Analysis: How LVR limits helped de-risk the NZ mortgage market

According to RBNZ’s recently published report, Mortgagor Vulnerability and Deposit Affordability in New Zealand Before and After the Loan-to-Value Restrictions, new owner-occupier mortgagors in New Zealand have become less vulnerable to the effects of a housing market downturn, declining wages and growing interest rates thanks to the LVR caps introduced by the nation’s central bank.

The LVR changes in New Zealand by implementation date are below:

• LVR1 (October 2013): Lending to borrowers with LVR above 80 per cent should not exceed 10 per cent of the total new mortgage lending of each bank (the “speed limit”).
• LVR2 (November 2015): Restricted the LVR for investors in Auckland to 70 per cent (speed limit of 5 per cent), while increasing the speed limit of non-Auckland borrowers from 10 per cent to 15 per cent.
• LVR3 (October 2016): 60 per cent LVR for investors nationwide (speed limit of 5 per cent) and 80 per cent LVR for owner-occupiers nationwide (10 per cent speed limit).
• LVR4 (January 2018): 65 per cent LVR for investors nationwide (speed limit of 5 per cent) and 80 per cent LVR for owner-occupiers nationwide (15 per cent speed limit).

While the Reserve Bank of Australia (RBA) has previously opposed the Australian Prudential Regulation Authority’s (APRA) macro-prudential measures, RBNZ claims in its report that such measures have helped reduce the share of households with high debt-to-income (DTI) ratios and high debt service ratios (DSR) while also decreasing the provision of high-LVR loans.

New Zealand’s central bank noted that since the caps were introduced, the average LVR dropped from 67 per cent in October 2013 to 55 per cent by the middle of 2016.

Additionally, loans with LVRs above 80 per cent provided to first home buyers also decreased significantly from more than 80 per cent of new mortgage lending in October 2013 to 35 per cent mid-2016.

Meanwhile, the average DTI for new mortgagors went down from 3.6 in 2012–2014 to 2.9 in 2014–2016, while the share of borrowers with a DTI above 4.0 decreased from 37 per cent to 24 per cent.

Further, the share of high-risk borrowers who have a DTI above 4.0 and an LVR north of 80 per cent reduced after the LVR restrictions were introduced, from 17 per cent to 7 per cent over the same period.

“The decline in the share of high-DTI borrowers may be related to the LVR policy as borrowers with high LVRs also tend to have weak serviceability. For example, low-income borrowers may have difficulty assembling a deposit through savings and are also more likely to have high DTIs,” the RBNZ report states.

The report also notes that the average DTI has been consistently higher in Auckland than in other parts of New Zealand, reflecting higher dwelling prices in Auckland compared to borrower wages.

The share of new borrowers (nationwide) where debt servicing required more than 40 per cent of their disposable income similarly declined from about 14 per cent in 2012–2014 to 7 per cent in 2014–2016 for P&I mortgages, and from about 8 per cent to 5 per cent for IO mortgages over the same period.

In line with lower DTIs, the central bank’s report states that the average DSR also decreased since mid-2014 for both owner-occupiers and investors, going from around 27 per cent in 2012–2014 to 22 per cent for principal and interest (P&I) mortgages, and from around 20 per cent to 16 per cent for interest-only (IO) mortgages.

These figures show an overall decline in risk, according to the Reserve Bank’s report.

This is because if mortgagors with high DTIs and low LVRs default on their home loans, they have a high equity buffer, which decreases the risk for lenders.

The downside is that since borrowers are required to chip in a larger equity share of their property purchases under LVR restrictions, deposit affordability has also declined, especially in Auckland, unhelped by rising property prices.

While the policy seeks to encourage borrowers to save deposits over a number of years, it is not clear whether it has inadvertently driven borrowers to draw from the “bank of mum and dad” or via other riskier means.

Still, according to RBNZ, the LVR policy means that mortgagors with low DTIs and high LVRs are more capable of continuing to service their home loan in times of financial difficulty.

“These trends suggest that new borrowers now have more flexibility to restructure their debt and are likely more resilient to a hike in interest rates or a decline in income,” the RBNZ report states.

In delivering the central bank’s Financial Stability Report for May 2018, RBNZ governor Adrian Orr said that both lending and house price growth had slowed in the past 12 months, partly due to its LVR restrictions.

“This more subdued lending growth needs to be further sustained before we gain sufficient confidence to again ease the LVR restrictions,” Mr Orr said in May.

Verdict: Not bad, but complicated

Many mortgage industry players and economists have noted the challenges of overregulation, including reduced credit availability to customers.

For example, the chair of the Australian Competition and Consumer Commission (ACCC), Rod Sims, recently noted that more regulation can “often be harmful to consumers”, particularly in industries that are already heavily regulated such as financial services.

UBS also cautioned in a report to its customers earlier this year that a tightening of mortgage lending standards will have a “material impact on the economy”, noting that property prices are not dictated by the demand for and supply of housing, but rather the demand for and supply of credit.

Even Federal Treasurer Scott Morrison warned that the government’s response to the financial services royal commission will need to be careful not to “create a self-fulfilling problem” by creating “unnecessary regulation” that “suffocates the economy”.

However, tighter macro-prudential measures may not be as bad for the economy as previously feared. In some cases, measures that were previously perceived to be detrimental were later recognised for having positive effects.

For example, APRA’s curbs on investor and interest-only credit growth (introduced in 2014 and eased this year on certain conditions) was not welcomed with open arms by the RBA, but recent words from the Treasurer suggest that the measures had the “desired effect” of “managing” house price growth, particularly in Sydney and Melbourne.

It is unclear how RBNZ’s report will impact future decisions made by the RBA or APRA, as they had previously decided against following RBNZ’s lead on introducing LVR limits.

But the report could prove to be a useful guide for Australia, given the ongoing anxiety around high levels of household debt, increasing financial stress, poor income growth, rising house prices, approval of loans outside serviceability and irresponsible lending practices.

[Related: Removal of ‘redundant’ APRA curb unlikely to trigger rebound]