Tag: New Zealand

RBNZ Cash Rate unchanged at 2.25 percent

Statement by NZ Reserve Bank Governor Graeme Wheeler:

The NZ Reserve Bank today left the Official Cash Rate unchanged at 2.25 percent.

Global financial market volatility has abated and the outlook for global growth appears to have stabilised after being revised down successively over recent quarters. There has been a modest recovery in commodity prices in recent months. However, the global economy remains weak despite very stimulatory monetary policy and significant downside risks remain.

Domestic activity continues to be supported by strong net immigration, construction, tourism and accommodative monetary policy. The dairy sector remains a moderating influence with export prices below break-even levels for most farmers.

The exchange rate is higher than appropriate given New Zealand’s low export commodity prices. Together with weak overseas inflation, this is holding down tradables inflation. A lower New Zealand dollar would raise tradables inflation and assist the tradables sector.

House price inflation in Auckland and other regions is adding to financial stability concerns. Auckland house prices in particular are at very high levels, and additional housing supply is needed.

There continue to be many uncertainties around the outlook. Internationally, these relate to the prospects for global growth and commodity prices, the outlook for global financial markets, and political risks. Domestically, the main uncertainties relate to inflation expectations, the possibility of continued high net immigration, and pressures in the housing market.

Headline inflation is low, mostly due to low fuel and other import prices. Long-term inflation expectations are well-anchored at 2 percent. After falling in recent quarters, short-term inflation expectations appear to have stabilised.

We expect inflation to strengthen reflecting the accommodative stance of monetary policy, increases in fuel and other commodity prices, an expected depreciation in the New Zealand dollar and some increase in capacity pressures.

Monetary policy will continue to be accommodative. Further policy easing may be required to ensure that future average inflation settles near the middle of the target range. We will continue to watch closely the emerging flow of economic data.

RBNZ Cuts Cash Rate to 2.25%

The NZ Reserve Bank today reduced the Official Cash Rate (OCR) by 25 basis points to 2.25 percent.

The outlook for global growth has deteriorated since the December Monetary Policy Statement, due to weaker growth in China and other emerging markets, and slower growth in Europe. This is despite extraordinary monetary accommodation, and further declines in interest rates in several countries. Financial market volatility has increased, reflected in higher credit spreads. Commodity prices remain low.

Domestically, the dairy sector faces difficult challenges, but domestic growth is expected to be supported by strong inward migration, tourism, a pipeline of construction activity and accommodative monetary policy.

The trade-weighted exchange rate is more than 4 percent higher than projected in December, and a decline would be appropriate given the weakness in export prices.

House price inflation in Auckland has moderated in recent months, but house prices remain at high levels and additional housing supply is needed. Housing market pressures have been building in some other regions.

There are many risks to the outlook. Internationally, these are to the downside and relate to the prospects for global growth, particularly around China, and the outlook for global financial markets. The main domestic risks relate to weakness in the dairy sector, the decline in inflation expectations, the possibility of continued high net immigration, and pressures in the housing market.

Headline inflation remains low, mostly due to continued falls in prices for fuel and other imports. Annual core inflation, which excludes the effects of transitory price movements, is higher, at 1.6 percent.

While long-run inflation expectations are well-anchored at 2 percent, there has been a material decline in a range of inflation expectations measures.  This is a concern because it increases the risk that the decline in expectations becomes self-fulfilling and subdues future inflation outcomes.

Headline inflation is expected to move higher over 2016, but take longer to reach the target range. Monetary policy will continue to be accommodative. Further policy easing may be required to ensure that future average inflation settles near the middle of the target range. We will continue to watch closely the emerging flow of economic data

IMF Highlights Risks In NZ Economy

On February 5, 2016, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with New Zealand. In the report, they examine a number of issues, including high house prices in Auckland, trade exposures, low GDP per capita and chronic low household savings.  “From the 2000s, New Zealand has lagged behind top OECD countries in output per worker by 20–25 percent. This gap can be explained by both substantial productivity gaps and lower levels of capital. While the latter may be partly influenced by the low savings rate (and higher interest rates), the productivity gap is striking, particularly when taking into account New Zealand’s sound institutional and policy settings: New Zealand’s per capita should be 20 percent above the OECD average based on structural policy settings, not 20 percent below”.

NZ-GDPThe economy’s strong growth after the global financial crisis has been supported by rising terms of trade and reconstruction activity after the 2010–11 Canterbury earthquakes, as well as high net immigration. Growth peaked at 3.5 percent year-on-year (y/y) in Q4 2014, bringing output slightly above potential. However, the tailwinds have recently waned. In 2014, dairy prices began to fall from historic highs, leading to a sharp drop in income growth after the positive effect of declining oil prices had worn off, and investment activity related to the Canterbury rebuild has reached a plateau. As a result, output growth is estimated to have slowed to 2.3 percent in 2015, despite resilient consumption. Meanwhile, unemployment has been edging up reaching 6 percent in Q3 2015. Due largely to the decline in oil prices, inflation has dropped to 0.3 percent (y/y) in Q3 2015. House price inflation in Auckland has remained high, driven fundamentally by supply shortages.

The exchange rate depreciation has cushioned some of the impact of the decline in dairy prices. The bilateral exchange rate against the U.S. dollar has depreciated as dairy prices fell and the Reserve Bank of New Zealand (RBNZ) eased monetary policy. The depreciation has mitigated the impact of the international dairy price decline on farmers’ incomes, and supported exports of travel and education services.

With growth below potential, measures of core inflation around the lower half of the target band, and a still strong exchange rate, monetary policy has been eased since June and the Reserve Bank stands ready to reduce rates further if warranted.

To manage risks arising from house price inflation in Auckland, macroprudential measures were introduced in 2013, leading to a temporary slowdown in price hike. A package of additional macroprudential regulations and tax measures was announced in May 2015, but having become fully effective only in November. The banking sector has increased capital and liquidity buffers, but reliance on offshore funding and a large share of mortgage lending remain sources of vulnerability.

Fiscal policy is also supportive of the economy in the short term, while consolidation is projected to resume in the medium-term. Automatic stabilizers have been allowed to work and public investment is being increased. Net debt is projected to decline further to around 5 percent of GDP in the medium term.

With chronically low national saving, New Zealand’s economy is dependent on borrowing from abroad. Its persistently negative savings-investment balance has led to the accumulation of a large net negative international investment position (IIP) which reached65 percent of GDP in 2014.

The short-term outlook is challenging with both external and domestic risks, the latter arising from rapid house price inflation in Auckland. However, New Zealand’s flexible economy is resilient, and medium-term prospects remain positive. New Zealand’s main exports—agricultural consumer products and tourism—should benefit from the ongoing shift to a more consumption-oriented growth model in China. Consumer demand in other Asian countries is also expected to grow. Overall, output growth is projected to recover to its estimated potential rate of 2.5 percent. With measures of core inflation around the lower end of the target range and expectations consistent with the band’s midpoint, inflation is forecast to rise to within the RBNZ’s target range of 1–3 percent in 2016.

Executive Board Assessment

Executive Directors welcomed that New Zealand’s economy continues to perform well despite the slowdown imposed by the fall in dairy prices, plateaued investment associated with the Canterbury rebuild, and slower growth in trading partners. Directors agreed that New Zealand’s sound and flexible policy frameworks, including the important buffer provided by the flexible exchange rate, position the country well to weather the recent slowdown. Medium-term prospects remain positive, and Directors were encouraged by the authorities’ alertness to the downside risks and challenges arising from real estate market pressures, a persistently low savings rate, and relatively low productivity.

Directors considered the current accommodative monetary stance to be appropriate and agreed that, if needed, the authorities should stand ready for further easing given low inflationary pressures and below potential output. With regard to fiscal policy, they agreed that the planned easing this year and next, including through an acceleration of public investment in infrastructure, combined with a resumption of gradual fiscal consolidation thereafter, is appropriate. These measures should support the economy in the short term and bolster the public sector balance sheet in the longer term.

Directors noted that the banking system is resilient and well-supervised. They commended the proactive prudential and tax measures being taken to address the risks stemming from the housing market. Noting that the underlying cause of the housing market boom in Auckland is a supply/demand mismatch, they encouraged the authorities to be ready to use additional prudential measures and consider steps to reduce the tax advantage of housing over other forms of investments, while continuing to address supply-side bottlenecks.

Directors agreed that raising national and in particular private saving is critical to reducing external vulnerabilities from the still heavy reliance on offshore funding. They noted that higher saving may also reduce capital costs by lowering the risk premium and thereby support productive investment and long-term growth. They encouraged the authorities to consider comprehensive policy measures to boost long-term financial savings, including through reform of retirement income policies, as this could also help deepen New Zealand’s capital markets and broaden options for retirement planning.

Directors observed that, notwithstanding high living standards, New Zealand incomes lag those of other advanced economies, due to relatively low capital intensity and productivity. Acknowledging that the economy’s small size and distance from markets likely limit gains from trade, they encouraged the authorities to build on the country’s business-friendly environment to take steps to boost competition in key service sectors, leverage ICT more intensively, and address key infrastructure bottlenecks. They welcomed the focus of the government’s Business Growth Agenda on these issues.

RBNZ Highlights Unprecedented Divergence in House Prices

The Reserve Bank NZ, released a Bulletin today which looks at house price trends across New Zealand. Since mid-2012, Auckland house prices have increased 52 percent, but house prices in the rest of New Zealand have increased only 11 percent. The extent of this divergence is unprecedented.

Since 1981, house prices in Auckland have increased much more than those in the rest of New Zealand. House prices in North Island provinces – where house prices have grown the least – are only 63 percent higher than they were in 1981. By contrast, Auckland house prices are 352 percent higher.

Figure 14 shows Auckland house prices as a ratio to those in the rest of New Zealand. High average rates of house price inflation in Auckland relative to the rest of the country have seen this ratio trend upwards since 1981. The extent of the increase in this ratio since 2009 is unprecedented.

RBNZ-House-PricesAn upward trend in this ratio might be expected over time, but it is not clear how steep that trend should be, whether it is time-varying, or whether it will persist. Notwithstanding that uncertainty, the ratio is currently 22 percent above a simple filtered trend. A divergence of this magnitude is also evident when Auckland is compared with urban centres only. This means that the upward trend has not been driven by a more general divergence between house prices in urban and provincial centres, but is an Auckland-specific phenomenon.

In previous instances when the ratio has increased relatively quickly – namely, during the late 1980s and mid-1990s – this has subsequently been followed by a period of lower growth. In 1987, house prices in Auckland increased while they were flat in the rest of the country. Then in subsequent years, Auckland house prices fell while those in the rest of New Zealand continued increasing. In the upswing of the 1990s, Auckland house prices increased relative to the rest of the country, and stayed elevated until the latter part of the 2000s cycle, at which time house prices in the rest of the country increased at a faster pace than those in Auckland.

DFA believes that the same forces are at work here, as in Sydney, London and other metro centres. Lack of supply, high levels of finance available, investors active, foreign investors active, and weak regulatory control. The perfect storm.

 

A Deeper Look at Recent Auckland Housing Market Trends: RBNZ

The Reserve Bank of New Zealand has published an analytic note “A Deeper Look at At Recent Housing Market Trends; Insights from Unit Record Data. It highlights the influence of investors and their impact on the overall market and the impact of LVR controls.

In October 2013 the Reserve Bank placed a temporary ‘speed limit’ on high loan-to-value ratio (LVR) residential mortgage lending, restricting banks’ new lending at LVRs over 80 percent to no more than 10 percent of total residential mortgage lending. This policy was implemented to reduce financial stability risks associated with the housing market, against the backdrop of elevated household debt, high and rapidly rising house prices, and a large share of new lending going to borrowers with low deposits. The policy had an immediate dampening effect on housing market activity and house price inflation, and facilitated a strengthening in bank balance sheets. However, since late 2014, upward pressure on the housing market has re-emerged, predominantly in Auckland, posing renewed risks to financial stability.

With the housing market showing renewed signs of strength, this paper provides a detailed overview of market conditions and examines developments following the imposition of the speed limit on high-LVR lending. We find that increased housing market activity in recent months has been driven by strong investor demand, both within and outside of Auckland, as reflected in increased investor purchases and significant growth in investor-related mortgage credit. Much of the increase in investor purchase shares has coincided with a fall in the share of movers, with the first home buyer share increasing slightly following its decline after the introduction of LVR speed limits.

We also investigate whether the LVR policy has led to an increase in cash buying activity or borrowing from institutions outside of the regulatory. We do not find evidence of the former with cash buyer shares falling in Auckland and remaining broadly flat in the rest of the country. There is some evidence of a modest increase in the share of transactions involving non-banks since October 2013, although non-bank activity remains low.

We then undertake a more detailed analysis of investor activity given their heightened prevalence in the market. The primary driver of their increased market share has been a rising incidence of small investors (that are heavily reliant on credit) in the market, as opposed to greater activity among larger investors. This suggests that the incoming changes to the LVR restrictions could have a significant dampening effect on Auckland housing market activity and house price inflation. We also find that investors are disproportionately represented at both ends of the price spectrum, contrary to popular opinion that investors predominantly buy relatively cheap properties for use as rentals.

Finally, we offer some additional insights into cash buyers, with the evidence pointing towards increased investor leverage relative to other market participants, consistent with the strong growth in investor-related mortgage commitments in recent months.

RBNZ Cuts Cash Rate

The New Zealand Reserve Bank today reduced the Official Cash Rate (OCR) by 25 basis points to 2.75 percent.

Global economic growth remains moderate, but the outlook has been revised down due mainly to weaker activity in the developing economies. Concerns about softer growth, particularly in China and East Asia, have led to elevated volatility in financial markets and renewed falls in commodity prices. The US economy continues to expand. Financial markets remain uncertain as to the timing and impact of an expected tightening in US monetary policy.

Domestically, the economy is adjusting to the sharp decline in export prices, and the consequent fall in the exchange rate. Activity has also slowed due to the plateauing of construction activity in Canterbury, and a weakening in business and consumer confidence. The economy is now growing at an annual rate of around 2 percent.

Several factors continue to support growth, including robust tourism, strong net immigration, the large pipeline of construction activity in Auckland and other regions, and, importantly, the lower interest rates and the depreciation of the New Zealand dollar.

While the lower exchange rate supports the export and import-competing sectors, further depreciation is appropriate, given the sharpness of the decline in New Zealand’s export commodity prices.

House prices in Auckland continue to increase rapidly and are becoming more unsustainable. Residential construction is increasing in Auckland, but it will take some time to correct the imbalances in the housing market.

Headline CPI inflation remains below the 1 to 3 percent target due to the previous strength in the New Zealand dollar and the halving of world oil prices since mid- 2014. Headline inflation is expected to return well within the target range by early 2016, as the earlier petrol price decline drops out of the annual inflation calculation, and as the exchange rate depreciation passes through into higher tradables prices. Considerable uncertainty exists around the timing and magnitude of the exchange rate pass-through.

A reduction in the OCR is warranted by the softening in the economy and the need to keep future average CPI inflation near the 2 percent target midpoint. At this stage, some further easing in the OCR seems likely. This will depend on the emerging flow of economic data.

Solvency Or Bust?

Public debt is a normal part of a government’s finances, but too much debt can have serious consequences for a country. During a seminar at the IMF-World Bank Meetings, Helen Clark, one former head of state, who left office with public finances in good standing, explains how her administration in New Zealand succeeded where others have so often failed.

Link to Podcast

New Zealand’s Restrictions on Mortgage Lending in Auckland Will Benefit Banks – Moody’s

Last Wednesday, the Reserve Bank of New Zealand (RBNZ) announced that starting 1 October 2015 bank lending to home investors in Auckland, New Zealand, will be restricted to mortgages with loan-to-value ratios (LTVs) of less than 70%. The RBNZ also said it was raising the percentage of residential mortgage loans that can be originated outside of Auckland with LTVs of 80% or higher to 15% of all mortgage loans from 10%. These measures are credit positive for New Zealand’s banks because they will reduce banks’ exposure to riskier mortgage loans in Auckland, where house prices are at historical highs, having risen 14.6% in the 12 months to March 2015.

Moody’s says these steps would particularly benefit New Zealand’s four major banks, ASB Bank Limited (Aa3/Aa3 stable, a2 review for downgrade), ANZ Bank New Zealand Limited (Aa3/Aa3 stable, a3), Bank of New Zealand (Aa3/Aa3 stable, a3) and Westpac New Zealand Limited (Aa3/Aa3 stable, a3). These banks held approximately 86% of total system mortgages as of 31 December 2014. Additionally, Auckland, New Zealand’s largest city, constitutes the largest market for these banks, and the RBNZ reports that around 40% of mortgage originations in Auckland are to investors.

The introduction of an LTV limit on property-investor lending in Auckland will reduce the risk of recently originated mortgages experiencing negative equity, where the size of the loan exceeds the value of the property. Both house prices and household indebtedness in Auckland are at historical highs creating a sensitivity to increases in unemployment and interest rates. Although LTV restrictions are likely to dampen house price growth in Auckland, we expect the effect to bemarginal owing to supply shortages and the official cash rate, which the RBNZ sets to meet inflation targetsand remains accommodative by historical standards, continuing to support price gains. However, reducingbank exposures to high-LTV loans that are more exposed to a house price correction would benefit banks.

NZ-Price-to-Income-May-2015The LTV restrictions would not apply to loans to construct new residential properties, given the RBNZ’s focus on alleviating Auckland’s housing shortage. Although the new 15% cap on high-LTV loans outside Auckland will allow banks to lend more at higher LTVs, price growth outside of Auckland has been relatively subdued. By responding to current housing market developments and loosening restrictions, the RBNZ is making housing finance more accessible in areas of New Zealand where there are fewer risks of stimulating excessive price speculation.

The proposals are the RBNZ’s latest in a series of steps aimed at reducing excess leverage in the financial system and reducing the threat of asset bubbles. In September 2013, the RBNZ raised the capital requirements for high-LTV lending and in October 2013 imposed a 10% cap on high-LTV loans. In March 2015, the RBNZ released a consultation paper indicating that banks would likely need to hold more capital against investor loans than against owner-occupied mortgages. The RBNZ intends to release a consultation paper later this month outlining its most recent announcement.

NZ Reserve Bank Consulting On Property Investor Loans

The Reserve Bank of New Zealand is consulting on a new asset class treatment for mortgage loans to residential property investors within its capital adequacy requirements. They propose to separate investment and owner occupied loans from a capital perspective, (once loan types are defined), and apply different capital treatments, requiring more capital for investment loans, reflecting potential higher risk. This would be applied to both standards and advanced IRB banks, and they would allow a period of transition to the new arrangements, commencing 1 July 2015. The net impact would be to increase the capital costs to lenders of making investment mortgages, and potentially slowing momentum in this sector. RBA please note!

The Reserve Bank’s analysis shows that residential property investor loans are a sufficiently distinct category of loans and that by grouping them with other residential mortgage loans one is not in a position adequately to measure their risk as a separate group of loans. This can have negative consequences for a bank’s awareness of the proper risk associated with those loans and lead to insufficient levels of capital being allocated to them. The Reserve Bank therefore proposes that all locally incorporated banks hold residential property investment loans in a separate asset or sub-asset class. In addition, a primary purpose of the consultation is to seek views on how to best define a property investment loan.

Consultation closes on 7 April and once the Reserve Bank has settled upon a definition, it proposes to amend existing rules by requiring all locally incorporated banks to include residential property investment mortgage loans in a specific asset sub-class, and hold appropriate regulatory capital for those loans.

Reserve Bank Head of Prudential Supervision Toby Fiennes said: “International evidence suggests that default rates and loss rates experienced during sharp housing market downturns tend to be higher for residential property investment loans than for loans to owner occupiers.

“The proposal would bring the Reserve Bank’s framework more into line with the international Basel standards for bank capital. The proposed rule amendment is designed to ensure that banks hold adequate capital for the risks that they face from investment property lending.”

The Reserve Bank has previously consulted on a possible definition that would have seen loans to borrowers with five or more residential properties classified as loans to residential property investors. Partly as a result of submissions received, the Bank has reconsidered the definition, and is now consulting on three possible alternative ways to define loans to residential property investors:

  • if the mortgaged property is not owner-occupied; or
  • if servicing of the mortgage loan is primarily reliant on rental income; or
  • if servicing of the mortgage loan is at all reliant on rental income.

The proposed new rule would apply to all locally incorporated banks.

While the current proposal is not a macro-prudential policy proposal, creating consistent asset class groupings to be used by all banks would help the Reserve Bank to implement targeted macro-prudential policies in the future, should that become necessary.

Looking at the proposals in more detail:

They propose that residential property lending should be grouped in a separate asset class because the risk profile of these loans is observably different from owner-occupier mortgage loans, particularly in a severe downturn. The capital requirements that apply to IRB banks require long run PDs to be estimated on the basis of data that includes a severe downturn or, where that is not possible, to include an appropriate degree of additional conservatism.

Fortunately in New Zealand, we have not had a severe housing downturn in recent decades. But this also means that we do not have information on the difference in terms to default rates between residential property investors and owner-occupiers in such a scenario.

Based on the information available from other countries that have had a severe housing downturn, there is evidence to suggest that property investor loans are more strongly correlated with systemic risk factors than owner-occupier loans. This would point to a higher correlation factor in the Basel capital equation than the one that is currently used for all residential property loans. Moreover, although minimum downturn LGDs are prescribed within BS2B, they are effectively calibrated to owner-occupiers. It is therefore likely that the estimated risk weights that banks currently use for residential investor loans are too low and do not adequately reflect the risk that these loans represent.

The higher risk associated with residential property investment loans does not only apply to IRB banks. A residential property investment loan made by a bank operating on the standardised approach is equally a higher risk loan compared to a loan to an owner-occupier. The Basel approach seems to deal with this by recommending higher average risk weights for all residential property loans under the standardised approach.

In New Zealand, this has been implemented by allocating risk weights to residential mortgage loans that range from 35 to 100 percent, depending on a loan’s LVR and the availability of lender’s mortgage insurance.5 However, housing loans are a crucial area for maintaining financial stability in New Zealand and these risk weights do not adequately capture the higher risk associated with residential property investment loans.

The Reserve Bank believes that in this area, there are good reasons why a consistent conceptual approach across standardised and IRB banks makes sense. In addition, the Reserve Bank has a suite of macro-prudential tools available to help address financial stability concerns in certain circumstances. Having the same asset class groupings across all banks would help the Reserve Bank to implement targeted macro-prudential policies if that becomes necessary. Contrary to previous consultation papers on this subject therefore, the Reserve Bank now proposes to include a new asset class for residential property investors within the standardised approach, i.e. BS2A. This new asset class would also have separate, prescribed, risk weights from those that apply to non-residential property investment loans.

It is necessary to define what constitutes an investment loan. The first and in some ways simplest option would be to restrict the current retail residential mortgage asset class to owner-occupiers only. Any mortgage on a residential property that is not owner-occupied would be classified as a residential property investment loan and grouped in a new asset class.

Banks would have to verify the use of a property under this option. This information is already being collected at loan origination to some degree. Possible ways of identifying whether a property is owner-occupied or not include checking the borrower’s residential address and
whether the property generates any rental income. Other possible indicators could include eligibility for tax deductibility of the mortgage servicing costs on the property. The Reserve Bank appreciates that there could be cases where a borrower has more than one owner-occupied residential property and splits his or her time between those addresses. An example could be if a borrower uses one address during the week for work purposes and another on the weekends when he or she is with the family. Another case might be a bach that is not permanently occupied but also does not generate any rental income. The information the Reserve Bank collects from banks on new commitments already distinguishes between owner-occupiers and residential property investors while allowing for owner-occupiers to occupy more than one residential address. The same or a very similar definition could be used to distinguish between second and more properties that are still owner-occupied and properties that are used as residential properties, subject to considering adequate safeguards to ensure that this is not used as an avoidance mechanism.

The Reserve Bank also appreciates that there could be challenges for banks to monitor how a property is being used. A second flat that is used as a second residence by the owner-occupier when the loan is taken out could at some point be let out. While the Reserve Bank does not expect banks to regularly seek confirmation form borrowers as to the use of a property, it is expected that reasonable steps are taken to maintain up to date information. This could mean updating important information when there is a credit event.

An alternative option would be to use mortgage servicing costs as an indicator. If mortgage servicing are predominantly reliant on the rental income the property generates, then that loan should be classified as a residential property investment loan. Predominantly was defined as more than fifty percent. In other words, if a borrower’s other sources of income minus the bank’s usual allowances for living expenses, other loan servicing obligations and so on are sufficient to cover more than fifty percent of the loan servicing obligation of the residential property, that is interest as well as repayment of principal, then the loan continues to be classified as a residential mortgage loan in the retail asset class. This test would only apply to investment properties. Owner-occupied properties would be exempt from this requirement and continue to be classified as residential mortgage loans. There is, however, a question as to the point at which the reliance on the property’s rental income separates that loan from loans to owner-occupiers. The Reserve Bank has previously consulted on a threshold of 50 percent. But this still leaves plenty of scope for borrowers to acquire a small portfolio of investment properties without those mortgages being classified as residential property investment loans. A stricter definition would be to make it dependent on any rental income.

Irrespective of which definition and asset class treatment is decided on, banks are likely to require some time to implement the new requirements. For example, banks will have to assess which of their existing exposures are caught by the residential property investment loan definition, make changes to their information capture and IT systems and retrain staff. This will take some time. The Reserve Bank is therefore currently minded to phase the new requirement in over a period of nine months.

IRB banks may also have to develop new models for their residential property investment loan portfolio, although that is not necessarily the case and existing PD models would form a good basis on which to build residential property investor specific models. IRB banks, however, would have to amend their capital engines for residential investor loans to use the proposed LGDs and correlation factors.

It is proposed that IRB banks operate under the same risk weight requirements as standardised banks until their new models have been approved by the Reserve Bank. Furthermore, it is proposed that the new asset classification for residential property investors takes effect from 01 July 2015.

They are also proposing changes to capital requirements for reverse mortgages. Managing a portfolio of reverse mortgages requires long term assumptions to be made concerning a number of factors. If those assumptions turn out to be wrong, the risk to a lender could be significantly affected. For example, advances in geriatric healthcare might mean that people stay longer in their houses than currently anticipated. That could increase the risk of incurring a loss on a portfolio of reverse mortgages due to compound interest, the possibility of the borrower being granted further top ups and the difficulty of predicted house prices years and decades ahead.

While arrangements whereby the reverse mortgage has to be repaid after a certain period of time or stay below a set LVR are theoretically possible, they are not the norm and would most likely be to the disadvantage of the borrower, and thus undermine the attractiveness of a reverse mortgage.

To emphasise, one way in which the risk profile of a reverse mortgages differs from a normal mortgage is in the time dimension. Whereas a normal mortgage loan decreases over time, the opposite is the case for a reverse mortgage.

Finally, the Reserve Bank considers it more appropriate group credit card and revolving retail loans in the “other retail category and to remove QRRE as an option from its capital requirements for IRB banks. This would improve clarity within BS2B while having no direct impact on banks since no bank has been given approval to use the QRRE option.

Basel II framework for IRB banks introduced the concept of a ‘Qualifying Revolving Retail Exposure’ as one of three categories of retail loans. The other two categories are residential mortgages and other retail, a catch all for retail loans other than residential mortgages. The QRRE category is intended to be used for short-term unsecured revolving lines of credit, e.g. credit cards and certain overdraft facilities. In New Zealand credit card loans account for approximately 1 to 3 percent of banks’ total lending portfolios. Compared to the other two categories, the capital requirement for QRRE loans is generally lower (except for some very high probability of default (PD) buckets).

In line with Basel II, the Reserve Bank’s capital adequacy requirements provide for the use of the QRRE category. However, use of the QRRE classification is subject to Reserve Bank approval and no bank has been granted approval as yet. The Reserve Bank is concerned that some of the underlying assumptions of the QRRE category do not apply in the New Zealand context. The evidence supplied by banks when seeking approval for QRRE use has not able to demonstrate the validity of those assumptions in New Zealand.

 

New Zealand’s Potential New Capital Rules on Investor Mortgages are Credit-Positive – Fitch

Fitch Ratings views positively the Reserve Bank of New Zealand’s (RBNZ) consultation on the capital treatment for mortgages to residential property investors. Higher capital requirements for investor loans combined with the existing loan to value ratio (LVR) limit could help protect banks against material losses in the event of a property price correction.

The RBNZ proposes to modify existing capital rules by requiring banks to include investor mortgages in a specific asset sub-class, and hold appropriate regulatory capital for those assets. Investor mortgages in New Zealand have performed similarly to owner-occupied mortgages but the experience in other markets has shown weaker asset quality performance in a downturn. The consultation paper seeks to define the terminology of investor mortgages in order to make policy decisions by end-April 2015. Currently investor mortgages are treated the same as owner-occupier mortgages for regulatory capital purposes in New Zealand.

The introduction of higher capital rules for investor mortgages may also slow the growth rates of property prices, particularly in Auckland. Increased investor demand and a rise in investor mortgages appear to be a contributor to this strong growth, and the RBNZ’s proposed limit could address some of the risks associated with these loans. The agency expects banks to charge higher interest rates on investor mortgages to offset the higher capital requirements which may deter some of the more marginal investment activity in the market. Price rises in Auckland have exceeded 10% per annum over the last 24 months which is unlikely to be sustainable in the long-term.

Investor mortgages typically have lower LVRs relative to owner-occupier loans and therefore are less susceptible to the RBNZ’s existing LVR restrictions, introduced in October 2013. Banks are only allowed to underwrite a maximum of 10% of new mortgages with an LVR in excess of 80% which has reduced some potential risk in the banks’ mortgage portfolios.

The new measures could also indirectly help to limit growth in household indebtedness by reducing house price appreciation closer to income growth. New Zealand’s household debt, measured as a percentage of disposable income stood at 156% at end-September-2014, which is high relative to many peer countries and has increased by 5pp since 2012. Although interest rates are still low compared to the historical long-term average, a rise in the official cash rate could place borrowers at risk of being unable to service their mortgages, and may eventually lead to asset quality problems for the banks. However, this risk is partly mitigated through bank affordability testing, which includes adding a buffer above the prevailing market interest rate when assessing serviceability.