-let properties, which now account for over 15% of new mortgages, something the Bank of England warned us last week could pose a risk to our financial stability. So we will act – but we will act in a proportionate and gradual way, because I know that many hardworking people who’ve saved and invested in property depend on the rental income they get. So we will retain mortgage interest relief on residential property, but we will now restrict it to the basic rate of income tax. And to help people adjust, we will phase in the withdrawal of the higher rate reliefs over a four year period, and only start withdrawal in April 2017”.

So now, this will change, in a move which will ‘level the playing field for homebuyers and investors’, according to the Chancellor, the amount landlords can claim as relief will be set at the basic rate of tax – currently 20 per cent. The change will be tapered in over the next four years. The expectation is that as a result more first time buyers will be able to enter the market.

The Bank of England recently said it would monitor buy-to-let lending more closely, and analysts are concerned about the potential impact should UK rates rise, even with the current incentives in place. A record of a June 24 meeting of the BoE’s Financial Policy Committee shows the bank asked staff to gather evidence for the government consultation later this year, and to look at what action it could take before gaining further formal powers. Last week the Bank of England warned that a surging buy-to-let market could pose a risk to financial stability as landlords are potentially more vulnerable to rising interest rates.

This mirrors concerns raised by the Reserve Bank of New Zealand who cite considerable evidence that investment loans are inherently more risky:

the fact that investment risks are pro-cyclical
that for a given LVR defaults are higher on investment loans
investors were an obvious driver of downturn defaults if they were identified as investors on the basis of being owners of multiple properties
a substantial fall in house prices would leave the investor much more heavily underwater relative to their labour income so diminishing their incentive to continue to service the mortgage (relative to alternatives such as entering bankruptcy)
some investors are likely to not own their own home directly (it may be in a trust and not used as security, or they may rent the home they live in), thus is likely to increase the incentive to stop servicing debt if it exceeds the value of their investment property portfolio
as property investor loans are disproportionately interest-only borrowers, they tend to remain nearer to the origination LVR, whereas owner-occupiers will tend to reduce their LVR through principal repayments. Evidence suggests that delinquency on mortgage loans is highest in the years immediately after the loan is signed. As equity in a property increases through principal repayments, the risk of a particular loan falls. However, this does not occur to the same extent with interest-only loans.
investors may face additional income volatility related to the possibility that the rental market they are operating in weakens in a severe recession (if tenants are in arrears or are hard to replace when they leave, for example). Furthermore, this income volatility is more closely correlated with the valuation of the underlying asset, since it is harder to sell an investment property that can’t find a tenant.

Reaction from the UK has been predictable, with claims the changes will put rents up, slow new property builds, and lead to a deterioration in the maintenance of existing rental property. In addition, some claim it will lead to landlord deciding to sell their property, releasing more into the market. Finally, there is debate about the comparison between investors and owner occupied property holders – Homeowners are not running businesses nor do they pay capital gains tax, for example, on disposal of their property.

That the UK is taking steps when 15% of property is buy-to-let should underscore the issues we have here when 35% of all mortgages are for investment property, and more than half of loans written last month were for investment purposes. This is bloating the banks balance sheets, inflating house prices, and making productive lending to businesses less available. The UK changes provides more evidence it is time to reconsider negative gearing in Australia

Home Lending Rose to $1.47 Trillion in May

The RBA lending aggregates for May 2015 tell the ongoing story of housing lending dominated by investment loans, and housing becoming an ever larger proportion of total bank debt. Total bank lending stock grew to $2.4 trillion in May, with $1.47 trillion in housing, growing at 0.42% in the month, business lending up 0.35% to $792 million and personal lending (excluding housing) down a little to $141 million. Overall housing lending was 61.1% of all bank lending (excluding government loans) – an all time high.

Looking more closely at housing, the $1.47 trillion was split into owner occupied lending of $958 million, up 0.42% in the month, and investment lending of $508m, up 0.81%, showing again the disproportionate focus on investment property.

We can but reiterate our two key points. First, housing lending is squeezing out productive lending to business, and in so doing continues to inflate banks balance sheets, and house prices, neither productive economically speaking; whilst business finds it hard to get the support it needs to create productive growth. In the context of a mining slow down, this is a serious problem, which will not be addressed by $20k capital write-offs. Capital rules favour home lending too much.

Second, the distortions created by ever larger bands of property investors, makes it harder for younger families to buy a home – indeed many are going direct to the investment sector in a bid to get a look in. However, those who analyse relative risks in an investment portfolio versus an owner occupied portfolio indicate there are higher risks in the investment pools, especially in a down turn. These risks are not recognised by the current Basel rules, and such risks are not currently priced into investment loans.

The data so far does not demonstrate any impact from the “tighter” APRA rules for investment lending, maybe next month? Even if one or two banks slow their investment lending growth rates and tighten their underwriting criteria, others will happily step in.

Perspectives on the Housing Debate

Last week amongst all the noise on housing there were some important segments from the ABC which made some significant contributions to the debate. These are worth viewing.

First Lateline interviewed the Grattan Institute CEO on the social and political impacts of housing policy, and also covered negative gearing.

Second The Business covered foreign investors, restrictions on investment lending and the implications for non-bank lenders who are not caught by the APRA “guidance”.

Third, a segment from Insiders on Sunday, dealing with both the economic arguments and the political backcloth.

Next a segment from Australia Wide which explores the tensions dealing with housing in a major growing city, Brisbane. No-one wants building near their backyard, so how to deal with population growth.

The Rise, and Rise, and Rise of Investor First Time Buyers

DFA has just released the latest analysis of survey results which shows that nationally 35% of all First Time Buyers are going direct to the Investment sector. However there are significant state differences, with more than fifty percent of transactions from first time buyers in NSW, and upticks in other states as the behaviour spreads. You can watch our latest video blog on this important subject.

Here is the data we used in the video. The first chart shows the national average picture, using data from the ABS to track owner occupied first time buyers (the blue area), data from DFA surveys to display the number of FTB investment loans (the yellow area), both to be read from the left hand scale, and the relative proportion of loans using the yellow line on the right had scale. About 35% of loans are going to investment first time buyers.

In NSW, the rise of investors has been running for some time, and as a result, more than 50% of loans are First Time Buyer investors. Note the growth thorough 2013.

In QLD, until recently there was little FTB investor activity, but we are seeing a rise in 2014, to a peak of 12%

The rise of FTB investors in VIC started in 2013, but is now growing quite fast, to about one quarter of all FTB activity.

Finally, in WA, where OO FTB activity is quite strong, we are now seeing the rise of FTB investors too. Currently about five percent are in this category.

There is a clear logic in households minds. They see property values appreciating in most states, yet cannot afford to buy a property for owner occupation in a place where they would want to live. So they choose the investment route. This enables them to purchase a cheaper property elsewhere by grabbing an investment loan, often interest only and serviced by the rental income. In addition they get the benefits of negative gearing and potential capital appreciation. Meantime they live in rented accommodation, or with families or friends. About ten percent of recent purchasers have received some help from “The Bank of Mum and Dad“. Finally, some see the investment route as a means to build capital for the purchase of an owner occupied property later, though others are now thinking more in terms of building an investment property portfolio. They are on the property escalator, with the expectation that prices will continue to rise.

There are some significant social impacts from this change, and there are probably more systemic risks in an investment loan portfolio, which should be considered. We are of the view that the recent APRA “guidelines” will only have impact at the margin, so we expect to see continued growth in FTB investment property purchases for as long as interest rates stay low and property values rise.

RBNZ Issues Consultation On LVR Rules For Auckland Residential Property Investors

The NZ Reserve Bank has published a consultation paper about proposed changes to the rules that banks must follow for high-LVR mortgage loans.

The proposals were announced in the Reserve Bank’s Financial Stability Report released on 13 May 2015. They would mean investors in Auckland property would generally need a 30 percent deposit if they’re borrowing for a property, while home buyers outside Auckland would see increased availability of high-LVR mortgages.

The specific proposals are to:

Restrict property investment residential mortgage loans in the Auckland region at LVRs of greater than 70 percent to 2 percent of total property investment residential mortgage commitments in Auckland.
Retain the existing speed limit of 10 percent for other residential mortgage lending, as a proportion of total non-property investment residential mortgage commitments, in the Auckland region at LVRs above 80 percent.
Increase the speed limit on residential mortgage lending at LVRs above 80 percent outside of Auckland to 15 percent of residential mortgage commitments outside Auckland.

A number of loan categories are exempted from LVR speed limits, and these exemptions will be retained under the proposed policy changes. Specifically, loans that are made as part of Housing New Zealand’s Welcome Home Loan scheme, and loans that are made for the purpose of refinancing an existing mortgage loan, moving house (without increasing borrowing amount), bridging finance or constructing a new dwelling will continue to be exempt from the policy.

The paper also offers further evidence on the different risk profiles of investment versus owner occupied loans in a down turn, including data from experiences in Ireland.

“Residential property investment loans appear to have relatively low default rates during normal economic circumstances. However, the Reserve Bank has looked at evidence from extreme housing downturns during the GFC, and this clearly indicates that default rates can be higher for investor loans than for owner occupiers in severe downturns. For example, as shown in table 1, forecast loss rates on Irish mortgages were nearly twice as high for investors as for owner-occupiers. Similarly, actual arrears rates were about twice as high for investor loans (29.4 percent) than for owner occupied loans (14.8 percent) as at December 2014. Furthermore, studies which have separately estimated default rates by LVR for investor loans and owner occupier loans suggest that investor loans are substantially riskier at any given LVR. The data shows an estimate of default rate based on current LVR. For example, if a loan was initially written at a 70 percent LVR and then prices fell 30 percent, the loan would appear in the chart below as LTV=100. This would have a mildly increased rate of default compared to a low-LVR loan for an owner occupier. But for an investor, the rate of default would be higher, and would have increased more sharply as a result of a given decline in house prices.”

Note: PDH is principal dwelling house, BTL is buy to let. LTV (loan to value ratio) is conceptually the same as LVR, but this dataset uses the current LTV (after the sharp falls in house prices) rather than origination LTV.

The consultation will run until 13 July. The Reserve Bank expects to publish a summary of submissions and final policy position in August, with revised rules taking effect from 1 October.

The Reserve Bank proposes that the policy changes take effect from 1 October 2015. This relatively long notice period is to allow banks to make the necessary systems changes in order to properly classify new lending. There is a risk that a notice period of this length could lead to some Auckland property investors rushing in to beat the policy changes. However, our expectation is that banks will observe the spirit of the proposed restrictions, and will act to curtail lending at LVRs of above 70 percent to Auckland property investors well in advance of 1 October.

Currently, compliance with the LVR policy is measured over a three-month rolling window for banks with monthly lending of over $100m, and over a six-month rolling window for banks with monthly lending of less than $100m. At the time that LVR restrictions were first introduced, all banks were provided with an initial six-month measurement period. This was done to accommodate outstanding pre-approved loans, and recognised the relatively short notice period provided. A longer first measurement period does not appear to be warranted for this change to the restriction, given more than four months’ notice of an intention to change the restriction. Further, the low speed limit for Auckland property investment mortgage lending does not provide much scope to smooth lending over a longer measurement period.

Banks Grew Home Loans Again In April to $1.35 Trillion

APRA released their Monthly Banking Statistics for April 2015 today. The total home loans outstanding on the bank’s books reached $1.346 trillion, up from $1.336 trillion last month. Overall growth in the portfolio was 0.74%, with owner occupied loans sitting at 0.6% up, and investment loans 1% higher. This is before the regulatory taps were turned.

We will this month concentrate on the home loan portfolio, because it is of the most significance just now. First, lets look at the APRA “hurdle” of 10% market growth. Now there are a number of different ways to calculate this important number. Some have chosen other methods which understate the true picture in our view. We have chosen to calculate the sum of the monthly moving averages, and the results are displayed below. A number of players are well over the 10% line, and might expect a “please explain” from the regulator. Officially, they have a little time to get into line by the way. Some players of course are subject to non-organic growth, and this will distort some of the figures.

In contrast, the OO portfolio (not subject to the 10% rule) also makes quite interesting reading. In both cases some of the smaller organisations are making hay and expanding quite fast. We hope they have their underwriting and approval processes set right!

Next, a view of the monthly portfolio movements for both OO and INV loans.

Finally, a picture of the relative shares of home loans, both investment and owner occupied loans, by some the the main players (in volume terms).

If you look at the relative distribution of OO and INV loans, you can see which players may have more to worry about is the regulatory tightening on investment lending gets more intense. Recent events from New Zealand are insightful here, with the proposal to lift capital requirements on investment loans. We covered this in an earlier post.

Turning to Deposits, balances rose by $7 billion, to $1.8 trillion, an uplift of 0.38% from last month. Little change in the mix between major players. CBA maintains its pole position, although NAB grew its portfolio the fastest.

In the cards portfolio, total balances fell slightly from $41.6 billion to $41.3 billion. Again little change in the mix between players, although CBA lost more than half of the value drop from its portfolio from March to April.

RBNZ Moves Closer To Changing Capital Rules For Investment Loans

The Reserve Bank of New Zealand published the results of its consultation on the proposal to vary the capital risk weighting of investment versus owner occupied loans. Stakeholders are invited to provide feedback on the proposed wording changes to the Reserve Bank’s capital adequacy requirements by 19 June 2015, with a view to implemention by October.

They cite considerable evidence that investment loans are inherently more risky:

the fact that investment risks are pro-cyclical
that for a given LVR defaults are higher on investment loans
investors were an obvious driver of downturn defaults if they were identified as investors on the basis of being owners of multiple properties
a substantial fall in house prices would leave the investor much more heavily underwater relative to their labour income so diminishing their incentive to continue to service the mortgage (relative to alternatives such as entering bankruptcy)
some investors are likely to not own their own home directly (it may be in a trust and not used as security, or they may rent the home they live in), thus is likely to increase the incentive to stop servicing debt if it exceeds the value of their investment property portfolio
as property investor loans are disproportionately interest-only borrowers, they tend to remain nearer to the origination LVR, whereas owner-occupiers will tend to reduce their LVR through principal repayments. Evidence suggests that delinquency on mortgage loans is highest in the years immediately after the loan is signed. As equity in a property increases through principal repayments, the risk of a particular loan falls. However, this does not occur to the same extent with interest-only loans.
investors may face additional income volatility related to the possibility that the rental market they are operating in weakens in a severe recession (if tenants are in arrears or are hard to replace when they leave, for example). Furthermore, this income volatility is more closely correlated with the valuation of the underlying asset, since it is harder to sell an investment property that can’t find a tenant.

Although the Basel guidelines for IRB banks envisage that loans to residential property investors be treated as non-retail lending, the same is not the case for banks operating on the standardised approach. The Basel guidelines consider all mortgage lending within the standardised approach as retail lending within the same sub-asset class. However, the guidelines also provide regulators with ample flexibility to implement them according to the needs of their respective jurisdictions. There are three reasons why any consideration as to whether to group loans to residential property investors in New Zealand should also include standardised banks.

the different risk profile of property investors applies irrespective of whether the lending bank is a bank operating on the standardised approach or on the internal models approach.
macro-prudential considerations include standardised banks as well as internal models banks. Prepositioning banks for a potential macro-prudential restriction on lending to residential property investors has to involve all locally incorporated banks.
risk weights on housing loans are comparatively high in New Zealand and, more crucially, the gap in mortgage lending risk weights between standardised and IRB banks is not as high as it might be in many other jurisdictions. In order to maintain the relativities between the two groups of banks for residential investment property lending, it would be useful to also include standardised banks in the policy considerations.

So the bank is proposing to impose different risk weightings on investment and owner occupied loans, for both IRB and standard capital models.

The Reserve Bank would expect banks to continue to use their current PD models until such time that new models have been developed or banks have been able to verify that the current models can also be applied to property investment loans. Through the cycle PD rates appear broadly similar to those of owner-occupiers if the evidence from overseas also holds for New Zealand, although it is not clear whether the risk drivers are the same between the two groups of mortgage borrowers. The Reserve Bank would therefore expect banks to assess in due course whether their current PD mortgage models can be used for the new asset class or whether new or amended versions of the current models should be used.

For standardized banks, the Reserve Bank has to prescribe the risk weights as per the relevant capital adequacy requirements. Those requirements currently link a loan’s risk weight to its LVR at origination. Maintaining that link, the Reserve Bank proposed higher risk weights per LVR band

These calibrations would lead to a higher capital outcome for residential property investment mortgages compared to owner-occupier loans. However, the capital outcome would be below that of using the income producing real estate asset class and, in the Reserve Bank’s opinion, reflect the mix of property investment borrowers that the new asset class would entail.

Stakeholders are invited to provide feedback on the proposed wording changes to the Reserve Bank’s capital adequacy requirements by 19 June 2015.

This further tilts the playing field away from property investment loans.

Total Housing At Record $1.46 Trillion in April

The latest data from the RBA, Credit Aggregates to end April 2015, shows that lending for investment property pushed higher again, whilst lending to business went backwards. Looking at the splits, overall housing credit was up 0.54% seasonally adjusted to $1.46 trillion, with owner occupied lending up 0.41% to $954 billion and investment lending up 0.79% to $503 billion. Personal credit fell 0.84% to $141 billion and lending to business fell 0.04% to $790 billion. As a result, the percentage of lending devoted to housing rose to 61% of total (excluding lending to government), up from 56% in 2010.

Tracking the relative monthly movements, highlights the concentration in the housing, and specifically the investment housing sector. We will see if recent moves by APRA and the banks tames the beast in the months ahead.

Looking at the housing data, the proportion of the portfolio in the more risky housing investment sector rose again, to 34.6%.

Further evidence of the unbalanced state of the economy.

Banking: Australian Banks’ Moves to Curb Residential Investment Lending Are Credit-Positive – Moody’s

In a brief note, Moody’s acknowledged that the bank’s recent moves to adjust their residential loan criteria could be positive for their credit ratings, but also underscored a number of potential risks in the Australian housing sector including elevated and rising house prices, declining mortgage affordability, and record levels of household indebtedness. As a result, they believe more will need to be done to tackle the risks in the portfolio.

Moody’s says the recent initiatives are credit positive since they reduce the banks’ exposure to a higher-risk loan segment. At the same time, it is likely that further additional steps will be required because the growing imbalances in the Australian housing market pose a longer-term challenge to the Australian banks’ credit profiles, over and above the immediate concerns relating to investment lending.

Therefore they expect the banks first to curtail their exposure to high LTV loans and investment lending further over the coming months; and second, they will gradually improve the quantity and quality of their capital through a combination of upward revisions to mortgage risk weights and capital increases. This is likely to happen over the next 18 months or so.

Cold Hand Of The Regulator On Bank’s Investment Lending

Following the disclosures in the recent bank results that many were above the APRA target of 10% portfolio growth, and their statements they would work to fall within the guideline, we have seen a litany of changes from the banks, which marks an important change in tempo for investment home lending. Regulatory pressure is beginning to strangle investment lending growth. Better late then never.

In the past few days, ANZ has stated it would no longer offer interest rate discounts to new property investor borrowers who did not also have an owner-occupied home loan with the bank; Westpac is cutting discounts to new investment property borrowers according to the AFR; and Bankwest has imposed a loan-to-valuation ratio cap of 80 per cent on investor Mortgages. Changes that took effect on Friday will mean Macquarie customers taking out fixed-rate investor or interest-only loans will pay higher rates than owner occupied borrowers. Recently the Commonwealth Bank, scrapped its $1,000 investment home-loan rebate offer and reduced pricing discounts for investment home loans. In addition more broadly, Bank Of Queensland has changed its underwriting practices. NAB has also changed its instructions brokers, and as of May 13, NAB would only consider pricing below advertised rates for owner-occupiers or personal loans. “Investment loans will not be eligible for any pricing discretions. Advertised rates will apply to investment loans,” the note said. Suncorp plans to pare down discounts for investor property loans while boosting incentives for homeowner lending, in reaction to the regulatory crackdown on housing markets.

Last week we showed that currently discounts are at their peak, so will we see overall discounts cut, or reinvigorated discounts on selected owner-occupied lending? Banks need home loan lending growth to make their business work. We think the focus will be on a drive to accelerate refinancing of existing loans, so expect to see some amazing offers in coming weeks to try and fill the gap.

We know from our surveys there is still significant demand for housing finance out there. We also know that some of the non-ADI players are playing an increasing role in the investment lending sector, and these players are of course not regulated by APRA. Securitisation of Australian home loans was up last quarter, and most were purchased by Australian investors.

Mortgage brokers, who have been enjoying the recent growth ride may suddenly be finding their world just changed.

Whilst its a change in tempo, its not necessarily the end of the mortgage lending boom. It may however be the tipping point on house prices in Sydney and Melbourne, where investment loans have been responsible for much of the rise.