The Reserve Bank's 40% deposit rule for investors already seems like yesterday's news…now all eyes are on the proposed debt-to-income ratios

By David Hargreaves

The final step in implementing round 3 of the Reserve Bank’s LVR restrictions was taken this week, resulting in barely any comment from the marketplace.

How different to the wave of turbulence that the then new loan to value restrictions caused upon introduction of this macro-prudential tool in 2013.

They say familiarity breeds contempt.

In this instance it’s more like a sense of comfort. Now that people know what they are dealing with. Well they have ways of dealing with it.

That’s not to say that the new measures won’t have some impact, but my feeling is the impact’s likely to be little more than a slight drawing of breath of the market.

Given that Auckland already had a 30% investor requirement in place, the move up to 40% wouldn’t seem likely to make too much difference there.

Uneven impact?

It might be more interesting to watch what happens in the rest of the country. Some Auckland money obviously was pumped into houses in other regions after the impost of investor LVR rules (round 2 of the LVRs) late last year. This helped to perk those markets up and the rest of the country has been doing its best to play ‘catch-up’ with the largest city this year. The move from zero restriction to a 40% cap for investors in the regions might therefore be more of a stumbling block.

And it’s possible that some regions might have got a bit ahead of themselves, particularly in places where there’s no discernible housing shortages. So, we might see the impact of round 3 fall unevenly.

But given how quickly the effects of the Auckland-specific measures wore off (was it even as much as six months?) it would be surprising if the latest moves lasted any longer than that – if indeed they last even that long.

The Reserve Bank was clearly caught out by how relatively ineffective the second wave of LVR measures was, having got good bang for its buck from round one.

As an aside I would say, however, that the RBNZ tends to play up the effectiveness of the 2013 LVR measures while rather underplaying the surely considerable impact that the (erroneous) four hikes to the Official Cash Rate in 2014 would have had. The subsequent need of the RBNZ to back track and more on the rate rises has poured a good deal of petrol on the house market since. 

LVRs – end of a love affair?

At the outset in 2013 the RBNZ stressed that the LVR measures were temporary. There was a good deal of scepticism in the marketplace that this would be the case. Subsequent events appeared to emphasise that the LVRs were here to stay.

But interestingly, more recently the Reserve Bank has again started to refer to the temporary nature of the LVRs. This suggests to me that the central bank might be feeling that the measures have, after all, reached the end of their useful life for now and just might be lifted within the next year or so. Could be wrong. Just a feeling.

Regardless of any arguments on the effectiveness of the LVRs in stifling house price rises, the measures have shored up the banks’ balance sheets – which is a very good thing. According to figures collected by the RBNZ, high LVR loans (those above 80% of the value of the secured property), now account for just 12% of banks’ residential mortgage exposures, compared with about 21% (and rising rapidly) just prior to the initial introduction of LVR restrictions in 2013. In dollar terms the reduction’s meant some $20 billion less of high LVR lending, which is a lot, and all helps to improve the banks’ relative position in any housing downturn.

So, the LVRs have certainly served a purpose. But clearly the RBNZ is now moving on and pinning hopes on debt-to-income ratios as the next big thing.

Be prepared

Considering how badly the RBNZ was caught out by the relative failure of round 2 of LVRs, you can bet it’s not going to wait too long into LVR round 3 before following up with the DTIs. It won’t want to be looking into the face of more rampantly rising prices without some cover. I would be surprised if we don’t have something substantive from the Reserve Bank, at least in terms of proposals, by March.

Frustratingly we don’t at this point have too much clue how the DTIs will look. We’ll have to see how they work in New Zealand in practice, but on the face of it, I’m a fan of the idea. You hear varying tales of how diligent banks are or aren’t in checking on people’s expenses when those people apply for loans. Banks of course say they are. I’ve talked to people who say they aren’t.

A standard applied measure across the banking industry, for all that the banks might not like that, informing who can and can’t be loaned to in terms of their income, can only be seen as a good thing.

Again, however, I wonder how much of a quelling impact this would truly have on house prices though. And again, I suspect as much as anything that this might be another measure that won’t halt the housing juggernaut, but will at least further strengthen bank balance sheets against a potential housing downturn.

Let’s not forget, of course, that the RBNZ’s not there to save house buyers from themselves. Its role is ensuring the financial markets stay stable. So, anything it does to help that aim is positive – regardless of whether it has very much impact on house prices.

What would stop it?

So, on that last point, is there anything that would really stop the house price rises – other than a global shock, a rise in interest rates, or a sudden massive increase in housing supply, particularly in Auckland?

(Let’s face it the first one of these could happen, the second is not likely short-term and the third won’t happen.)

What we are seeing with both the latest round of LVRs and the proposed DTIs is measures very much aimed at the individual, the end user, the borrower.

I still think ultimately if you want to make a real difference, you’ve got to target the supplier of the money – yes the banks.

The RBNZ’s raised the possibility of using ‘capital overlays’ – getting banks to hold more money against their mortgages.

The way in which some banks appear to have been tightening up their own credit procedures recently would suggest they are attempting to head that one off. They wouldn’t like such a measure because it would dampen profitability, but I think it should be done. Make the banks hold more capital and you reduce the amount of money they have to lend.

It’s all this free money at the moment on virtually non-existent interest rates that’s the real fuel for the fire. Just do it, I say.

The other thing that I think would be a big help would be a clampdown on interest-only borrowing. This would clamp down on the more speculative end of housing investment and would therefore potentially improve financial stability and take some pressure off prices.

Sit them in the same boat

Now these things might appear restrictive, but the banks have shown with the LVRs that they can work round such measures and ultimately there’s no room for complaints if everybody is in the same boat.

Indeed you wonder if banks wouldn’t at times prefer to be told they can’t do something (interest-only for example) which they might instinctively think is not actually good prudent banking practice, but which they currently do because they don’t want to lose customers to the competition.

All things being equal and if there isn’t a global catastrophe, my bet would be that the housing market’s going to continue to climb sharply after the first quarter of next year. And I reckon the RBNZ is going to need to come back with more measures.

Anyway let’s see what happens. It won’t be dull.