JP Morgan warns loan caps based on income could lead to further house price declines in Australia

iStockA storm rolling towards Sydney’s Bondi Beach.
  • Australian home prices are now lower than a year ago, the first time that’s been seen since late 2012.
  • The slowdown follows the introduction of tighter lending restrictions from Australia’s banking regulator, APRA.
  • New restrictions based on debt and income levels could be introduced, something JP Morgan believes will slow housing credit growth and possibly lead to further price declines.

For the first time since November 2012, Australian home prices are now falling on an annualised basis, largely reflecting weakness in Sydney and Melbourne, the nation’s largest and most expensive housing markets.

A major factor behind the recent reversal, in stark contrast to recent years, is that growth in housing credit is slowing, reflecting recent efforts from Australia’s banking regulator, APRA, to reduce what were growing financial stability risks in the housing market.

After introducing limits on annual growth in investor housing credit back in late 2014, APRA followed that move up in early 2017 by capping interest-only lending to 30% of total new mortgage loans.

It’s had a pronounced effect, cooling the housing market even with official interest rates sitting at the lowest level on record.

JP Morgan

While APRA removed the limit on investor lending last month, suggesting it had now served its purpose with investor credit growth now running well below its 10% threshold, the regulator also announced that further restrictions on mortgage lending — this time based on income and outstanding debt levels — could be introduced in the near future.

Ben Jarman and Henry St John, Economists at JP Morgan, are not surprised that APRA’s macroprudential policies are evolving in this direction, pointing to recent revelations at Australia’s Banking Royal Commission and a desire from policymakers at the Reserve Bank of Australia (RBA) to bring housing credit growth more in line with growth in household incomes.

“We have expected introduction of more stringent lending criteria and tighter assessment of borrowing capacity such as income and expenses,” they say.

“The Royal Commission has highlighted slippage in these areas, and two weeks ago the banking regulator APRA instructed banks to set portfolio limits on new lending in high debt and loan-to-income (DTI and LTI) loans.

“High LTI lending has been a source of concern for the prudential regulator for some time, as a central driver of the increase in aggregate household debt to 189% of disposable income.”

They also note that RBA governor Philip Lowe has also communicated that he would like to see household debt – currently running at 6% year-on-year for mortgages — grow more in line with household incomes over the longer-term at around 3% to 4% per annum.

So what would happen if new limits on lending more than six times annual income were introduced?

To Jarman and St John, it would be pronounced.

“Placing limits on high loan-to-income loans will have a significant impact on credit growth over the medium term, and while the adjustment path is designed to be gradual, there easily could be bumps along the way,” they say.

“While policymakers see an urgent need to stabilize household leverage, the official focus is on limiting risk in new housing exposures, with the regulator showing little appetite to tighten conditions on existing loans.

“This means that even refinancing, to the extent that it is involuntary is unlikely to be subject to LTI or DTI restrictions.”

The new restrictions would likely be placed on new loans, in other words.

Using data provided by APRA, Jarman and St John note that around 10% of new loans had a LTI in excess of six times income in recent years, accounting for around of 31% of the value of new mortgage lending based off JP Morgan’s calculations.

JP Morgan

“If such loans can no longer occur, this will slow credit growth,” they say, adding that could lead to further property price declines.

“The restrictions on new high-LTI loans may be the most significant headwind.

“With a high share of turnover funded through high LTI lending, facilitating sales becomes a matching problem where high-LTI owners trade with lower LTI (4x-6x) buyers.

“All things being equal, this generally will necessitate some form of concession via lower house prices.”

NOW READ: ANZ Bank says Australian home loan restrictions are likely to get even tougher

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