A Prudent Response to Expensive Housing

With 60% of Australian bank lending housing related, banks are bound inextricably to the property cycle. Unlike the worst-hit global geographies, the Australian household did not go through a period of deleveraging post-GFC, as housing credit continued to outpace income growth. With this backdrop, regulators are now doing their utmost to increase banks’ resilience and the banks too are chipping in.

There is not only one Australian housing market. For example, residents of Moranbah in Queensland (who saw the median house price in their mining town soar to over $700,000 during the recent mining boom before plummeting to current median prices of $165,000) will tell you a different story from those in the plush Melbourne suburb of Toorak where prices have continued to firm over the last five years. While we see pockets of weakness and oversupply - particularly in the Brisbane and Melbourne apartment markets - more new supply remaining below underlying demand as well as ongoing low unemployment and low interest rates, act as near-term mitigants to valuation risk across the broader property portfolios banks are exposed to.

Banks will never be untethered from the fortunes of the property cycle. However, the Australian Prudential Regulation Authority (APRA) has acted to lessen the impact of property prices by enforcing the following macro-prudential controls:

• Annual growth in investor loans to remain comfortably below 10%; and
• Interest-only lending limited to 30% of new lending. Beneath that, the banks are required to have strict internal limits on interest only lending at Loan to Valuation ratios (LVRs) above 80%, and require good cause for interest-only lending above 90% (the regulator will struggle to see a good cause).

However, APRA has not yet signalled job-done. We expect continued focus on:

• Pressuring banks to put more effort into ensuring realistic projections of household expenses which they use in mortgage serviceability calculations.
• Like the RBNZ, APRA continues to investigate loan-to-income ratios.

In addition to regulatory enforced tightening, banks are now tightening internal credit standards.

Mortgage brokers play a significant role in the Australian market (see box below). Given their role, mortgage brokers are an excellent source of unfiltered insight into Australian mortgage lending standards. Conversations with mortgage brokers on Harbour's recent Australian research trip revealed that:

• Banks are increasing their documentation requirements
  • Particularly so for interest-only loans, where pricing has increased by 75-90bps.
  • Banks are applying more scrutiny to expenses and including not only basic living expenses, but also discretionary expenses.
• The difference between banks’ standards is increasing. This complexity adds to a mortgage broker’s value proposition.
• One of the major banks is offshoring part of its credit process. This has resulted in a significant reduction in service as brokers are finding it difficult to ascertain the status of an application. This is likely to impact market share until brokers are satisfied new processes are bedded down.

It is important to put these increases in standards in an historical context, as a response to regulatory concerns over high valuations and loose standards. While new loans are of a higher quality, we are certainly not dismissing all risk, given the earlier credit binge assisted prices to the current elevated levels.

While Australia may face a ‘slowly slowing’ housing market as tighter lending controls continue to take the heat out of warmer parts of the market (with potential for location specific weakness), the tighter controls ultimately reduce overall financial system risk.   

We can see many parallels with New Zealand: a housing market that is cooling off in hot spots, but also a banking system that has pre-emptively increased it resilience and reduced exposures to the riskiest loans.

With housing still the largest investment for many New Zealanders and Australians, a gradual cooling near term, which supports a stronger financial system, may ultimately protect the long term value of this investment.

IMPORTANT NOTICE AND DISCLAIMER
Harbour Asset Management Limited is the issuer and manager of the Harbour Investment Funds. Investors must receive and should read carefully the Product Disclosure Statement, available at www.harbourasset.co.nz. We are required to publish quarterly Fund updates showing returns and total fees during the previous year, also available at www.harbourasset.co.nz. Harbour Asset Management Limited also manages wholesale unit trusts. To invest as a Wholesale Investor, investors must fit the criteria as set out in the Financial Markets Conduct Act 2013. This publication is provided in good faith for general information purposes only. Information has been prepared from sources believed to be reliable and accurate at the time of publication, but this is not guaranteed. Information, analysis or views contained herein reflect a judgement at the date of publication and are subject to change without notice. This is not intended to constitute advice to any person.  To the extent that any such information, analysis, opinions or views constitutes advice, it does not consider any person’s particular financial situation or goals and, accordingly, does not constitute personalised advice under the Financial Advisers Act 2008. This does not constitute advice of a legal, accounting, tax or other nature to any persons. You should consult your tax adviser in order to understand the impact of investment decisions on your tax position. The price, value and income derived from investments may fluctuate and investors may get back less than originally invested.  Where an investment is denominated in a foreign currency, changes in rates of exchange may have an adverse effect on the value, price or income of the investment. Actual performance will be affected by fund charges as well as the timing of an investor’s cash flows into or out of the Fund. Past performance is not indicative of future results, and no representation or warranty, express or implied, is made regarding future performance. Neither Harbour Asset Management Limited nor any other person guarantees repayment of any capital or any returns on capital invested in the investments. To the maximum extent permitted by law, no liability or responsibility is accepted for any loss or damage, direct or consequential, arising from or in connection with this or its contents.