Investors in the big four Australian banks had better be watching the Reserve Bank and other regulators – because there are some tough actions coming to try and slow the lending boom to investor home buyers.
And those actions will crimp the ability of the banks to maintain earnings from their booming home lending operations.
Investors quickly cottoned on the dangers to the banks profit and loss accounts and marked down their shares.
All big four banks were down. Westpac (WBC) fell 0.9% to $32.47 is on the brink of going into correction, having lost 9.5% since April.
The NAB was the biggest loser, dropping 1.4% to $33.04, the Commonwealth (CBA) was down 1.1% to $76.42, while the ANZ shed 0.9% to end at $31.38 and is now well into correction territory (a fall of 10% or more from its most recent high).
The Big 4 YTD – Banks turn down as regulators target property boom
The AMP’s chief economist Dr Shane Oliver said we can “expect increasing jawboning from the RBA with a rising likelihood of credit growth restrictions for investors if it doesn’t slow soon”.
As a result, he said “the medium term return outlook for residential property is likely to be very constrained”.
And that means it will also be constrained for the banks.
The latest Financial Stability review from the RBA outlines a considerable escalation in the RBA’s concerns about the lending boom (as forecast a week ago).
"The low interest rate environment and, more recently, strong price competition among lenders have translated into a strong pick-up in growth in lending for investor housing – noticeably more so than for owner-occupier housing or businesses. Recent housing price growth seems to have encouraged further investor activity.
"As a result, the composition of housing and mortgage markets is becoming unbalanced, with new lending to investors being out of proportion to rental housing’s share of the housing stock. Both construction and lending activity are increasingly concentrated in Sydney and Melbourne, where prices have also risen the most.
“The direct risk to financial institutions would increase if these high rates of lending growth persist, or increase further,” the RBA warned.
With RBA governor Glenn Stevens due to appear on a panel at a financial services conference in Melbourne at lunchtime today, we will certainly hear more about this issue this afternoon.
The latest comments are the most comprehensive and pointed on the housing boom from the central bank for perhaps a decade, since the last big housing boom.
The Bank said it is talking to the Australian Prudential Regulation Authority and other members of the Council of Financial Regulators about "further steps that might be taken to reinforce sound lending practices, particularly for lending to investors".
While it didn’t reveal what measures are being contemplated, some analysts reckon the bank will be forced, reluctantly, to introduce some form of macro prudential controls on investor lending in particular.
The review suggest that loan-to-valuation (LVR) limits on bank lending (like in NZ) are not being considered, given the share of bank loans approved with an LVR of more than 90% has fallen over the past year.
The review notes that it is investors rather than first home buyers who are driving prices, and investors typically have higher levels of equity and hence relatively low LVR loans.
While it didn’t find any loosening of bank lending standards, the RBA asked “a crucial question for both macroeconomic and financial stability is whether lending practices across the banking industry are conservative enough for the current combination of low interest rates, strong housing price growth and higher household indebtedness than in past decades.”
The review’s highlighted the debt-to-income ratio of households, which is currently at an historically high level of 150%, indicates the level of concern a crash in house prices and the investor-led boom, allied to the higher level of household debt, could force a slowing in consumption and the wider economy, and then possibly the banks and the rest of the financial system.
One possible way of slowing lending might be to lift the interest buffers loans to investors that banks have to consider in assessing their loans.
Banks build a buffer into loans as an add-on to current mortgage rates when assessing a borrower’s capacity to service their loans. So instead of a loan at a rate of say 5.5%, the bank assesses the ability of the borrower to repay if rates were at 7.5% (the buffer is currently around 2%).
That could be raised to 8.5% or more for investor loans, but not for lending to owner occupiers.
The RBA thinking is suggested in the comment “there is some risk that households may attempt to take out loans that they would not be able to service comfortably if interest rates were to rise”.
"It will be important for banks’ own risk management and, in turn, financial stability that they do not respond to revenue pressures by loosening lending standards, or making ill-considered moves into new markets or products," the RBA said.
"Banks need to ensure that loans originated in the current environment can still be serviced by borrowers in less favourable conditions – for instance, at higher interest rates or during a period of weaker economic conditions."
The RBA warned that "the direct risks to banks will rise if current rates of growth in investor lending and housing prices persist, or increase further”.
The RBA said it was also concerned about the increase in interest-only loans, which "might also be consistent with increasingly speculative motives behind current housing demand".
The stability review highlighted particular concerns about the commercial property sector, where rising prices were "increasing the vulnerability of the commercial property market to a price correction”.
"One risk facing the commercial property sector is that a reversal in the strong growth in investor demand might expose the market to a sharp repricing," the RBA said.
The RBA said risks to banks from commercial lending books were currently limited but “a deterioration in future loan performance of commercial property cannot be ruled out."
And remember commercial lending is always watched closely by regulators because this is where the banks take their biggest losses in a property crash or in a recession (which triggers a crash).
