Last week the Reserve Bank of New Zealand (RBNZ) announced the first phase of what is likely to be a series of measures over 2013 that are designed to take the heat out of New Zealand’s housing market.
We discussed the need for this in our blog last month (see The Reserve Bank’s housing dilemma ).
Specifically, the RBNZ announced yesterday that the four major banks will now have to hold more capital for mortgages with an LVR above 80%. The Loan-to-Value ratio (LVR or LTV) is the value of the mortgage, divided by the purchase price of the property.
This means that it becomes less profitable for the banks from a Return on Equity (ROE) perspective to provide these high LVR loans to borrowers. When these loans are less profitable, banks will provide fewer of them, and/or charge higher interest rates.
The proportion of mortgages made at LVRs above 80% is now around 30%, a record level. So, this has been an important factor driving our house prices higher, and the RBNZ is right to target a reduction in volumes of this riskier low-deposit lending.
But how much of an impact will this actually have on bank lending, housing prices, and our interest rates and economy?
The precise details regarding the capital impact are difficult for an outsider to estimate because they rely on these banks’ own assessments of their capital position, under the so-called Internal Ratings Based (IRB) system of measuring capital. The RBNZ will have a fairly good idea of the impact, however.
In the RBNZ’s estimates, these four banks will now have to hold 35% more capital against high LVR loans. That sounds relatively high – indeed it means the banks’ profitability or ROE on these loans falls by 35%. That suggests a reasonable change in behaviour may follow. However, at the same time the RBNZ has estimated that the impact on the interest rates that banks charge on high LVR loans could be as low as 0.04% and only as high as 0.30%. Thus, once the new policy becomes effective in September, a high LVR mortgage that may have previously cost a borrower 6%, could then cost 6.3%.
In our view that would only have a small impact on current borrowing and price dynamics in the housing market. This is partly because mortgages are likely to remain one of the only areas where banks can generate any growth in their loan books – hence banks may continue to push these products even if they are less profitable. Further, in the hottest markets of Auckland and Christchurch the powerful factors of low supply and investor enthusiasm are likely to remain more dominant in the short term.
Expect to see further policies announced over coming months as the RBNZ continues to attempt to cool the housing market, without having to resort to its usual and strongest tool of higher interest rates.
David Lewis
Senior Portfolio Analyst