Investors: Too hot to handle?

This growth is catching the eye of savvy mortgage brokers, who have seen that the market segment is creating huge opportunities. However, investor loans are also on the radar screens of the regulators, who are not quite as enthusiastic about the growth trend as brokers.

With historically low interest rates, high levels of household debt, strong competition in the housing market and accelerating credit growth, APRA is concerned about a relaxation of lending standards.

At the end of last year, the regulator announced it is considering increasing the level of oversight for mortgage lending, thereby taking steps to promote “more prudent” lending approaches.

That’s regulator-speak for pouring cold water on a hot market and it has sent more than just a few ripples through the industry.

Happily, at this stage, APRA chairman Wayne Byres says he doesn’t feel it necessary to introduce (and reinforce) a series of hard lending restrictions – “sound residential mortgage lending practices”, he calls them.
If it did, it would mean the introduction of caps on investor loans and a raft of similar restrictive initiatives.

Mr Byres says he will be paying particular attention to ‘specific areas’ of prudential concern.

The strong growth in investor lending is one of these areas. In particular, APRA will be looking at investor portfolio growth materially above a threshold of 10 per cent as an important risk indicator.

A measured approach

Mr Byres notes that most lenders do already operate in line with APRA’s supervisory expectations. But he’s still worried about bursting bubbles. The upshot though is that if it feels it needs to, APRA will go ahead with this pre-emptive strike on the investor market.

The APRA chair calls it a “measured and targeted” response to emerging pressures in the housing market. “These steps represent a dialling up in the intensity of APRA’s supervision, proportionate to the current level of risk and targeted at specific higher risk lending practices in individual ADIs,” he says.

For its part, the Reserve Bank of Australia, though sceptical earlier, is now right behind APRA. Governor Glenn Stevens has said he is worried about the double digit growth of the investor market, and in particular that a lot of the lending is interest-only in an environment of rising house prices.

“I think it is perfectly sound and sensible to ask ourselves whether there are tools that might, at least, ‘lean’ on that a bit,”

he said recently at the Melbourne Economic Forum, adding that the worst thing that could happen is that nothing happens. But at least ‘leaning on it a bit’ might have some small impact, he says, and if it helps to cool things a little, then it’s worth a try.

Strong house price growth in Sydney and Melbourne has also triggered ASIC’s interest. The corporate watchdog is chiefly interested in checking on compliance, particularly in the interest-only loans area, which it considers to be at the higher-risk end of the lending spectrum.

Although they include both owner-occupied and investment properties, interest-only loans as a percentage of bank approvals of new housing loans reached a new high of 42.5 per cent in the September 2014 quarter.

Here, ASIC is keen to look into the conduct of all lenders – banks, including the big four, and non-bank lenders alike – regarding their compliance with the new consumer protection laws – in particular their responsible lending obligations.

ASIC deputy chairman Peter Kell said that while house prices have been experiencing growth in many parts of Australia, it remains “critical” that lenders are not putting consumers into unsuitable loans that could see them end up with unsustainable levels of debt.

“If our review identifies lenders’ conduct has fallen short, we will take appropriate enforcement action,” says Mr Kell.

Two of the industry’s leading economists have come out in cautious support of the regulators. But both of them warn of unintended damage if the superpowers bring out too heavy a stick.

Beneficial role

Shane Garrett, senior economist at the Housing Industry Association, feels it is important that the financial system is given adequate protection against adverse scenarios that might arise. However, he warns against regulator over-zealousness.

“The more stringent level of supervision now faced by mortgage lenders must not be allowed to inhibit transactions in the housing market or stifle the volume of new home building,” he says.

Instead, the regulators should remain mindful of the beneficial role investors actually play in the housing market.
Mr Garrett argues that investor demand results in more homes being built than would be the case in their absence:

“Investors also boost the supply of rental homes, resulting in lower rental costs for lower income households in Australia,” he says. “Measures to reduce investor participation in the market could simply end up penalising lower income households and exacerbating supply bottlenecks.”

AMP Capital chief economist Shane Oliver feels APRA’s further steps to restrain investor lending are clearly in response to RBA concerns that housing lending has become unbalanced.

He also feels it is highly likely that APRA will follow through with its plan to step up macro-prudential supervision. All lenders should – and probably will – err on the side of caution.

“It seems pretty clear to me that if banks do not restrain their total lending to property investors to 10 per cent annual growth, apply an interest rate buffer of at least 2 per cent with a floor of at least 7 per cent in assessing new loans and restrict higher risk mortgage lending, then they should expect further supervisory action that could include a requirement to hold more capital,” Mr Oliver says.

“APRA and the RBA clearly do not want to allow a housing bubble to develop given the risks this would pose to the economy if it bursts. Nor does the RBA want excessive housing market strength to restrict the help it can provide to the broader economy via low or even lower interest rates,” he says.

So should APRA’s move be taken seriously? Perhaps, but one decorated mortgage broker is unhappy at the attention the investor market is getting and the threats that are emanating from it.

Soft targets

The broker, who prefers to remain anonymous, agrees that the market might be overheated in some areas, but taking the heat out of the investor sector is not the way to cool it down. Instead, he says, the regulators are deliberately going after brokers because they are easy targets.

“We have seen a clear-cut example of this in the media via The Australian newspaper blatantly stereotyping brokers as fraudulent and incompetent,” the broker says.

Addressing the overheated section of the market, he says where interest in the suspected housing bubble stems from is New South Wales and Victoria, arguing that legislation is driving this activity.

“The major piece of legislation passed recently to stir such strong growth in these states is from international investment visas,” he says.

On this point he takes a jibe at the regulators themselves, accusing them of egocentricity. “Since the global financial crisis, regulatory bodies are drunk on creating new legislation to justify their existence.

Instead of just bashing easy targets, the regulators need to understand where the growth in housing prices is stemming from, and then take the appropriate action,” the broker says.

Subsequently, there really is no need for brokers to take a new approach to servicing the investor market. If loan writers are already conscious of their compliance, they have nothing to worry about when the regulators apply additional scrutiny.

“As a duty of care we sit with clients anyway, and run through their cash flow expectations against variables such as interest rates, fees, vacancy rates and capital growth. With these scenarios, clients are more comfortable in their decision-making even if the market or their situation changes,” he says.

The broker has his files independently audited on a quarterly basis – by choice. It ensures he meets his compliance requirements, and it also ensures he can prove it if he is ever required to.

It sounds like a good business practice to implement, and it seems he is not the only one who thinks so.

“Colleagues in our aggregation say they have also implemented the same system.

But ultimately it remains the decision of the client to proceed with an investment purchase, and the broker’s role is simply to provide the most suitable finance option based on their needs,” he says.

Where to from here?

Shane Oliver expects APRA’s initiative will likely drive a further cooling in the housing market in 2015. He predicts property investor housing credit will peak at its current growth level of 10 per cent year-on-year (as at November 2014) and will then slow during the course of this year. 

For brokers and lenders, this means that the growth rate in business is probably at, or close to, its ceiling. “But in the absence of interest rate hikes it is still likely to remain solid,” says Mr Oliver.

He also expects it may begin to get a bit more difficult for investors to get a loan.

“But only at the margin as APRA’s aim appears to be to restrict investor loan growth to current levels, not to contract the level of investor loans,” he says. 

On the other hand, Mr Oliver believes that for home owners, the APRA move is good news. “It gives the RBA more scope to cut interest rates again, to help the broader economy which is still growing at a sub-par rate,” he says.

HIA’s Shane Garrett believes that regulation must be “fine tuned” in order to facilitate the smooth operation of financial markets and the economy.

He is confident this smooth operation will happen, despite APRA’s concerns. “We can take comfort from its letter of 9th December 2014 indicating that such measures [the introduction of restrictive macro-prudential tools] are off the table for the time being.”

But he warns against complacency. Mr Garrett is quick to remind us that APRA has promised it will be monitoring residential mortgage lending in terms of risk profile during the first quarter of 2015.

“Where lending practices are found not to be prudent, the supervisory oversight will increase in a graduated fashion,” he says, which could ultimately result in increased capital requirements being imposed on the mortgage lender.

“At this stage APRA has prescribed no explicit targets but it has said investor credit growth above 10 per cent would trigger its attention in considering supervisory actions.”

While Mr Garrett is comfortable so far that the measures outlined late last year are less drastic than they might have been, given the previous speculation about hard lending restrictions being introduced, in the context of Australia’s shortage of dwelling stock, excessive financial regulations risk hampering new home building and exacerbating the housing supply shortage.

As one door closes…

In another development, non-bank specialist lenders, which are not governed by the prudential regulator, have been grabbing the opportunity to help out investors at this time. Perhaps this is to be expected. 

“Investors tend to chase maximum borrowing power,” Pepper Australia’s director of sales and distribution, Mario Rehayem, told The Adviser’s sister publication Mortgage Business.

“We have a lot of very affluent clients who have reached their maximum capacity at the mortgage insurers,” Mr Rehayem says, “so they come to us because we have no affiliation with the mortgage insurers.”

In addition, Pepper assesses the rental income of a borrower’s investment properties and has alternative income verification methods that more ‘mainstream’ lenders generally do not permit.

“So we allow more types of income as part of serviceability,” Mr Rehayem says. “We take 100 per cent rental; we do negative gearing; so we are no different to a lot of banks that are known to investors.”

Specialist lenders have traditionally been known for helping clients who are credit-impaired, and Mr Rehayem admitted there are many affluent investors in this position.

“What we do at Pepper is take on a client knowing what their risk component is,” he says. “We take on their past behavioural problems or life cycles and events and look at what we are going to do with them, moving forward.

“Because we have been in business long enough, we understand where to play in the market – who to lend money to and who not to.”

Another significant segment for specialist lenders is self-employed borrowers.

“Just because you are self-employed doesn’t mean you can’t be an investor,” Mr Rehayem says.

“Just because you have been in business just shy of 24 months and can’t produce tax returns doesn’t mean you cannot be an investor.”

Same playbook

APRA has downplayed the significance of macro-prudential tools by putting the current investor-lending boom in context. “Actually a lot of what we are talking about is just normal regulation and regulation responding to circumstances,” Mr Byres says.

The newest thing about the current conversation regarding bank regulation is the word ‘macro-prudential’, he says.

Comparing current market conditions with those of 2003 and 2004, when house prices also experienced rapid growth, Mr Byres said APRA has “the same playbook” and has taken the same course of action.

“At that stage, we were talking about the issue and the governor of the Reserve Bank at the time was talking about the issue, we collected some extra data from banks to observe who the outlying guys were or who the more aggressive lenders were,” he says.

APRA then took additional measures to cool the property market by implementing changes to capital requirements and requirements around mortgage insurance.

“We did some other things designed to just temper the incentives and you shouldn’t think of this as some grand new framework and completely new,” Mr Byres says.

“I always think much of it is APRA doing its job, which is [to act] as things start to get a bit frothy or more exuberant or whatever – the right phrase might be there is a gradual ‘turning up of the dial’ of supervising intensity and regulatory intensity,” he says.

“In many respects I suppose it depends on how far you want to take this concept of macro-prudential, but at least in the way we are thinking about it, it is conventional supervision, conventional regulation and, in very simple terms, it is getting people to be prepared for adversity in the future,” Mr Byres says.

And there is nothing new in that.