In this How-To Session we're going to explore what the potential move from APRA might be
after the macro-prudential regulations they introduced in late 2014.
Firstly, who is APRA?
APRA stands for the Australian Prudential Regulatory Authority, and their job is to
regulate the lenders who lend money out into the marketplace.
Now, when you've got historically low interest rates, you obviously have cheap cost of money
— the risk with cheap cost of money is asset bubbles and asset appreciation.
So, what actually happened in 2014 was in the marketplace — especially in Sydney and,
to some degree, in Melbourne and some other parts of Australia — property prices were
moving very, very quickly.
We all understand that property prices are set by supply and demand — so, when demand
is high but, obviously with property it takes a while for supply to come online, we potentially
have this risk where we get ahead of ourselves and we create a property bubble.
So what APRA did once they realised that, really, the RBA had no movement — in terms
of they needed to keep interest rates really low to try and stimulate business investment,
which will obviously stimulate jobs and keep the economy growing — APRA had an idea.
Their idea is they wanted, basically, to shave away some of the demand in the marketplace.
How they did that was this: they focused in on the investment lender, and the first thing
they did was they introduced a speed limit.
We talked about this in late December 2014, but they really started to introduce it in
early 2015.
That speed limit meant that the lenders couldn't move the amount of money they were borrowing
by greater than 10%.
So they couldn't grow their loan book greater than 10% per annum.
Obviously, this meant that the amount of investment lending coming to them, potentially, they
couldn't handle — so they had to put a brake on it.
How did they put a brake on?
Well, effectively, what they did as part of the story —if you think about the banks,
they're a business, and they've got to return money to shareholders and effectively APRA’s
told them they can operate with one hand behind their back — is they started to lift investment
lending rates.
They argued that the risk was getting higher and the cost of money was getting higher,
which isn't really true because when you lend to an investment lender, the default rates
are actually lower than the lending to owner occupiers — but we’ll talk about that
on another day.
Let's focus on this: they basically put this speed limit on, then they looked at the banks
— how confident they were around the amount of capacity, in terms of servicing capacity
of the borrowers — and they thought the lenders were a bit too relaxed.
So they started to claw back the amount of borrowing capacity people had by increasing
what they call the Risk Rating, or The Servicing Assessment, that they were doing.
They did this, again, to lessen demand.
The final thing they did was introduce interest-only lending, which meant — at that time, interest-only
lending was growing at over 30%, in some cases 40% — they wanted to bring this down.
They said to the lenders, “We want to cap that at around 30%, or less.”
Now, this automatically happened because what we then saw was the price of interest-only
loans went up, which meant a lot of people switched from interest-only to principal and
interest repayments.
So, that's clearly worked —we've definitely seen a big reduction.
Now, we have levels of 10 ¬– -20% interest-only in new lending.
It has definitely balanced the book out.
That's all been well and good, and it has certainly served a purpose in bringing them
that level of demand.
So, as we move through 2018, we are going to see that level of demand starts slow down
and we're definitely seeing more supply coming to the market.
That's going to put pressure on property prices, but it's going to be a gradual “smooth landing”
as opposed to any significant correction, which is what they were worried about.
That's why they've introduced this regulation over time, to reduce the level of demand;
and we're potentially going to have a soft landing when it comes to property prices.
But, after that point, what if property prices start to slow?
What if construction starts to slow?
What if the economy and jobs relating, both directly and indirectly, to the property market
start to slow?
The regulator is going to have to loosen those grips, those regulation measures, those levers
they've put in place.
And if we have any indication of what might potentially happen, we only need to look to
our neighbor in New Zealand, where they're starting to ratchet back some of those macro-prudential
regulations.
So, what is next?
What are they going to do?
Well, in my view, they've got a couple of choices, which is going to be dependent on
how competition in the lending market works.
If we see some banks start to reduce the margin between investor lending and owner-occupied
lending, this may increase the stimulus, which may increase the number of people back into
the marketplace.
That's one way.
But then APRA may not necessarily need to do anything because the market forces will
adjust accordingly as competition gets tougher and tougher for your lending business.
So we may see that creep back.
If that doesn't happen, we would certainly see APRA start to talk about reducing or removing
their 10% speed limit on growing their investment loan book — opening themselves up to more
growth.
And this obviously stimulates more competition.
Hopefully, once there's more competition, it means the interest rates that we, as retailers
and consumers, will pay will actually drop down.
One thing I don't think they'll have an appetite to do, is to relax the borrowing power for
now.
I think, ultimately, interest rates are going to stay lower for longer.
So I think they'll still be prudent in the amount of money that people can borrow.
Like most people, they can't trust the broader community, in terms of money management.
So that's what we think APRA are going to do next.
We think if they are going to pull a lever, it's going to be reducing that speed limit
to try and increase competition.
Hopefully, what we will see, is new entrants coming into the lending market space who are
going to offer competitive interest rates for investment lending as opposed to just
owner-occupied lending.
We know that there will be some challenges there with Basel III.
We've seen some new report papers come out, talking about risks of how servicing calculators
are using rental income to assist in that.
So, you might see a change in risk rating, which APRA will also talk to the banks about.
That's a real risk.
But I hope to think that competition will win out and lenders will identify that property
investors, on the whole, are a pretty good risk compared to owner-occupiers.
So that's what we think APRA's next move may be.
Thanks for watching.
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