What's behind the banks approach to LVR policy?

by Alistair Helm in ,


Image courtesy of the Reserve Bank of New Zealand

Image courtesy of the Reserve Bank of New Zealand

It is now 10 months since the Reserve Bank implemented its LVR policy, the macro-prudential tool designed to bring a cooling effect to what was clearly a heated property market, especially in Auckland. 

Ten months in which the property market has seen a significant turnaround. The market was already loosing momentum during the winter of 2013, having seen over two and a half years of volume growth when sales had risen on a moving annual total from 55,000 to 80,000.

NZ sales MAT Jun 2014.png

However the impact of the LVR policy by the Reserve Bank in October last year effectively stalled the engine of the property market. From a peak of 80,677 in October last year the annualised total of property sales has already fallen to 75,637 and year-on-year monthly growth has been negative since October plummeting to a 20% fall in April.

Prior to the implementation of the LVR policy limiting lending above 80% loan-to-value to 10% of the total loan pool of the retail banks, this higher risk / low deposit sector was accounting for upwards of 25% of the total lending - at least that was what the data released by the Reserve Bank showed for the months of August and September of last year. Now I can fully believe that these months were somewhat inflated as those prospective buyers with low deposits rushed to take advantage before the door closed on these 90% and 95% mortgages.

The make up of the customer base of these high loan-to-value loans is hard to accurately identify. Certainly there would be 1st home buyers, however there is no way that close to 1 in 4 of property buyers were at anytime 1st time buyers, more likely would be a number around 10%. The other customers of these high loan-to-value mortgages would be a mix of investors and speculators. 

Investors like to leverage their purchases allowing them to acquire a portfolio of properties whilst maintaining an available cash pool for future opportunities so they like 90+% loan-to-value mortgages - the low deposit multiplies the appreciation of the property in relation to their return on investment.

Speculators also like high loan-to-value mortgages as it frees up cash for property renovations and improvements without having to constantly go back to the bank for progress requests for additional funding - speeding up their process of renovation and subsequent sale. 

There is no doubt these 3 segments of the property market were active in the the period of 2011/2012 as these 3 groups and particularly the latter two are generally good at reading the market and getting in quick before the market rises and then sticking or flicking (in the case of speculators) as the market ramps up.

The subsequent months since October of last year have shown a significant slowing of the lending to these 3 segments.

As the chart shows the subsequent months (with the exception of October) has seen the retail banks lend considerably less than their allowable quota of 10% of all loans (based on a 3 month moving average). 

Now here is the question. How complicated is it for the major retail banks to manage the lending to optimise this segment of the market whilst at the same time ensure that they do not breach the 10% threshold?

You would think that given retail banks make profits from lending rather than hoarding they would be keen to continue to lend high loan-to-value mortgages to these customers based on the situation that if they did not, then some other bank might, after all they do operate in a highly competitive marketplace. Certainly the banks have advanced computer systems, modelling capability and staff to be able to manage that threshold day-by-day and hour-by-hour to ensure that they leant exactly 9.9% of their loan book each month. So why is it that over the course of the past 10 months instead of lending $3.9 billion of high loan-to-value mortgages they have only leant $2.7 billion? - they have in effect collectively denied themselves the opportunity of lending an extra $128 million per month for 10 months!

The answer to the question may lie in two alternate scenarios:

Scenario 1 - Banks hide behind Reserve Bank

Retail Banks despite their commercial imperative are conservative businesses and they mitigate risk. They also operate within a highly regulated industry. Their objective is to defray risk by ideally lending to low risk borrowers at higher rates than they pay to depositors on safe assets. Now property, especially residential property is generally regarded as a low risk asset. However the past decade has taught us all to regard nothing as low risk. Whilst the worst of the excesses of the sub-prime mortgage market was never close to our shores, the ripple effect was felt and has created a sense of caution in the banking industry. 

The Reserve Bank action in implementing its LVR policy effectively provided the retail banks with a legitimate escape card to which all of them could with one voice state that prospective customers should take more responsibility for the asset they wanted to buy by having a greater deposit than the traditional 10% or 5%. In one fell swoop the retail banks managed to avoid a great chunk of risk. Sure the impact was a collective loss of lending opportunity but given the favourable underlying economic conditions and the fact that the impact fell evenly across all banks there could be argued a view that the banks collectively were happy to shave a small amount off their earnings for a significant reduction in risk.

This is merely a hypothesis but one that to me, has a degree of logic, I am not an economist but I feel there could be a part of the rationale at work within the retail banking industry over this issue.

 

Scenario 2 - Banks can’t sell these high Loan-to-value mortgages

An alternative scenario is one that I have not heard voiced, so I’ll give it a go!

There is actually insufficient demand to fulfil the supply side opportunity of high loan-to-value mortgages at the current 10% threshold

This logic relies heavily on a recursive argument that the impact of the announcement of the implementation of the LVR policy certainly can be seen as having a rush-for-the-door effect before the 1st October deadline and that mild panic matched to a clear media messages after the fact that banks were becoming highly restrictive of such high loan-to value mortgages would have had a dampening effect on demand.

That dampened demand certainly lead to a slowing of sales, which was quickly reported in the media, which in turn lead to talk of the deflation of any property bubble, which whilst in principle a signal that should send a message of comfort to the market, actually caused a reaction from a core target market for these loans (being primarily investors and speculators) who believing that the market had peaked. They then judged that this was the time to exit the market, either through consolidating their portfolio or selling properties. This action suddenly and significantly depressed this segment of the market, possibly from a level of 15% - 20% of the market down to 5% of the market.

Add to this behaviour another key issue of the Reserve Bank data as presented in the charts and numbers - the total value of mortgages each month as reported by the Reserve Bank is defined as ‘Total New Commitments’ - this sum $4,499 million in the case of June is the total value of all new written mortgages and includes refinance mortgages, especially including a significant component of moving from floating to fixed rate mortgages.

The fact is over the past 10 months and especially the past 6 months with the clear signals of impending OCR increases the residential mortgage market has transitioned back to fixed term mortgages. This will have driven the total of 'new commitments' and therefore will have had a depressing factor on the percentage of high loan-to-value mortgages.


So having presented the two scenarios I take the view that what we have seen in the market is probably a combination of both scenarios. Banks like to negate risk, it is highly probable that investors and speculators have moved to take a back-seat int he market and the re-mortgaging factor has also been at play.

The only party therefore who have been a pawn in these moves has been true first home buyers who have been significantly effected by the LVR policy and also by rising interest rates. As to whether they are heading back into the market as witnessed and reported in the media, I doubt it and sadly there is no accurate data to back this up.

 

 


Mortgage rates on the up - what will be the reaction of the property market?

by Alistair Helm in , ,


Last week we witnessed the first increase in the OCR since July 2010 when the rate was then raised from 2.75% to 3.0% - that change was short-lived as in March of 2011 it was dropped to 2.5%; a level it has maintained since. 

The fact is that the current levels of interest rates, which have been pretty much stable for the past 5 years represent an unprecedented period of low interest rates. A quick look back in history shows exactly how the past 5 years contrasts with the volatility of the past 50 years.

Historically mortgage rates have experienced typical cycles of rises and falls, especially over the past 25 years, with rates topping 20%+ at the end of the 80's. To put that into perspective a 30 year mortgage for a median priced $415,000 property which today based on an 20% deposit costs $1,948 per month would cost $4,198 at 15% mortgage rates and a staggering $5,684 per month if we were to experience the 20.5% mortgage rate of June 1987 again!

We are certainly going to have to adjust our expectation as mortgage holders to paying more a month in the coming years as the trend is upward. The recent 0.25% increase added $53 to the monthly cost of a 30 year mortgage of the median priced house.

Of equal concern to most home owners with a mortgage is the likely impact these rises in mortgage rates will have on the property market, both in terms of levels of activity and price.

Whilst data from the Reserve Bank on interest and mortgage rates goes back 50 years the data on property sales and prices from the Real Estate Institute only goes back 20 years, however the past 20 years does provide us with some valuable data as to the property cycles of the period for analysis.

The chart above tracks floating mortgage rates since 1992 and as highlighted by the coloured sections, this timeline does showcase some parallel periods of rate changes which can provide a basis for analysis.

Rising interest rates - The red sections "A" - this occurred between March 1994 and September 1996, a period of 31 months.  A similar rising interest rate period was from October 2003 to July 2008, a period of 58 months.

Falling interest rates - Green section "B" - this occurred between April 1998 and August 1999, a period of 17 months.  A similar falling interest rate period was from August 2008 to July 2009, a period of 12 months. 

Volatile interest rates - Orange section "C" - this occurred between September 1999 and December 2001, a period of 28 months.  A similar period of volatile interest rates was from February 2002 to September 2003, a period of 20 months. 

So taking these three defined parallel periods of activity it is very interesting to see what happened to property sales volumes and prices during these times.

 

Rising interest rates

The two periods of rising interest rates were lengthy and progressive and both covered periods when economic activity was strong and with it the threat of inflation and that was the trigger for tighter monetary policy.

The impact of these rising interest rates spread over 3 to 5 years was to depress sales as the chart below shows. It is somewhat striking to see the degree of correlations between these two discrete periods. The period in the 90's did see some recovery towards the end of the period but the first 12 months was generally depressed. In the case of the 2000's the long term impact (heavily influenced by the GFC) was a significant depressing of sales volumes.

When it comes to property prices as measured by the median price the trend across these two discrete periods again shows a high degree of correlation. Both periods witnessed a decline in the growth of property prices. It was only towards the end of the 5 year period in the last decade that prices actually went into negative growth.

Falling interest rates

The two periods in which interest rates fell were short-lived, representing just 17 months in the end of the 90's and just 12 months in 2008/9. Both of these periods came about as a function of the necessary reaction of the Reserve Bank to external stimuli - in the late 90's it was the Asian Economic Crisis and a decade later the Global Financial Crisis.

The impact of these significant cuts in interest rates was to stimulate property sales as the chart below shows with again a striking correlation between the two discrete periods.

When it comes to property prices the fact is the data shows that the falling interest rates aided the stimulation in property prices. In the most recent period of 2008/9 dragging prices back from actually falling, whilst in the 1998 period it managed to stave off what could have been and was very close to falling prices.

 

Volatile interest rates

The past 20 years have witnessed two coinciding periods when interest rates showed significant volatility, in the space of 2 years interest rates rose and then fell to return to the prior period rates.

These instances occurred during the early years of the last decade and were triggered largely by global economic events. Clearly this degree of rising and falling rates can lead to uncertainty.

In the case of property sales, volatility in interest rates seems to establish no clear correlation between the two periods nor in fact any clear direction of the market. The earlier 1998/9 period saw sales fall and then recover, almost in line with the interest rate hike and then cut; as for 2002/3 sales fell but with some rebound.

As to property prices during this volatile period, again as with sales volumes the correlation between the two periods is not clear and the trend seems to show no significant movement up or down. The 2002/3 period did see a very marked rise after 12 months as interest rates fell; this was though the beginning of a very strong bull run on prices through to 2007.

So whilst by no means scientific, there is clear data to support the view that the occasions when interest rates are rising is a time when property sales ease and prices slow; whilst interest rate cuts stimulate property sales and inflate prices. However uncertainty in interest rates tends to leave the market marking time. With the Reserve Bank clearly signalling that we are about to experience a period of 2 to 3 years of interest rate rises it would seem to be fair to say we will see sales volumes ease and price growth slow.


The LVR speed limit - crippling or merely cooling the market

by Alistair Helm in ,


Speedlimit_80_shutterstock_107472449.jpg.png

The Real Estate Institute in their monthly report for October stated in headlining their report that "LVR Restrictions Impacting Sales Volumes" - they went on to say "sales volumes eased back in October following the introduction by the Reserve Bank of restrictions on high LVR lending". The actual sales in October were 6,778 which was up 2% on a year ago, that month of October 2012 was up 32% on the prior October of 2011, which itself was up 28% on the prior year being 2010. So in the space of 3 years sales volumes are up 74%, in fact the level of 6,778 is the median for the past 21 years. 

Property sales growth is slowing - looking at the trend of monthly sales as compared to prior year we are coming to the end of a run of 30 straight months of growth in sales year-on-year, by no means the longest run, but a strong recovery from the property crash of 2008 as the chart below shows. Typical towards the end of a long run of growth comes more erratic variance as the growth begins to turn negative as we are seeing in the October figures.

REINZ monthly sales var.png

 

Added to these factual statistics from the Real Estate Institute was the monthly survey of real estate agents published by the BNZ and initiated through the Institute. This survey which I have mentioned before could be a vital sense of a pulse of the property market as the Institute represents almost all licensed agents. Given that it is a shame that from the population of close on 10,000 such low reporting of the monthly survey occurs. This month the survey looked for verbatim responses to the statement "What effects have you noticed from the LVR rules?". There were 247 responses published by the BNZ report. A quick count up had 180 of these comments showing a very pessimistic view on the impact of these LVR changes and the impact on first time buyers and open home attendance as well as performance of auctions. Here is sense of the responses:

 auction rate under the hammer has dropped dramatically

number of first home buyers in the market has decreased markedly

More very frustrated Vendors

Majority of first home buyers dropped from the market

Drastic decrease in competitive bidders/bidding

Massive decrease of first home buyers

Definite drop off in first home and migrant buyers

Huge decrease in people looking at property

A lot of Sale and Purchase agreements are not going unconditional or if they are it is at a cheaper, 
renegotiated price

Massive reduction of attendees at open homes

Overnight no enquiry from first home buyers. they have been scared away

 

Reading through these and the other verbatim comments reflecting a net 72% negative you would soon become depressed about the future months of property sales with a sense of up to 30% decline as that has been the often quoted component of 1st time buyers. However the reality is there is no accurate source of data that shows what 1st time buyers actually represent of the market so any prediction of effect is largely guess work, and the views of agents from what is a very small sample - just 247 from 10,000 (2.5%) should be taken with a note of caution.

There is though data from the Reserve Bank that reports the weekly levels of Housing loan approvals of both new mortgages and re-mortgages. Such data provides vital opportunity for analysis as I have done in the charts below.

RB actual mortgage approvals.png

This chart shows in the red line the 4 week moving average of the number of housing loan approvals made by trading banks. The last few weeks of October certainly showed an accelerated decline, however the trend as best seen in the grey line being the 12 week moving average shows that volumes had been declining since a peak in May of this year, however they still remain around 6,000 a week.

The next chart shows the trend of volume comparing the 4 week moving average year-on-year. This chart certainly would seem to show a picture of the announcement of the decision to implement the speed limit of high LVR triggering a slowing in volume of new housing loan approvals, in effect reversing a period of recovery which began in July, although as with the prior chart the longer term trend still shows slowing growth.

RB mortgage trend.png

We will need to wait until at least the November sales figures and more likely until the new year as well as to study housing loan approvals before the definitive statement can be made as to the true impact on the changes as a consequence on the high LVR restrictions, indications certainly show an impact, though that impact in sales is not huge as yet.

 

 

 


The silver lining of the new LVR Restrictions

by Alistair Helm in


Calendar-1.png

The first day of October has dawned and with it the introduction of the LVR restrictions imposed by The Reserve Bank on the main trading banks forcing them to reign in their lending to borrowers with low deposits (less than 20%).

Certainly this is going to have an impact on the property market. It will impact those who either do not have the necessary 20%+ deposit and also importantly those who do not want to tie up that much capital in a property, especially an investment property. Investors tend to like to highly gear their investment properties so as to maximize their interest cost recovery against tax. Therefore there will likely be an impact not only among first-time buyers but also investors.

However as with all matters economic, there is always a contrary position and in fact there will be winners or potential winners from the LVR restrictions.

The fact is the main trading banks whilst strictly adhering to the new policy (especially as their operating license is at stake, not something they are likely to risk for one second) will not for a moment relinquish their desire to continue to build their business by lending against property as a secure asset. These banks are hardly going to be able to settle back and report to their shareholders that they have seen their profits fall because of this policy. Their shareholders will rightly expect them to seek to find alternative lending options to make up for any potential loss of clients in the high LVR market.

This is where that contrary position comes in. If you are not a first-time buyer or an investor. If you have a healthy equity ownership in your property and you are possibly looking to buy a house or refinance. You may well now find out that your local bank is even more happy to see you, greet you warmly and encourage you to discuss options with you.

The fact is that for every large value low-LVR mortgage that a bank can write, will effectively allow them to offer a lifeline to first-time buyers and investors.

Here is a somewhat simplistic example to illustrate this situation.

Lets say a bank as of last week has 25 prospective mortgage customers. 10 of those customers are after a 90% mortgage to buy a property and they all want to borrow $300,000 to fund that purchase of a $333,000 property. The other 15 customers happen to be customers with a larger portion of equity. They are looking to borrow $750,000 each to buy a $1.25m home – 60% LVR mortgage.

Bank mortgages 1.png

This package of mortgages totals $14.25 million and results in the bank having 21% of its mortgage book in loans over 80%. A situation that the Reserve Bank says has to stop from the 1st October.

So from the 1st October the bank in the same scenario of those 25 new customers would have to turn away 6 of the 10 customer who wanted 90% mortgages to ensure that their total mortgage book has no more than 10% in high LVR mortgages. This decision would cost the bank a 13% fall in overall lending, down to $12.45 million and likely a consequential fall in profits.

 

Bank mortgages 2.png


However if the bank reached out to some more of these higher value customers who are well below the 80% LVR threshold and offered them an enticement in the form of lower interest rate or other inducement then by attracting just 2 more of these higher value customers they could also satisfy one more first home buyer and in so doing end up with 22 customers rather than 19. They would have a total mortgage book up 5% at $15 million and a potential competitive advantage.

Bank mortgages 3.png

So my advice is be alert to some very friendly and generous bank representative courting you if you are after large mortgages and if you have a good strong equity position in your home!


Potential impact of policies to address the 'hot' property market

by Alistair Helm in , ,


Real estate agents might be urging the government to "be careful what you wish for" in regard to any government or fiscal intervention  in the NZ property market -  especially if they have read about their colleagues in Hong Kong!

Bubble iStock_000006996157XSmall.jpg

With further evidence that the NZ property market is building up a significant pressure bubble – the ever-present question is whether that bubble will see the pressure released slowly or just simply burst with negative repercussions. 

Measured on a 5 year basis the REINZ Stratified house price index shows a 17% increase, with over half of that gain in the past 12 months! This has prompted extensive calls for some form of non-monetarist intervention via the Reserve Bank to focus on LVR and also calls for controls on overseas buyers.

With this as a backdrop it is worthwhile to compare and contrast the NZ market with the Hong Kong market given its topicality. Accepting the Hong Kong market is a very different market; the choice is a result of the fact that the local government has recently introduced far-reaching controls to bring some reigning in of a super hot market that has seen property prices rise 120% since 2008.

These new measures coupled with the tightened of existing policies is an attempt to make property, especially apartments more affordable – now where have we heard that cry before?

However to begin with there is an important perspective that needs to be seen when comparing the Hong Kong market with the NZ market. We are so often told that NZ and again particularly Auckland has some of the most unaffordable property in the world when comparing house prices to salary. The NZ ratio has house prices close to 5 time the average salary – that pails into insignificance as Hong Kong sits at a whopping 12.6 times average income!

The measures brought in include a doubling of stamp duty to 8.5% for property over HK$2 million (NZ$330,000) . I was interested to read in the South China Morning Post article of what I would consider as the most appropriate measure, being the requirement for banks to assess the ability of borrowers to manage a three percentage point increase in mortgage rates, up from the prior test at two percentage points. Additionally a stamp duty has been introduced to curb speculation payable by sellers if properties are sold within 3 years – the duty is now between 10% and 20% of the selling price. Lastly the measures also include (which will be of interest to NZ) a 15% levy on non-local property buyers!

All in all some very stringent measures, which from the data published in the article shows the policies appear to be making an impact as property sales collapse.

  Estate
agents march in protest at moves to control sky high Hong Kong property prices  






  
  
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 Estate agents march in protest at moves to control sky high Hong Kong property prices

This collapse is having its effect on the industry of over 40,000 real estate agents in Hong Kong  which interestingly equate to 1 agent per 175 of population, compare that to NZ with 1 agent per 440 of population. These agents are up in arms as the slowing sales cuts their income – so much so that these agents association are marching on Government headquarters to have these policies reversed – could this end up being the case in NZ if proposed government and Reserve Bank measures cool the NZ market ending it backwards and jeapodising the income of 10,000 agents? – it will be interesting to see!