Reserve Bank wants big 4 banks to include personal loans and credit card debts in LVR calculations

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By Gareth Vaughan

In a move that won't thrill the country's big four Australian owned banks, the Reserve Bank wants to fully align the way they categorise loan-to-value ratios (LVRs) on residential mortgage lending with the way the rest of the country's banks do it.

This means personal loans and credit card debts, when secured by a property, would have to be included in LVR calculations by the big four as they are by the other banks. The move could potentially see the percentage of the big four banks' residential mortgages classed as high LVR loans increase.

Other areas also coming under Reserve Bank scrutiny include how banks calculate LVRs when more than one property is used as security for a loan, or when a residential property has more than one buyer, and how banks treat loans to owners of lifestyle blocks. The Reserve Bank is also casting an eye on how banks treat lending exposure to properties used for both residential and commercial purposes, and residential properties that include multiple dwellings.

And the Reserve Bank says it also wants to ensure valuation policy isn't affected by "current market conditions" by making sure banks' valuations on residential properties they loan against stick to the valuation at the time a residential mortgage loan is originated.

In a consultation paper entitled Review of bank capital adequacy requirements for housing loans and internal models processes the Reserve Bank says it wants all claims secured by way of a first ranking mortgage to be included in how banks calculate their LVRs.

The big four banks - ANZ, ASB, BNZ and Westpac - use what's known as the internal model, where they build their own models to calculate their regulatory capital requirements and must then get them approved by the Reserve Bank. All other banks, including Kiwibank, run what's known as the standardised approach where the Reserve Bank prescribes their regulatory capital requirements. Allowing the big four to run the internal model approach is in line with international guidance from the Basel Committee on Banking Supervision.

Differences

The standardised approach and the internal model approach don't currently contain the same definition of the loan amount, or the numerator in the LVR equation, the Reserve Bank says.

The standardised approach states the “loan value is the total amount, as at balance date, of: (i) all claims secured by way of first ranking mortgage over the residential property; and (ii) all undrawn commitments to the borrower that when drawn down will be secured by way of first ranking mortgage over the residential property.”

The internal model approach says the  “LVR is defined as the current loan balance …. . The current loan balance includes the exposure at default amount of any off-balance sheet exposures…”

The Reserve Bank says as much as possible all banks should be subject to the same definition of the loan amount when calculating LVRs.

"The current situation where one group of banks includes all claims secured by the residential property, whereas the other group does not, leads to the calculation of LVRs that are inconsistent and therefore lack comparability across both groups of banks," the Reserve Bank says.

"The first definition (standardised approach) clearly includes all claims secured by way of first ranking mortgage, while the second definition (internal model) does not state so explicitly. Although the intention has always been for both groups of banks to calculate their LVRs on an equal basis as far as that is possible, (the internal model approach) may be interpreted as not including other claims secured by the residential property."

"It is the Reserve Bank’s understanding that this is how internal model banks have interpreted the definition. Standardised banks, on the other hand, currently add all claims to the loan amount," the consultation paper adds.

'All obligation mortgages' bringing in personal loans & credit cards

The paper adds that most mortgages are "all obligations" mortgages, which generally means if a customer defaults on any other loan he or she has with the bank, for example a personal loan or a credit card debt, the bank can exercise the security it holds over the residential property and sell the house to recoup what it's owed through the outstanding credit card or personal loan balance.

"In practice, a bank’s incentive to take this measure will depend on the size of the defaulted loan, and a more common scenario might be that the outstanding balance is simply added to the mortgage loan," the Reserve Bank says. "This link from other loans, such as credit cards or personal loans, to the residential property suggests that all other claims should be included and that the definition currently in the standardised approach should also apply to the internal model banks."

Ensuring an LVR restriction is effective; Change could lead to higher LVRs

The treatment of "all other claims in the LVR calculation" is important for its incoming LVR restrictions, the Reserve Bank points out.

"Excluding them from the LVR calculation leads to lower average LVRs and could impact the effectiveness of an LVR restriction, particularly if borrowers became tempted to use their credit card facilities or personal loans to raise or increase the deposit needed to obtain a mortgage. This would be an extremely expensive approach to take, since these other loans are typically more expensive to service than a mortgage loan, but it could diminish the effectiveness of an LVR restriction."

Thus, at this stage, the Reserve Bank says it believes all claims legally secured by a residential property should be included in the loan amount when an LVR is calculated.

"Although we are cognisant of the argument that the treatment of the lending as an unsecured loan means that it already incurs a higher capital charge, ensuring that an LVR restriction is effective requires the current standardised approach definition to be extended to internal model banks."

To the extent internal model banks don't include all claims and undrawn commitments secured by way of first-ranking mortgage over the residential property, this change could lead to higher LVRs and therefore increase risk weights on residential mortgage loans, the Reserve Bank points out.

"The Reserve Bank is interested in gaining a better understanding of the capital impact this might have and the implications of changing IT systems to implement the proposed new definition."

Meanwhile, the Reserve Bank says it also wants to ensure valuation policy isn't affected by "current market conditions." Therefore it proposes the following requirement; "Property value is the value of the residential property determined under a bank's residential property valuation policy when a residential mortgage loan is originated."

What to do when there's more than one buyer or more than one property used as security?

The Reserve Bank also wants to "deepen its understanding" of how banks calculate LVRs when more than one property is used as security for a loan, or when a residential property has more than one buyer, as it looks to set minimum rules, - if necessary.

And there could be changes afoot for how life style blocks are treated for capital adequacy purposes. Where the borrower is predominantly reliant on income generated by the property, the farm, to make loan payments, it shouldn't be treated as residential property for capital adequacy purposes, the Reserve Bank argues.

And residential properties with multiple dwellings are also coming under scrutiny with two options cited.

"The first option is a solution similar to what we propose for lifestyle blocks. That is, if the borrower is dependent on the income generated by the residential property dwellings to make principal and interest repayments, then the loan is treated as a business rather than a residential mortgage loan," says the Reserve Bank.

"The second option is to set a limit on the number of dwellings that can be included in a residential mortgage loan. Under this option, if there are more than four dwellings used as security by the borrower, then the exposure(s) is business rather than residential mortgage. This second option is intended as a more pragmatic solution that recognises some borrowers invest in a second, third or fourth house while continuing in their usual occupation, but as some point (which we propose to be dwelling number five) the investment becomes a business rather than a supplementary source of income. We anticipate this definition would be easier for banks to administer than option one."

Deadline looms

Submissions on the proposals are sought by October 25. The Reserve Bank says it'll then analyse feedback and publish a summary of submissions and updated capital requirement details with new conditions of bank registration.

"It is currently envisaged that the new requirements will take effect in Q1 (the first quarter) of 2014, subject to feedback on the time required for (bank) IT system changes."

From October 1 all banks must restrict new residential mortgage lending at LVRs of over 80% to no more than 10% of the dollar value of their new housing lending flows. Allowing for exemptions the Reserve Bank estimates this 10% "speed limit" will effectively limit the banks’ high-LVR lending flows to about 15% of their new residential lending, versus the estimated 30% they've been doing in recent months.

Banks do, however, have six months to phase in the new restrictions meaning the first test of the LVR restrictions will effectively come at the end of March next year.

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26 Comments

When this LTVR idea was mooted , I put up a message on this site about the internal complexities for a Bank in managing an LTVR on each loan on an ongoing basis .
In particular , banks could facing problems if they "penalise " a client unfairly when his property LTVR reduces beow 80% and his interest rate is negatively affected .
 

Just watch the building industry tank as the LVR restrictions bite.
Bye bye affordable housing- have pity for the renters.
 

The trouble Big D is that too few people actually understand what happens. They don't understand the flow on effects of a lack of building. If the Government and Bureaucrats keep up with this by the time 2050 arrives a house is going to cost around $8 to $10million.
 
 

whoa - this is a biggie:
 
And the Reserve Bank says it also wants to ensure valuation policy isn't affected by "current market conditions" by making sure banks' valuations on residential properties they loan against stick to the valuation at the time a residential mortgage loan is originated.
 
Major, major change. Great idea. All those property investment training providers will go out of business! lol. 

You would need to go back at least a year to find any reference to the Banks expressing concerns about the professionalism of the "valuation profession" and its work product .. and work ethic .. so much so the Banks were planning on going into the "valuation business" themselves .. then silence

I just see this as clarifying the rules. Lots of commentators and 'bank economists' came out with ways to break the new rules and this has clearly stated what can and can't be done.
Seems sensible to do it now and not 6 months into the LTVR.

Break out the sticking plasters! Layer them on. The RBNZ is now in a race to close the loopholes that LVR restrictions encourage. Poor quality regulation (usually well intentioned to solve a particular problem) creates lots of loopholes that need more and more sticking plasters. Whole new "industries" are created (think Finance Companies and Resource Management Consultants).
Seems to me the RBNZ may be working on the wrong level of the problem. Perhaps an absolute limit of 100% loan to deposit ratio for the banks would be the answer.

The holes will get plugged, sure a new one will be found for a few months, then its blocked off...no biggee.  Its certinaly better than raising the OCR and killing our exporters/economy.
100% loan to deposit would be gold standard like in its effect? I think  ie kill our economy.  I suppose its a case of frying pan or fire at times, both are going to hurt the Q is which is least. It would also collpase our housing market, few would be buying....except maybe those from abroad with cash.....
Certainly I think too much leverage is bad, the Q is I suppose whats sensible and whats excessive. 
regards

Yes, I guess I was just getting the sense that the need for extensive loophole filling suggested the root problem lay deeper. Your point about causing unnecessary damage is a valid one if you assume the adjustment is rapid. There are two aspects to making changes - making the right changes and managing the transition.
 

Not so sure on extensive, but time will tell. If nothing else I'd be surprised if finding the loopholes and exploiting them doesnt cost the wouldbe buyers $s....in which case why isnt that used for a straight mortgage.  A lot of it I think is the attitude of the central bank....if they really want to make this work, well then they will strong arm it.  Otherwise just like GW Bush, remove what "restrictions" you can and appoint cronies who will do nothing with whats left.
If the change has the multipliers suggested and that's not realised the change could be un-intendedly  (is that a word? LOL) rapid. Steve Keen lays out that impacting the LVR even 1 or 2 % has a huge effect due to leverage.
If from my point if view we are in a 2x bubble well that suggests a bloody big pop....especially if the property gamblers push it up a bit higher yet.....say 2.5 x 1.....and then it pops and not deflates....ouch.
regards
 
 

There seems to be an idea that fluid dynamics applies, that, as with an aeroplane if you slow the engine a little you get a controllable descent, but if you slow it too much you stall and spiral out of control until you hit the ground. This corresponds to the idea that provided nominal GDP is positive and debt growth is less than nominal GDP growth then all is well. As you point out, it may not be possible.

Just watch the property spruikers and entrenched investors feign "concern" for first time buyers and the building industry at large now that young people can't be saddled recklessly with debt. Save your crocodile tears, this is a long overdue change and will go some way to redressing the problems with the overheated property market (it's only a start mind you!)

Labour here wants to build 100,000 new houses. Labour in Britain wants to build 200,000 a year - http://www.theguardian.com/politics/2013/sep/23/labour-ed-miliband-house...

Good find - others in the same organ are less than kind:
 
Labour's one-nation mantra can't disguise a clapped-out party

In Brighton Labour will again go through the motions, without hope of finding the radicalism needed to transform Britain  Read more
 

Labour Britain. Sheesh. The party that invaded Iraq against the people's wishes.

So lets say I was looking at spending $500K to buy a home now, what would you guys do? Wait for FHB's to be pushed out?

MK - it would be stupid to not buy now given the statement and targets that have been released. 

I don't know much about those but I will say this, a friend of mine said its worth buying a property simply because if they bring in rules around property, its not just you thats $%^&ed, everyone is $%^&ed

If they get the LVR wrong and collapse the market, yep.....nasty.
regards

Steven - look at the inflation rate, remember land is not in the CPI figures so doesn't get a mention, take the supply shortages, high immigration, foreign investment, dysfunctional local bodies and I can hardly see how the property market could collapse.
 
What happens to people with money in the bank? The get stuff all interest, pay withholding tax, and inflation wrecks the rest - they are essentally losing money anyway.
 
House numbers are not going to be built in any great numbers in the short-term, building material supplies are going up way above the inflation rate.
People have to do their due diligence and make sure they can afford the mortgage payments, rates and insurances etc. As long as you can afford the mortgage payments and have some breathing room then you I believe you are better to own your own home.
 
Paying rent is dead money that doesn't increase a persons wealth.  Yes it might be tough meeting the payments at the start. But if people can double the principle repayment on a weekly basis they can get ahead quite quickly.  Rent out a spare room for a year or two if you have to and use that money to pay off come principle. Or get extra work in the weekends etc. The important thing is to have a plan and ideas and the ability to pull it off.
 
Keep within your budget and don't worry about keeping up with other people. Live where you can afford to live. Spend money on security if you have to.
 
 

'.... I can hardly see how the property market could collapse....'
Say the FED (and others) stopped printing vast amounts of money and ended the artificially low interest rates and mortgages jumped up back to around 8-9%. That would end the boom in the AKL housing market. It would be a disaster. Spoke with a real estate agent the other day who told me we are in a new world now, low interest rates forever. Yeah right. I'm not putting money on it, but wish I had a buck for everytime someone told me this time its different....
 
Everything else you say I agree with.

I would say its unwise to buy, but there you go.
regards

I would keep looking, assuming you know value in your market there should be more opportunities through the current uncertainity...

Outside of Auckland where the boom hasnt happened, yes that would seem worth considering.  Where the boom is happening, harder call....though personally I wouldnt take on debt to buy anywhere right now and I'd aim to preserve my $s eg not in a bank deposit account......but then this GFC has dragged on 3 years longer than I thought...
YMMV as they say.
regards
 
 

I've heard obvious vested interests say that the LVR restrictions won't dampen house prices. I think thats blatantly wrong because once the restrictions are in a massive chunk of demand in first homes is gone. Thats going to drop the price of homes seen as first homes.

@Muppet King ..I dont see  ( and have not seen ) any clear evidence that the LTVR restrictions will cause the a fall in prices or a collapse of the first buyer market, as you suggest .
Take our family as an example 
I have three kids , two of whom would buy property  if the prices were not so high.
If the market collapses and prices fall 20% , I will help them both with the required deposit, as the properties will be much cheaper .
Also , if property prices fall even 10% , and rents remain the same , I may consider buying a lower priced rental property on the North Shore.
There must be hundreds if not thousands of Kiwis in the same position, with the same thinking as us
Also , there ia a real shortgage of affordable housing, so the probelm has nothing to do with the LTVR  
With all these elements , and huge migration from China , restricted land supply , and cheap money I dont see the LTVR brining house prices down