Opinion: Five reasons why I don't think the RBNZ will use LVR restrictions on home loans this year

By Gareth Vaughan

Now that Reserve Bank Governor Graeme Wheeler has his shiny new macro-prudential toolbox there's much excitement in the media and among some economists. One view seems to be that use of the most talked about of the four tools, restrictions on residential mortgage loan-to-value ratios (LVRs), is imminent.

I don't subscribe to this view, which has been articulated by, among others, two voices I respect in the form of BNZ head of research Stephen Toplis, and my interest.co.nz colleague David Hargreaves.

It can be a dangerous game to second guess the Reserve Bank Governor. But I don't see Wheeler dipping into his toolbox anytime soon to pull out the LVR restrictions tool, which is the macro-prudential tool the banks fear most. That's not to say he mightn't pull out one or more of his other new tools before year's end.

The Reserve Bank has been like a broken record over recent months commenting on its concerns over a hot Auckland housing market. It has also raised concerns about banks' high LVR lending - where borrowers have less than 20% of the deposit for a home loan, or less than 20% equity in their home when they refinance. It estimates around 30% of banks' new mortgage lending is coming through high LVR loans, up from about 23% in October 2011.

My recent breakdown of new mortgage lending from the five big banks here shows who the major culprits are  - of late - in this high LVR lending. ASB has been leading the way. A staggering 84%, or $1.4 billion of its $1.7 billion of home loan growth between October and March, came through high LVR lending.

For the March quarter alone, the most recently available data, ASB's high LVR lending comprised 71% of its total $791 million home loan growth. The only other of the big five over 30% was BNZ at 35%. ANZ, the country's biggest bank, was right on 30% of its $843 million growth. Westpac and Kiwibank would've been the Reserve Bank's pin-ups at just 8% and 5%, respectively.

Banks have been offering everything from TVs, iPads and vouchers for groceries or petrol with their home loans as they strive to entice borrowers to choose them over their rivals. But the latest series of special mortgage offers from the big four banks - ANZ, ASB, BNZ and Westpac - all include the criteria that borrowers have at least 20% equity. Keep in mind here that refinancing is the main game in town with growing numbers of home loan borrowers prepared to move between banks chasing better deals.

Reserve Bank data shows weekly mortgage approvals comfortably topping $1 billion in value week after week, against a backdrop of overall mortgage market growth that has averaged under $900 million monthly over the past six months.

1) Growth of the big banks' high LVR lending will slow

My guess is the big banks' next round of general disclosure statements, covering the three months to June 30, will show a drop - significant in ASB's case - in the percentage of their mortgage growth coming from high LVR lending.

I don't know what the Reserve Bank has in mind as its preferred upper limit in terms of the percentage of home loan growth banks get from high LVR loans. But I'm going to guess it might be between 20% and 25%. So if the next round of figures from the banks show it dropping into, or towards this level, that may be enough to placate the Reserve Bank.

2) Wheeler must 'consult' with the Government before implementing any of his new tools

Then there's the memorandum of understanding on the macro-prudential tools between Wheeler and Finance Minister Bill English. It states that;

The Bank will keep the Minister and the Treasury regularly informed on its thinking on significant policy developments relating to macro-prudential policy, and of emerging risks to the financial system.

The Bank will consult with the Minister and the Treasury from the point where macro-prudential intervention is under active consideration, and will inform the Minister and the Treasury prior to making any decision on deployment of a macro-prudential policy instrument.

So consultation with the Government where English, who appointed Wheeler to a five-year term last year, and Key's views will presumably be made clear.

We know Prime Minister John Key is no fan of LVR restrictions.

Here's what Key has said about them;

Any consumer can effectively go around that [LVR controls]. All historical attempts to stop that haven’t been very successful.

You can certainly protect the banks’ balance sheets from over-exposure to the property market, but the capacity of someone to go to their friend or lawyer or some other institution to get that other piece of equity that they don’t have, is always real.

Any suggestion that the imposition of LVR restrictions on home loans might squeeze first home buyers, who along with their parents double as voters, out of the housing market won't go down well around the Cabinet table. Especially as we inch closer to the next election.

Keep in mind that, based on the most recent national average median house price of $390,500 recorded by the Real Estate Institute of New Zealand, a home buyer would require $78,100 to muster a 20% deposit. And based on the Auckland median price of $555,000, they'd need $111,000. That's hardly the sort of money most young, would-be first home buyers can easily source.

3) The Reserve Bank doesn't really want to do it

It's also worth keeping in mind what the Reserve Bank's consultation papers have said.

One on all four macro-prudential tools in March pointed to a range of potential problems with high restrictions on high LVR lending. These included; adversely affecting efficiency, favouring wealthy home buyers/investors over first home buyers, arbitrage through non-mortgage (unsecured) top-up loans, and a risk of "leakage" to the unregulated sector and foreign banks should there be an increase in new lending by the non-banking sector. It also noted restrictions on high LVR lending would need to be "vigorously" enforced and monitored in order to reduce avoidance.

And this week's consultation paper, on LVR restrictions alone, has the Reserve Bank waving its finger at banks, warning them against gaming the system. The prudential regulator says banks would be expected to comply with both the spirit of the policy, as well as the letter of the law/regulations.And all this, remember, comes after the Reserve Bank decided to plump for "speed limits" limiting the share of new high LVR lending that banks may do, rather a temporary ban on such lending altogether, noting the banks themselves had expressed a preference for this approach.

All this doesn't give me the impression of a Reserve Bank Governor with an itchy finger struggling to restrain himself from pulling out his new LVR restrictions toy to play with.

That said, Wheeler did recently say that;

While there are important design issues to address in devising such measures, the empirical evidence to date suggests that during episodes of quickly rising real estate prices, LVR limits can help reduce the incidence of credit booms and decrease the probability of financial distress and sub-par growth following the boom.

But my hunch is Wheeler's trying to talk tough so the banks will pull their heads in, at least to some degree, and he won't have to try and enforce LVR restrictions.

4) Wheeler has other tools at his disposal that the Reserve Bank's more comfortable with

Amid all this talk of LVR restrictions it's worth noting that Wheeler has three other newly minted, less controversial macro-prudential tools up his sleeve. Plus the potential to raise the Official Cash Rate if the heat comes out of a New Zealand dollar, that has been trending down against the greenback, slipping below US79 cents last night.

The other macro-prudential tools are;

Adjustments to the Core Funding Ratio - altering the amount of equity, retail funds and longer-term wholesale funding banks have to hold.

A Countercyclical Capital Buffer - effectively banks holding more capital during credit booms.

Adjustments to sectoral capital requirements - increasing the amount of capital banks must hold in response to risks specific to certain sectors such as housing or farming.

The countercyclical capital buffer, adding an additional layer of up to 2.5% of risk weighted assets to banks' balance sheets will be available, in the Reserve Bank's arsenal, from January 1, 2014. Albeit, using it requires giving the banks 12 months notice.

The major banks are already strongly positioned against the current core funding ratio of 75%, helped by covered bonds. Which leaves adjustments to sectoral capital requirements.

Keep in mind here the Reserve Bank recently moved to force the big four banks to hold an average of 12% more capital against their housing loans to cover potential losses from high LVR loans. Although this only adds up to $500 million between the four, or an average that frankly for banks of their size is piffling at $125 million, it perhaps gives a good idea of the Reserve Bank's preferred approach to the use of its macro-prudential tools.

On top of that relatively small step it could more broadly increase the amount of capital banks must hold against residential mortgage lending through its macro-prudential tool.

5) Watching for a pick up in housing supply

The Reserve Bank is also keenly aware of the supply versus demand issues in the key heated housing markets of Auckland and Christchurch, highlighted yesterday by Barfoot & Thompson whose inventory is the lowest it has been since at least 1998. In his most recent speech Wheeler noted there were "large housing shortages in Auckland and Christchurch" and;

House price increases are being driven by a combination of supply shortages (especially in Auckland and Christchurch), pent up demand, and the lowest mortgage rates since the mid-1960s.

Holding fire on his LVR restriction trigger will give Wheeler the opportunity to see whether the Auckland Housing Accord, reached between the Government and Auckland Council last month, gets off the ground, and looks like getting anywhere near meeting its pledge of building 39,000 new houses in the three years from September. The Government's currently rushing legislation through Parliament giving it beefed up powers to speed up housing construction.

Also keep in mind the Reserve Bank's primary concern is overall financial system stability, not the housing market. That said, lending on houses is comfortably the biggest chunk of New Zealand banks' loan books.

See all our stories on the macro-prudential tools here.

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