The Reserve Bank has its sights set on property investors. The Bank has said for some time now that Auckland’s runaway property market is unsustainable and a risk to the financial stability of the NZ economy. Their concern is that property values will come to a sudden and sharp halt, with a domino effect on loan defaults and the economy generally.
While the rate of property price increase in Auckland is unsustainable, I think the good times will end as a drawn-out whimper rather than a short-sharp collapse , primarily because Auckland’s house price boom is not caused by debt driven demand, as was the case in the mid 1980s. This boom is caused by poor planning regulations that have choked the supply of affordable housing, and strong migration inflows. It’s those dynamics that will determine how much heat there is left in the up-cycle.
Nevertheless, the Reserve Bank seems poised to introduce regulations to back up its strong talk, which to date has had no obvious effect. New rules will target bank lending to residential landlords specifically. It is currently “consulting” on the matter, but that is more do with defining “lending to a property investor”. The Bank says, “Once we have settled on a definition, we propose to amend existing rules by requiring all locally incorporated banks to group residential property investment mortgage loans in a specific asset sub-class and hold appropriate regulatory capital for those exposures.”
The new rules will take effect from 1 July 2015. There will be a nine month transition period (to 1 April 2016) after which lending to property investors must be classified correctly.
The Reserve Bank already has capital adequacy rules for five main lending classes, each with unique risk characteristics: equity, banks, sovereign, corporate and retail. “Retail” includes all residential mortgage lending. The new proposal would separate out lending to landlords because they say that grouping has higher risk characteristics than owner-occupied borrowers.
In effect the Reserve Bank will have its hands on six credit taps which it will adjust to influence the amount of credit flowing through into the economy. The new property investor tap will control the amount of credit available to property investors and therefore a substantial chunk of the demand in the property market. If the Bank wanted to rein in the property market it would turn down the flow of credit by requiring the trading banks to hold more capital reserves viz-a-viz its lending to investors.
Although the property inflation problem is essentially an Auckland one, the Reserve Bank is taking a more macro view. It says, “This is not about the state of the property market or penalising borrowers or regions. It is about helping to maintain the stability of our financial system by ensuring that banks classify their lending correctly and hold the appropriate level of capital backing for their loans.”
This approach of putting bank lending into silos based on risk, then regulating the flow of credit, is consistent with the standards recommended by Basel Committee on Banking Supervision. That Committee first met in 1975 and now meets some three or four times a year to overview ways to better manage lending risk by controlling bank equity to avoid the chances of a banking system collapse, the latest being the Global Financial Crisis in 2008.
It remains uncertain what effect the new restrictions will have on property investors. The general view amongst commentators is that mortgage interest rates could rise by about 25 basis points (0.25%). Given the strong competition within the banking sector to lend out funds, as evidenced by the discounting being done to attract low risk borrowers, it is quite possible that the impact will be absorbed by the banking sector without any visible impact on retail lending rates (a little like fuel tax rising a few cents, at a time when crude oil prices are falling).
The most likely impact will be felt by highly-geared investors with low levels of equity – in particular speculators who aggressively gear up their investments to ride the back of rising property prices. They are the ones the Reserve Bank is targeting and the ones most likely to walk away from their liabilities should their house of cards fall down.
Whether a new property investor tap controlled by the Reserve Bank will deter speculators is a moot point. It may well just drive them into non-bank sources of lending and create a resurgence of second-tier mortgage lenders who operate in a less regulated environment. Those with more than 20% equity are unlikely to be affected, given the high level of competition in the banking sector.