Here we are again. Another week, another housing debate. And it’s not going away. Because nothing will change, and we’ll be discussing the same thing again in a few months’ time.
On Friday, bank regulator APRA awoke from a deep slumber, clutching at thin air. While sleeping, the housing market had run away from it. But APRA, still in a dreamy fog, is yet to realise this reality.
It attempted to ‘do something’ about out-of-control house prices by requiring banks to reduce the proportion of ‘interest-only’ loans to 30% of total lending, down from current levels of 40%. From The Australian Financial Review:
‘The new measures will include limiting the flow of new interest-only lending to 30 per cent of total new residential mortgage lending, and within that, placing strict internal limits on the volume of interest-only lending at loan-to-value ratios (LVRs) above 80 per cent, and ensuring there is “strong scrutiny and justification of any instances” of interest-only lending at an LVR above 90 per cent.’
There was no change to the 10% growth limit on investor loans first implemented in late 2014 (which hasn’t worked anyway), just more wordsmithing:
‘…APRA wants banks to manage lending to investors “in such a manner so as to comfortably remain below the previously advised benchmark of 10 per cent growth”, to “review and ensure that serviceability metrics, including interest rate and net income buffers, are set at appropriate levels for current conditions”; and to “continue to restrain lending growth in higher risk segments of the portfolio”, citing high loan-to-income loans, high LVR loans, and loans for very long terms.’
Anyone who has gone to a bank for a loan will tell you that ‘serviceability metrics’ are a joke. Most people I know walk out of their meeting gobsmacked at how much a bank will lend them.
To service the maximum loan a bank will make, you really need to have minimal expenses. No wonder people are turning to interest-only loans in response.
The implication here is that any future interest rate rise will have a much larger impact on the economy than it had in the past.
I know interest-only loans are popular with property investors. It’s a way of maximising the tax deductibility of a loan. Very Australian…
But there is clearly also a growing number of owner-occupiers taking out interest-only loans too. Up to 40% of bank loan books are interest-only loans. That’s a huge percentage. If you already can’t afford principal repayments, an interest rate hike can only be managed by cutting expenses elsewhere. This will take money out of other parts of the economy.
And anyway, what sort of regulator allows interest-only loans to reach such a high proportion of the overall loan book? It’s astounding. It’s classic Ponzi economics, overseen by the RBA and APRA.
Given APRA’s recent moves, which will have a small but limited effect, there’s little chance of seeing a move by the RBA at its monthly board meeting [today]. Rates will remain at the ultra-easy level for at least another month.
While you might think APRA’s decision to target interest-only borrowers could be the straw that breaks the camel’s back, I’d encourage you to think again.
It will take interest rate hikes by the RBA to bring the housing market down. And the RBA is simply not about to do that. In fact, it’s still thinking about rate cuts more than anything. As The Australian reports today…
‘In his latest testimony to the House of Representatives economics committee, RBA governor Philip Lowe said some on his staff argued weak employment growth warranted a further rate cut.’
Given that house price growth is still occurring at double-digit rates in Sydney and Melbourne, this is an extraordinary analytical outcome.
I’ll say it again: The RBA is not about to raise rates and derail the housing market.
But don’t just take my word for it. Follow the money. Look at the share prices of the major banks. They are breaking out to new highs. This doesn’t happen if the housing market is about to collapse.
Take the Commonwealth Bank of Australia’s [ASX:CBA] share price. The chart below shows its path over the past two years. Last week, it hit its highest point since mid-2015. It’s up 22% since bottoming late last year.
[Click to enlarge]
What about ANZ Bank [ASX:ANZ]? As you can see in the chart below, it’s been climbing higher since early 2016. The share price is up 45% from the lows. It’s a similar picture for Westpac and NAB.
[Click to enlarge]
The Big Four banks are massively exposed to Australia’s property market. Their balance sheets basically consist of land. These share price charts are telling you that land prices are not about to collapse.
It really is as simple as that.
You can worry all you want about Australia’s high debt levels and fragile economy. But while interest rates remain as insanely low as they are right now, you’re not going to see house prices fall.
In fact, Australia’s highly-leveraged economy is working in its favour. Thanks to resurgent commodity prices, Australia’s terms of trade are improving for the first time in years. That means incomes are improving too.
The combination of low rates and rising national income is bullish for our highly-leveraged housing market. It may not make any sense to you, especially if you live in Sydney or Melbourne. But the market rarely makes sense.
It is only in hindsight that all is revealed. And by then, it’s too late to do anything about it.
For The Daily Reckoning
Editor’s Note: This article was originally published in Money Morning.