The LVR policy - a successful policy for the property market

by Alistair Helm in


The Reserve Bank Governor Graeme Wheeler should consider himself pretty pleased with his initiative to reign in the property market. In my opinion it’s been a great success as a surgical tool to address one key part of the economy whilst not significantly impacting the others.

The policy of enforcing a threshold by which banks could not excessively lend to borrowers with a deposit of less than 20% has not only curbed the first home buying sector but also dampened the activity of speculators and investors - the very groups that tend to inflate the market.

There is no doubt that this macro-prudential tool of LVR (Loan to Value Ratio) will be eagerly assessed by other Reserve Banks around the world, particularly the Bank of England at this time as they grapple with a similar inflated property market.

Around this time last year we could see from all the stats that the property market, particularly in Auckland was on a fast track towards a potential bubble. As ever the options for the Reserve Bank were limited as the tool of choice was interest rates, a rather blunt instrument which, effecting all aspects of the economy, tends to cause un-wanted consequences especially in pushing the exchange rate higher and thereby effecting export competitiveness and as a consequence, the earnings potential of the country.

Examining the options, the Reserve Bank must have reflected upon the effect of the restrictions imposed by the retail banks back in 2008 at the time of the GFC to cease lending on residential property at ratios of loan-to-value in excess of 80%. This strategy was the right choice at the time in defraying the risk of property price falls onto the shoulders of borrowers, who were thereby effectively risking all their equity if they had to provide 20+% of the purchase price. This action in 2008 lead to the significant collapse of property sales in that year, a year that started out with a 12 month total of just under 90,000 sales and ended the year at just 56,000 a fall of 38% in a year.

With this test-case the Reserve Bank started to talk the proposal of LVR in the media over the winter months of last year in part to signal that the market was getting too hot and was ready to impose this LVR strategy with little notice.

It was on 20th August last year that the Reserve Bank announced that from 1st October the retail banks would be restricted to 10% of their total value of mortgage lending being of mortgages with deposits of less than 20%.

That announcement lead to a somewhat mild panic in the market with buyers very quickly looking to secure their position of pre-approved loans prior to the implementation deadline. This resulted in property sales in September shooting up from a 3 month average growth rate of around 8% to 19% in that month, before seeing successive months of property sales decline to date.

The Reserve Bank is nothing if not prudent and conservative. The last thing they want to portray in decision making is spontaneity or knee-jerk reactions. Their message is of the classic “this may hurt now, but it better for you in the long term”.

With this as a backdrop to their decision making process, it was somewhat surprising that within 2 months of the implementation of the LVR policy they were making a concession to exclude new builds from the restriction. This was in someways surprising and at the same time illuminating. To my mind this was a very clear early signal that the internal data (at that time not published) was telling them that the retail banks were being far tighter on lending restriction than the Reserve Bank had signalled. Remember, the direction that the Reserve Bank had given was that based on an initial 6 month average, retail banks were not too exceed 10% of the total value of lending to borrowers with less than 20% deposit. The data was showing at that time a level of 12% in October falling to 7% in November and what was to be just over 5% in December. To act in a manner which by their own measure was hasty was a clear indication of early success.

By January the data published by the Reserve Bank had shown that the retail banks were extending new mortgages at LVR of over 80% at below 5%. So low in fact that to meet the initial 6 month average criteria the loan book for March alone could have been as high as 25% and the banks would still have been below the threshold of 10%. These numbers of course represent the aggregated total across the main retail banks, there is no indication if any one bank was more lapse or more restrictive than any other.

Having seen the impact of the LVR policy, the key question for the Reserve Bank was what action was needed on interest rates and OCR. It had signalled for quite sometime that a succession of rates was to occur and delaying this was not a signal the Bank wanted to send; so the rises in March and April were pretty much baked in and implemented.

However now the Reserve Bank sits here in May and have to assess what appears to be a difficult situation. The recent 0.5% increase in interest rates has kept the dollar exchange rate high which is hurting exporters and the general economy and further interest rises will only exacerbate the situation. Set against this is a fast cooling property market where the sub $400,000 sector has all but disappeared (down 32% in April vs prior year). Added to this there is no doubt that the OCR increases flowing through to mortgage rates has further weakened the property market and has pushed a large proportion of mortgage holders into fixed rate agreements. This was probably a much desired outcome by the Bank to reduce exposure of homebuyers to interest rate volatility.

So I would judge (not being an economist) that the Reserve Bank now has the chance to back track on the planned further increases in the OCR at least until later in the year. It also has the ability to make some adjustment to the LVR, possibly as some have speculated to increase it to a 15% threshold. I would judge that this is a medium term solution to be implemented within the next 3 to 6 months. I would further judge that the speculation that the LVR policy could be removed before the end of the year is very unlikely, for whilst the threat of its re-implementation is always a powerful dagger to hold over the market, I sense that the Reserve Bank is not wanting to be seen to implement a innovative new policy as this still is and then to remove it, especially in an election year where political considerations weigh heavy on the media's mind.

This may be a viable outlook, it may not be - I am merely providing my own interpretation, however as I stated at the beginning I would judge that the Reserve Bank governor is quietly pleased with himself and his advisors for the implementation of a policy that effectively can be used to ring-fence the property market speculative bubbles of the future without damaging the wider economy.


Property Market Update Video - August

by Alistair Helm in


I was today invited by the team at Interest.co.nz to participate in what they describe as a double-shot interview with David Hargreaves.  As is expected the community that follow Interest.co.nz are posting their comments to this video - worth checking out.

The topics we discussed were: 

  • The Reserve Bank's move to implement the LVR restriction

  • The state of the property market

  • The real estate industry's continual promotion of auctions as the method of sale and how this potentially might be undermining their inherent value proposition over private sales 

These are coincidentally topics I have covered in previous articles, but great to be able to discuss these issues with David face to face. 


Unintended consequences of macro-prudential economic policy

by Alistair Helm in ,


Is the policy from the Reserve Bank an accelerant to an already volatile property market?

Is the policy from the Reserve Bank an accelerant to an already volatile property market?

It may be too early to tell, but I have a deep concern that the Reserve Bank may have unintentionally applied a volatile accelerant upon the property market just when what they wanted to do was quell the flames of a heated market.

Property sales when measured on an annualized basis are this month edging closer to 80,000. The rise in sales has been steady and progressive from the low in year to April 2011 when sales bottomed out at just below 55,000. This is a far cry from the heady days of 2007 when the market was overheated at well over 100,000 sales.

NZ Property sales MAT.png

What is more interesting is that the rate of growth in sales is slowing and has been for 9 months, slipping from 21% year on year growth to 14% year on year growth in the 12 months to July.

 

NZ Property sales - rate of growth slowing.png

The fact is that price follows sales in property market cycles and as sales slow and inventory builds which we certainly witnessed in the July data from the NZ Property Report so prices will ease.

So just as we start to see some meaningful easing in the market the Reserve Banks screams “Restrictions from the 1st October” and all those in the property market rush to the bank to secure a mortgage based on their current deposit of less than 20%.

Armed with this pre-approved mortgage willingly offered by the friendly banks who are only too happy to lend before the deadline these eager property buyers will be pouncing on almost any property they can on the basis that at least they can get a foothold on the property market.

All of this is fine if it ends up that these properties meet the needs of the buyer, however the fact an added surge in demand placed upon a still listings-short property market mixed with an exuberant real estate industry hell bent on auctioning anything that looks like a house with a 2 week marketing period is very likely to lead to buyers panicking. That panic could well lead to lapse due diligence, rash purchases of property ill-suited to buyers true needs and over-commitment of mortgage debt.

I hope this is not the case. I am not in the situation of being such a buyer, however when reading this excellent heartfelt opinion piece by Nadine Chalmers-Ross the host of TVNZ Business News, I was struck by the true feelings and anxiety of those who do feel disadvantaged by this new policy and who may be rushing as you read this to the bank to secure what might seem like a last desperate chance to grab a hand-hold on the property ladder. I just hope that the ladder is not engulfed in the flames fuelled by this latest move by the Reserve Bank, it would be a sad irony.