Reserve Bank cautious on further LVR controls; only says 'closely monitoring developments to assess whether further financial policy measures would be appropriate'; tells Govt to worker harder on housing supply

Reserve Bank cautious on further LVR controls; only says 'closely monitoring developments to assess whether further financial policy measures would be appropriate'; tells Govt to worker harder on housing supply

By Bernard Hickey

The Reserve Bank has pushed again for the Government and Auckland Council to do more to increase housing supply as it grapples with an Auckland housing market that is heating up again and worsening the outlook for financial stability.

The bank released its half-yearly Financial Stability Report (FSR) this morning, including a vague comment about assessing the need for further financial policy measures, but Governor Graeme Wheeler was much more specific in a subsequent news conference, saying the bank was actively considering introducing debt to income multiple limits or toughening existing Loan to Value Ratio controls, possibly for all of New Zealand as well as Auckland. See more from the news conference here.

Earlier in the FSR, the bank stopped short of signalling new Loan to Value Ratio (LVR) controls, saying only that it was 'closely monitoring pressures returning to the market' that had increased the risks to the financial stability outlook and was assessing whether 'further financial policy measures would be appropriate' -- without specifying those measures.

Instead, the bank called on the Government and the Auckland Council to do more to increase housing supply.

"The Bank remains concerned that a future sharp slowdown could challenge financial stability given the large exposure of the banking system to the Auckland housing market," Governor Graeme Wheeler said in a statement released with the bank's half yearly Financial Stability Report (FSR).

"Further efforts to reduce the imbalance between housing demand and supply in Auckland remain essential. This includes measures such as decreasing impediments to densification and greenfield development and addressing infrastructure and other constraints to increased housing supply," Wheeler said.

Deputy Governor Grant Spencer said in the statement with the Report that the moderation in house price inflation after the Reserve Bank's second round of LVR controls in November last year had been transitory, but the two rounds of controls had substantially reduced the proportion of risky housing loans on bank balance sheets and improved financial system resilience.

“The Reserve Bank is closely monitoring developments to assess whether further financial policy measures would be appropriate," Spencer said.

Banks may need to borrow NZ$40 bln offshore

The Reserve Bank included a detail discussion of the international environment and the financial risks to the New Zealand economy and its financial institutions in the half yearly report.

It said credit growth had accelerated across the household, agricultural and business sectors over the last 18 months to the point where aggregrate credit growth was now outpacing deposit growth.

"This may induce banks to compete more aggressively for retail deposits, or to increase their reliance on long-term wholesale funding, either of which could place upward pressure on bank funding costs," the bank said, adding that higher funding costs would keep lending rates up relative to the OCR and short-term wholesale rates.

The bank noted a 50 basis point rise in offshore funding costs over the last year, relative to domestic wholesale rates.

In particular, the bank noted that banks may have to raise up to NZ$40 billion in longer term wholesale debt offshore over the next three years to meet their Core Funding Ratio (CFR) requirements if they kept growing lending at currently high rates.

"Bank lending is growing more rapidly than deposits. If this trend is maintained, banks may lower their CFRs from current levels. Alternatively, banks may choose to protect their CFRs by issuing longterm wholesale funding to fund new lending and to replace long-term funding as it approaches maturity," the bank said.

"It is estimated that locally incorporated banks will need to issue around NZ$40 billion of long-term wholesale funding in the next three years to maintain CFRs if lending and deposit growth persist at current rates," it said.

"Banks could also maintain their current CFRs by competing more aggressively for deposit funding, or by reducing the rate of lending growth."

Australian policy changes worsens funding pressures

The bank also noted that funding pressures may be worsened by a new policy imposed by the Australian Prudentual Regulatory Authority (APRA) on the big four Australian-owned banks' parents in late 2015.

"Funding pressures for the Australian-owned New Zealand banks may also be exacerbated by changes to requirements imposed on parent banks under APRA’s Prudential Standard APS 222," it said.

"These changes give Australian parent banks five years from the start of 2016 to reduce non-capital exposures to their New Zealand operations to less than 5 percent of Tier 1 capital. In addition, banks that had non-capital exposures to their New Zealand operations in excess of the 5 percent limit at end-June 2015 must reduce the percentage excess by at least one-fifth each year over the fiveyear transition period," the Reserve Bank said.

"The Reserve Bank understands that the affected New Zealand banks have plans in place to accommodate these new requirements and transitional arrangements."
See more on this from Gareth Vaughan on March 12.

High interest-only lending noted

The Reserve Bank did not discuss what financial measures it might be assessing to respond to the revival of the Auckland housing market and the spreading of the 'Auckland halo' to the rest of the country, but it did highlight the growing use of interest-only loans by investors in particular and a rise in debt-to-income ratios.

"Credit growth is likely to exceed income growth in the near term, resulting in higher debt relative to incomes. Low mortgage interest rates have helped to contain debt servicing costs but the household sector would be vulnerable to an increase in interest rates or an economic downturn. While a large increase in mortgage rates seems unlikely in the current global environment, a relatively small increase could put pressure on some borrowers," the bank said.

"There are signs of a build-up in risk among new borrowers. For example, a large share of new lending is extended at high debt-to-income ratios. With gross housing lending flows remaining strong at around 35 percent of the outstanding stock, this is being reflected relatively quickly in banks’ overall portfolios," it said.

The Reserve Bank noted that housing credit growth had risen this year to 8%, its highest rate since 2008.

"New housing commitments are also elevated at around 35%  of outstanding housing debt. This suggests that the characteristics of new commitments will be reflected relatively quickly in banks’ overall portfolios. This increases the risks associated with the high share of lending being undertaken on interest-only terms or at high total debt-to-income multiples," it said.

"There is a risk that strong house price growth could result in a further stretch in household debt-to-income. While low interest rates have helped to contain debt-servicing ratios (DSRs) for New Zealand as a whole, high and rising debt levels leave households vulnerable to an increase in mortgage rates or a deterioration in economic conditions," it said.

"A large increase in mortgage rates is unlikely in the current global environment, barring a significant deterioration in the cost of bank funding. However, a relatively small increase in interest rates could place pressure on some borrowers, especially those with high debt-to-income ratios. This is particularly the case in Auckland, where DSRs for new buyers are elevated, even at current low interest rates. If interest rates returned to the 10-year average of 6.7 percent, DSRs for the representative new buyer in Auckland would significantly exceed the pre-GFC peak."

'Pressures returning to the market'

The bank said its November 2015 LVR controls had a bigger impact than expected because of the associated disclosure and 'bright line' test measures taken by the Government in October, with annual inflation in Auckland falling from 27% in September to 12% in March, but the impact appeared to have been transitory.

"It is likely the housing-related government tax changes, together with an apparent reduction in offshore demand due to global financial market volatility and more rigorous enforcement of capital controls by Chinese authorities, also restrained housing demand over this period. The fact that ex-Auckland house sales also declined, despite looser LVR restrictions, reinforces this view," the Reserve Bank said.

"While this is a positive development, Auckland prices are still very high relative to both incomes and rents, and near term indicators suggest pressures may be returning to the market," it said.

"A resurgence of house price inflation in Auckland would be of real concern, given that prices are already very stretched relative to incomes and rents."

It also warned it was watching housing market inflation that was rising outside of Auckland.

"Housing market pressures have been particularly pronounced in the areas immediately surrounding Auckland, but increasingly these appear to be spreading to other major centres. To some extent this reflects a shifting of demand, which may be helping to alleviate some pressure from the Auckland market," the bank said.

"House price-to-income ratios are generally lower in these areas than in Auckland, and housing supply is likely to respond more rapidly, which could act as a brake on further house price appreciation. However, there is a risk that house prices outside Auckland are driven to levels that pose a financial stability risk," it said.

'Supply not meeting demand'

The Reserve Bank warned that continued market pressures could further stretch house prices in Auckland, given the supply shortfall was still growing.

"Auckland house prices picked up strongly in the February and March months and house sales have lifted from recent lows. Market participants also report an increase in auction clearance rates relative to late 2015 levels. There remains a risk that continued market pressures lead to further stretch in house prices," it said.

"The shortfall of available housing stock is expected to increase this year as population growth outstrips the supply of new housing. Net migration into Auckland remains strong, with more than 30,000 migrants moving to the city in the year to March. Although building consents have also risen, to 9,600 annually, the supply of new housing is insufficient to match the increase in demand arising from migration and natural population growth," he said.

"Continued house price growth in excess of income growth could present a risk to financial stability as household balance sheets of new borrowers become increasingly stretched. Concerns would be raised if high house price inflation was sustained across New Zealand, or if price growth was accompanied by rising investor activity and expectations of significant future capital gains."

Scenario shows dairy farm prices could fall 19% to 63%

The Reserve Bank spent part of the FSR discussing the risks to dairy lending and repeated much of its dairy stress test work published earlier this year, noting that banks were supporting farmers.

"There have been relatively few forced sales to date which, alongside low interest rates and a positive medium-term outlook, has provided some support for farm prices. Nevertheless, prices have fallen 13 percent over the past year and there is a risk of further price declines if cash flow pressures result in more forced sales," it said.

It also included a discussion on how over-valued farm prices might be in Box B. That included modelling of two scenarios that could see farm prices fall anywhere from 19% to 63%.

Banks pass new stress test

The FSR's Box C included the results of a new stress test of banks by the central bank, which was slightly less detailed than a full stress test in 2014.

The stress test assumed real GDP fell by 6 percent, unemployment rose to 13 percent, and dairy incomes remained at low levels. It assumed residential property prices fell by 40 percent nationally and by 55% in Auckland, while commercial property values fell 40%.

"Finally, the 90-day interest rate fell by about 3 percentage points due to monetary policy easing, although banks typically assumed a partially offsetting increase in funding spreads above risk-free rates. Banks were asked to simulate the impact of this scenario on loan portfolio performance, and to trace through the implications for their balance sheet and profit and loss statement," the bank said.

"The cumulative hit to profits averaged around 4 percent of initial assets, which is a similar outcome to phase 2 of the full regulator-led exercise conducted in late 2014. About 30 percent of total losses were related to mortgage lending, with half of this due to the Auckland property market. SME and rural lending accounted for most of the remainder of financial system losses. Loss rates for mortgage lending were around 2 percent, significantly lower than the 5 percent loss rate observed for most other sectors," the bank said.

"The underlying profitability of banks – earnings from core activities, prior to accounting for bad debt expenses – is a first line of defence against rising loan losses. On average, banks assumed a moderate decline in net interest margins during the scenario, reflecting rising defaults reducing interest income and the assumed increase in funding spreads. However, in line with the experience of the GFC, banks expect to be able to maintain net interest margins at around 2 percent by eventually passing on higher funding spreads to customers (rather than reducing mortgage rates by the same amount as the OCR). As a consequence, underlying earnings during the scenario were of a similar magnitude to reported credit losses, so that return on assets averaged around zero," it said.

The bank said that although projected credit losses were largely absorbed with underlying profitability, capital ratios were expected to decline throughout the scenario because of a rise in average risk weighting.

"Although remaining well above the regulatory minimum, the average Common Equity Tier 1 (CET1) capital ratio declined from 10.3 to 8 percent as a result. The total capital ratio came under more pressure, due to smaller initial buffers to the regulatory minimum. As a result, the average bank reported falling into the upper end of the capital conservation buffer in the final year of the test, which would trigger restrictions on dividend payments to shareholders."

(Updated with links to tougher comments in news conference)

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maybe becuase he read the fiqures like the rest of us and saw up to 40% of the buyers are from overseas, which this government will do nothing about so LVR's will only have the impact of stopping locals buying

For as long as there is more demand for houses than supply, Auckland is actually not a speculative bubble, by definition it is not. speculation = not supported by fundamentals such as supply & demand

In all bubbles, demand outstrips supply. Prices start rising and people get caught up in the capital gains and keep pushing prices higher. You can tell its speculative when rents don't keep up with prices. like most are missing the affordability issue. If/when the tide goes out, you can have all the demand in the world, but if everybody is poorer (job losses/interest hikes/rate hikes or whatever) the inability to pay may cause a reset ie lower prices but still a demand.

Also when things go wrong credit gets tightened considerably. The effect in the US collapse made it nearly impossible to get any loans. Most people can't afford a house with a 100% deposit.

In Ireland and Australia there was a massive oversupply of housing. That's not happening here because National introduced so much paperwork just to get any consent that it's hard to make any money building houses to meet supply. National have focused intensively on increasing compliance costs while providing no benefits. Even the loopy rules report quotes compliance costs for building consents increasing 2 to 3 times.

More houses could be built but the paperwork is a major problem. In addition post leaky buildings the Councils try to avoid any risk, but they do this by putting up meaningless barriers which doesn't help them avoid risk anyway. Oversupply isn't a good thing but the very low rate of building consents for residential housing is making things worse.

What would happen to house prices if consent processes were simplified and allowed affordable construction? What would happen to house prices in Auckland if high speed public transport was available so living outside of Auckland could quickly commute to work? What would happen to house prices if the big banks were caught in a major bubble collapse in Australia that caused them to fail?

3% - 40% same - same.

The Wellington housing market is significantly tighter than Auckland on many metrics , yet has not seen the rapid price gains . Auckland is simply a speculative bubble , that will splat all over the fabric of New Zealand , it will crush the dreams of a generation of New Zealanders..

Even Wellington prices have been pushed too far for a lot of people. People here aren't selling because they can't afford the leap up to the next house (insufficient equity). Of course this does mean that Auckland prices are completely insane.

If there is a large price crash in Auckland it with have a similar effect to the events of 1987.

Already has.

Yes indeed it has.

I think that is partly because Wellington is quite a high earthquake risk, unlike Auckland. So many of the overseas buyers, even some NZ ones, they see it as too high a risk. I know people who wouldn't buy in Wellington or Christchurch, because of the risk, spending all that money. I live in Wellington, but wouldn't buy an expensive house here for that reason.

Well that was a shocker..... rome burns and the fiddlers are noodling. We are know the Council will be voted in or out depending on the whims of the auckland nimbies - which means even more time is lost.

Nobodies doing anything by the looks of it - and its very very sad.

If i ran my business like these people are running the country i would be on the streets within a year. Supply and demand need to be balanced. If i cannot supply it, i tell my clients you cannot have it. Its so simple...

But if no one can supply it, you sell it to the person who is prepared to pay the most!

I think you mean if you are the only supplier (supply) and more than 1 person wants it ( demand) you can charge a much higher price than what's it's worth.
That's what this government does not get they think lets just add more suppliers which if it comes off will end badly as you will reverse the equation
Te idea is to work both ends to try to match one to the other and achieve stability

If interest rates returned to the 10-year average of 6.7 percent, DSRs for the representative new buyer in Auckland would significantly exceed the pre-GFC peak."

No chance if Aussie forecasters are indicative of future trends..

Australia is headed to the polls with a mounting debt burden, yet thanks to central bank easing investors are cutting its borrowing costs with a world-beating bond rally.

Local sovereign securities surged 2 percent in the week to May 9, the most among developed-market peers tracked by Bloomberg World Bond Indexes. The rally was helped by disappointing inflation data that prompted the Reserve Bank of Australia to cut its cash rate for the first time in a year, with the 10-year yield sliding to within a basis point of a record low on Tuesday. Australia’s June 2035 bond yielded just 2.91 percent, less than the 2.96 percent on three-year notes at the time of the last federal election in 2013.

While the shift down in yields is a global phenomenon fueled by record monetary easing from Tokyo to Frankfurt, RBA officials gave local rates an extra nudge when they said core inflation will probably only bottom out in the next two years. Swaps traders are betting the central bank’s key rate will fall to 1.38 percent in a year from 1.75 percent. Read more

Can the Aussie banks save themselves from poor internal lending policies irrespective of domestic rate cuts without taking out the NZ subsidiaries?

Australian banks, already grappling with a plethora of challenges including holding more capital and rising corporate defaults, have one more worry to contend with: the struggle to meet profit expectations. Australia & New Zealand Banking Group Ltd. and its main competitors posted first-half profits that fell short of what analysts had expected. That was the first time in at least 10 years that three of the nation’s largest lenders -- ANZ, Westpac Banking Corp. and National Australia Bank Ltd. -- missed estimates at the same time, according to data compiled by Bloomberg. Read more

Just remember the procedure for bank liquidity problems leading to a bank run: duck and cover, no wait it's withdraw as much as possible from the ATM up to the daily limit.

Stephen H. Good points as usual.
I note in the report above:
"This may induce banks to compete more aggressively for retail deposits, or to increase their reliance on long-term wholesale funding, either of which could place upward pressure on bank funding costs," the bank said, adding that higher funding costs would keep lending rates up relative to the OCR and short-term wholesale rates.

The bank noted a 50 basis point rise in offshore funding costs over the last year, relative to domestic wholesale rates.

In particular, the bank noted that banks may have to raise up to NZ$40 billion in longer term wholesale debt offshore over the next three years to meet their Core Funding Ratio (CFR) requirements if they kept growing lending at currently high rates.

The $40 billion likely required presumably more or less guarantees and equates to a current account deficit of the same amount, and notably at high cost and a generous return to foreigners.
The RBNZ make the statement as though they have no potential role in supplying those funds. If they were to supply them at more or less their OCR rate, the RBNZ gets the return, and the exchange rate does not stay above a fair value point. I'm not sure why they are forcing the banks to get money offshore. On this score the Aussies seem to be managing far better, with the RBA printing money to fund their banks, at least up to a point.

I posted this retort in respect of the quoted statements in your post.

The massive reliance on O/N funding is quite astounding and dwarfs potential longer term funding which you will note if you refer to RBNZ table L3.

The $40 billion fund raising is speculative at this point other than APRA is demanding a return of NZ Aussie bank capital to the parent operations over an extended time frame - see comment in article.

Must be a few straggling pesky owner-occupiers who haven't yet been eliminated from the market.

How does the RB propose to both introduce income to debt ratios and demand more housing supply at the same time? The former will have a restrictive effect on the latter.

I don't think the hot real estate market poses a significant risk to the economy, seriously ! When did NZ house prices fall 25% in value or more... NEVER BEFORE. When things turn sour, stocks tumble but most people tend to sit on their houses which creates a small decline in value followed by a long time of steady values. Just look at 2008, 1992 and further back

A troll, surely.
They've said the same things elsewhere, then property falls 25%
Does that guarantee it happening here? No.
But I'd say it's a 50/50 prospecr

The data absolutely support Yvil's opinion (in Auckland at least). Just ask yourself what it would take to create a firesale for property in Auckland. There are some obvious scenarios that basically involve a serious global or local recession. Only if the people who are currently servicing their mortgages lose their jobs and have to sell will they sell at any price. As long as they can continue to service a mortgage they will hold onto their house. Sure that recession could occur, prices could drop. but it is far from inevitable in the next 5-10 years.

BTW I have answered your immigration question back on Jason K's article.

Way to jinx it Yvil.

Yvil - your logic on NZ housing market prices is like saying 'I've never had a heart attack or stroke before, therefore I will never have one in the future'.

I wish I could live in denial...

@ Yvil,

1970's and after 1987

Yes I sold a rental in 87 before the prices went down took years to come back to what I sold it for

Jesus would have wept if he could see what this country has become.

.....he left judas in charge.

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