By Bernard Hickey
Remember mid 2003?
It was just before the Rugby World Cup in Australia. Carlos Spencer had yet to fire that amazing between-the-legs pass for Joe Rokocoko to score in the quarter-final against South Africa. George Gregan had yet to taunt Byron Kelleher with his "four more years boys, four more years" sledge in the semi-final a week later.
New Zealand was in the middle of a migration boom in July 2003 with net migration hitting 33,300.
The median house price in Auckland had just risen 15% to NZ$298,000 and the average floating mortgage rate was 7%, but was about to rise.
The average two year fixed mortgage rate was 6.13%.
The weighted average time before a mortgage had to be repriced was 9.9 months because most borrowers were either still floating or on short term fixed rates.
Something big and unthinkable was about to happen, and it wasn't just watching Carlos throw that pass to Stirling Mortlock and then losing THAT match to Australia.
The migration boom, massive foreign borrowing by banks and rising floating interest rates were about to dramatically shift the behaviour of home owners and force the Reserve Bank to push much harder on its interest rate brake than it wanted just four years later.
Borrowers started fixing on longer term mortgages in droves through late 2003 because banks were offering much cheaper fixed deals.
Those banks could easily borrow very cheaply on international markets because markets had become very stable and credit was plentiful. This period became known in financial circles as the 'Great Moderation'.
The arrival of Kiwibank sparked a rash of competition between banks that saw them slash their profit margins to fall over themselves to offer cut-price fixed rate deals to win customers.
The race to fix drove the average time to reprice a mortgage to a peak of 19.9 months just four years later.
By mid 2007 the median house price in Auckland had jumped 49% to NZ$448,000 and the Reserve Bank was in real muddle. Its rate hikes through 2004 and 2005 had only limited impact. By the time it became clear that the massive fixing of rates through that period had insulated borrowers from the rate hikes and made the bank's monetary policy brake pedal 'spongy', it was too late.
The bank was forced into four further quick rate hikes in succession from March to July 2007.
This sprint higher sent floating rates over 10.5% by early 2008 and dragged up the average two year fixed rates to 9.6%. This, combined with a drought, was more than enough to drive the economy into recession, even before the Global Financial Crisis had hit.
Fast forward to mid 2014 and we are in eerily familiar territory.
New Zealand is in the middle of another migration boom with a net 34,400 arriving in the year to April. The median house price in Auckland is NZ$611,000, up 14.6% from a year ago.
Global financial markets are entering another extended period of calm with plenty of easy and cheap credit to be found.
Some are calling it the Second 'Great Moderation.'
Earlier this week ANZ's Australian parent was able to borrow US$2.25 billion in New York at an interest rate of 1.25%.
New Zealand's banks have started competing much harder to win market share by offering cut price fixed rate mortgages. They can do this because their profit margins are healthy and they are able to find cheap funding overseas and locally.
They are now loading up their discounts onto their two and three year fixed rate deals. The difference in bank profit margins between floating and fixed is startling. Westpac CEO Peter Clare told me last month the profit margins on floating mortgages are around 150 basis points, while the profit margins on fixed rate mortgages can be as low as 50 basis points.
The end result is that two and three year fixed rate mortgage rates have now been cut to around 5.8%, well below floating mortgage rates, which have risen three times in as many months to 6.5%.
Just as in 2003, the average two year mortgage rate is 80 basis points cheaper than the floating rate and the average time to reprice is 9.9 months.
The market is now ripe for a repeat of the rush into longer term fixed mortgages seen between 2003 and 2007.
Anyone with a mortgage would be mad to ignore the big gap that has opened up between longer term fixed and floating rates and the opportunity to 'claim' some of that profit margin off the banks.
At the end of April there were NZ$131.7 billion worth of mortgages that were either floating or fixed for less than a year. There was just NZ$61.1 billion on terms longer than one year.
The opportunity is enormous.
If just half of those floating mortgages were to switch to two year fixed rates those borrowers would save themselves over NZ$500 million in interest costs each year, and by extension reduce the bank profits by the same amount.
The Reserve Bank was remarkably sanguine at its announcement this week about the risk of another rush to fix and the resulting dilution of the power of monetary policy to slow down the economy. "We still think it carries quite a punch," Governor Graeme Wheeler said of his main OCR tool, pointing to the average time to reprice mortgages of 9.9 months. His predecessor Alan Bollard didn't give the fixed vs floating issue a second thought back in mid 2003, but within four years he was referring to the lack of traction when welcoming a Parliamentary inquiry into the then persistently high exchange rate, which was at least partly caused by foreign borrowing to fund cheap fixed mortgages.
The banks and their regulator would argue this time it's different. Banks are now forced by a Reserve Bank-mandated core funding ratio rule to avoid relying too heavily on cheap short-term foreign funds.
The banks are also seeing heavy flows of local term deposits to fund their local mortgage books, which are growing at an annual rate of 5.4%, rather than the 13% rate seen in mid 2003.
But still, few thought in 2003 that house prices would double within a decade or that the All Blacks would lose to Australia and France in semi and quarter finals in the next two World Cups.
Let's hope history does not repeat.
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A version of this article also appears in the Herald on Sunday. It is here with permission.
23 Comments
Deja vu's all very well , Bernard ... but the future just isn't what it used to be ... and if we've learnt anything from Big Al Bollard , it's that he didn't hand the little green governor's manual over to his replacement , Graeme Wheeler Dealer ...
... if you're in a tightening cycle , don't put the OCR up in a zillion baby steps , whack it up lickety-splick , 'cos the property buying idiots are no fools ...
Page 1 , I think .... just after the addresses of the best bars and bistros in Wellington ....
and hit commercial and business owners well before that.
"Something big and unthinkable was about to happen, and it wasn't just watching Carlos throw that pass to Stirling Mortlock and then losing THAT match to Australia."
So you're saying that year was the start of aucklanders ruining things for the rest of nz?
.... Carlos Spencer is a Levin man born & bred. Played his first NPC game for Horowhenua-Kapiti when he was 16...
Interest rates only seem to have any effect on house prices when they are set super-high, not medium high.
Even if Bollard had hiked suddenly to 8 or 9% in 2005/6, it may not have had much impact.
NZ-ers instinctively know property is the best hedge as well as shelter. Add immigration, landlord investment, foreign buyers, etc ..... Maybe interest rates are irrelevant, unless the RBNZ goes completely ridiculous and hikes to 10% ! Meanwhile .....
Typical yield curve movement over the cycle (completely influenced by the markets perception of where the OCRs going and zero to do with how much funds banks have to lend - banks don't determine the shape of the yield curve). At the bottom of the cycle long-term rates rise as the markets forsees rate hikes 6-12 months out, then as the hikes start the short term rates rise, then if still on track the longer ones start risking again, eventually towards the top of the cycle the shorter ones catch up again and we get a flat curve. Then at what it starts to think is the top, the curve starts going negative, and if they're right eventually we get OCR cuts down towards the bottom of the cycle, then a flatten curve...etc etc.
According to this thread, modest interest rate rises won't affect the house market (questionable) but on that logic we're hprobably in faze two now ( flattening as the short term rates come up, before the longer term ones start to rise a bit again after that). Unless the RBNZ is happy with where things are at, we're a way away from a negative yield curve...and if you understand RBNZ speak, you couldn't get a clearer "not happy/pissed off" message from them at last weeks MPS
http://www.businessweek.com/articles/2013-11-14/2014-outlook-banks-want-higher-interest-rates
Banks will be pleased with rising interest rates. They have heralded these in for the last 4 years - and finally got it right. Or was that successful lobbying?
“Higher rates improve the profitability of banks,” says Christopher Lee, a money manager who specializes in financial stocks at Fidelity Investments. “If the environment improves next year, I think they are well prepared to capture that growth.”
Youre confusing higher rates with higher margins again, not to mention the US with NZ..different legislation, different alot...and name me a business that doesnt want higher margins ? Some times you get them, some times you don't, and when you do its never for long.
Fear not Bernard, this time IS different.
Using the roost affordability report as a guide, in Auckland the percentage of income required to service a typical mortgage is about 87%, the same as it was in December 2006. And for New Zealand it is 63%, the same as in June 2005.
As Wheeler said this week, 68% of mortgages are floating or fixed for less than a year, and we've already had 3 of the 8-9 hikes the RBNZ has warned about.
The current rate people are moving to fix is quite slow. So in terms of impact, we are not too far away from the 2007 scenario already.
Yes, ZP, they should be able to crash/stall the general economy relatively quickly this time around. Given that many sectors of the NZ economy & consumer/retail and provinces have had no recovery since 2008. So much more fragile this time than 2007.
Curious
The coversation focuses entirely on residential mortgage interest rates
No mention of the proposed introduction of investors who own 5 or more properties being treated as businesses and moving to business rates of interest. Intended introduction date was June 2014. It is noted that the RBNZ has now capitulated to the bank lobbyists and pressure from the major banks to postpone the implementation date out to December 2014
Banks are also seeking to have existing clients who fall into that category remain under current rules.
So, what are the current rates of interest for business loans compared to residential mortgage rates ??
Yes I have observed the exact same thing.
3 years fixed at 6.25 means gauranteed insulation from anything the RBNZ can come up with.
Gov wants longer term fixed to be higher, sorry but he doesn't control the cost of capital internationally, which is going to continue to be very cheap for years to come.
Interest on commercial loans/ business loans relate to the risk involved. Unfortunately, a 'commercial loan' to a property investor is no more risky (often less risky) than to a owner occupier, so banks will not price them any higher on a risk basis. Capital requirements for commercial loans will make them less attractive though, so on this basis may add a small margin depending on demand for them (low demand, have capacity to lend, may leave rates as is). Don't expect them to be anymore than 0.5% up though, prob just enough to undo the discounts they all recieve now anyway due to big borrowing book and good LVR most investors have (unlike owner occupiers who emotively borrow to the hilt to keep up with the jones)
This time is different, if only just.
Wheeler is raising interest rates without waiting for inflation.
Wages have not jumped, to service a massive rise in borrowing.
Political risk in property investment, that was not there in 2003.
Population movement. If Christchurch can get its act together, it should be the place to be.
Agree, the problem I see is the CB seems wedded to a) BAU (growth for ever), b) a certain form of economic orthodoxy, c) ignoring evidence that when other CB's ie sweden raised their OCR triggered caused a recession, d) ignoring a non-drop in un-employment and yes e) no wage increases for most people..
These seem common blind spots for those convinced we are recovering. For me we appear to have a 2 speed economy, the have's are doing well but it looks like its at the expense of the have nots and the have nots are not doing well at all.
Property of course has been an ignored risk for a decade. The feel good factor of fat asset increases is like drink for Pollies, great until its hangover time.
regards
Walking on a snow cornice, and enjoying the view. Today the US federal reserve, JP Morgan,Deutsche Bank, Bank of Japan, Royal Bank of Scotland and a host of others are all insolvent on a mark-to-market basis. Collectively the derivatives balance sheets of some of those aforementioned institutions amount to multiples of world GDP, but in the event of an almost inevitable crisis the underlying assets could evaporate to almost nothing. This time the risk's are so much greater than back in 2004, because now we have peak oil, bail ins, and deleveraging baby boomers to worry about. I humbly propose that the asset purchaser of 2014 has quite a different motivation compared to 2003.
agree
Kimy and Simon - banks don't offer commercial loans at the same rate as residential loans.
When did either of you last seek funding to purchase a commercial property?
The last time i sought finance to purchase a commercial property (which was early last year), both ANZ and Westpac wanted between 1 to 1.5% more than residential floating rates.
Plus their is the issue of amortisation. For commercial loans banks require 10 to 15 years not 25 to 30 years like residential loans.
Banks also usually require the borrower to have between 35 - 40% equity in the deal.
So the main differences from a commercial loan to a residential loan is the interest rate, the period of amortisation, and the amount of equity required. These are big differences. I do not know how strict they intend on being with residential property investors with 5 or over - but if they treat them fully as though they are borrowing for commercial property, then the adverse implications could be significant.
Our point was the underlying asset determines the lending risk and hence the rates not an arbitrary classification. Did your commercial borrowing consist of a plurality of residential dwellings that could be auctioned off tomorrow to first home buyers? That's the difference.
I thought Kimy said,"the difference lies in the LVR restrictions rather than in interest rates". And you replied, "yes i have observed the exact same thing."
When you state the underlying asset determines the lending risk - for my example the cap rate was 5.5% (conservatively), the same tenant had been there 25 years, they had 3 years left on the lease, and I was putting 46% equity into the deal. The banks accepted their lending risk was minimal yet they maintained that due to the risk they associated with "commercial lending" the rate was higher than residential loans. I wriggled and they moved a bit.... but not a lot.
I asked my relationship manager about this exact topic on Friday of last week and he replied,
"We actually don't know whats going to happen. We already treat residential investors differently once they've got a certain number of properties, so who knows where this is going."
My point is, the terms (and rates) for commercial loans are different to that of residential loans. If the banks are forced to treat some residential property investors as though they are commercial property investors - then these investors could be in for an upleasant surprise.
The key issue here is that with most commercial loans ($1m plus) they calulate the exact ROE based on a Credit Risk assessment which works out how much of their own (banks) capital has to be put aside to cover that specific risk.
On residential secured loans the RBNZ to date has risk wieghted these loans at 50% simplistically Banks can lend twice as much based off their capital base on Residential Loans than Commercial Loans.
However I know clients who have a strong credit risk rating who with commercial loans are paying less than housing rates as they are strong in trade record of profitability, strong balance sheet and undoubted management.
I agree with Triple that if mutli property residential property investers were priced purely for risk (risk doesn't just mean LVR) than they would face a unpleasant surprise.
Please note Commercial Loans doesn't just mean lending against commercial property but includes all aspects of Commercial Lending including Asset Financing, Cashflow Lending and Trade Facilities. These may or may not be secured apart from a GSD.
Interesting article Bernard.. just a small note. ANZ borrowing at that interest rate is both misleading and lacks detail. What was the duration.. if it was short term then that is actually quite expensive, but regardless, once swapped back into NZD (or AUD in this case) the rate is much higher. Add to that the fact that the banks have limited ability to take advantage of this source with the RB capping wholesale borrowing in the wake of the GFC
Oh man... rugby analogies Bernard? And during a Football World Cup??
Cripes, I barely managed to finish it! We have to put up with rugby union dominating every other aspect of mainstream media and advertising in this country - please don't let it infect your otherwise brilliant website!
Correlation <> causation.
But, honestly, " few thought in 2003 that house prices would double within a decade"????
The other thing that changed over that far-off time period was the Gubmint's Welcome Home Loan introduction after a pilot run a couple of years before: feast yer peepers on This:
The money shot:
"people can borrow most or all of the cost of a house. For houses up to $150,000, eligible borrowers do not require a deposit. For houses costing more than that, they need to contribute a 5 per cent deposit. Depending on their ability to meet repayments, people can borrow up to $280,000 to purchase their new home."
Now, see what this sorta munny could buy one in 2004: the median dwelling price was $245,895.
NZ's very own sub-prime - so ask yerself this basic question:
- if'n I can sell ma hoose to a personage who can (a) fog a mirror and (b) borrow $280K from a dopey Gubmint, what should I price it at?
Answers on the back of an envelope, please....and you've just identified a prime driver of house price inflation - easy munny.
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