Australia's mortgage market is on the brink of a shake-up -- here's what it might look like

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It looks like tougher restrictions on Australian housing investors are on the way.

According to reports in the Australian Financial Review today, a special regulatory working group — containing officials from ASIC, APRA and the RBA — was set up last week to crack down on bank lending to riskier investor and low-deposit borrowers.

The AFR says the decision was a result of direct intervention by Australian federal treasurer Scott Morrison, with the tougher restrictions set to be introduced “imminently”.

The group is said to be considering measures such as halving the annual speed limit on investor credit growth to 5%, down from its current level of 10% introduced by APRA in December 2014, along with tougher loan serviceability tests for borrowers.

Some are also speculating that capital risk weightings for investors with multiple properties in their portfolio may be increased fourfold.

Faced with heightened risks in the housing market stemming from increased investor loan growth, rapid price growth in Sydney and Melbourne, low household income growth and an stuttering labour market, all the noise at present points to the need for a policy response, particularly given separate concerns over housing affordability for first-time buyers.

Source: UBS

As many others have done recently, UBS’ Australian economics and equities team have been assessing what form tougher macroprudential measures might take, if and when they arrive, producing an excellent synopsis as to what homeowners should expect.

It may even provide the special regulatory working group with a few ideas in the process.

In terms of the most likely macroprudential response, UBS says that lowering the annual cap on investor credit growth appears the most plausible outcome.

“A cap of around 7% would still be twice the level of household income growth and a logical step to reduce the risk to financial stability,” it says. “We see this as a likely outcome in coming months.”

UBS says that this would lead to a reduction in investment property credit growth, mirroring the outcome seen in 2015 following the introduction of APRA’s 10% annual cap in December 2014.

Source: UBS

Another policy option would be potentially to introduce tighter lending restrictions by location, adopting a similar approach used in New Zealand to cool the Auckland property market.

“Given the vast majority of house price inflation in Australia is concentrated in Sydney and Melbourne policies which target these cities are possible,” it says.

“This would be done most easily on a postcode or municipality basis. This may include limits on investor credit growth within these postcodes or loan-to-valuation caps.”

Another possible solution, UBS says, would be for greater scrutiny over home loan applications.

“We believe mortgage misrepresentation is systemic in Australia with our recent evidence lab study showing 28% of mortgagors stating they were not factually accurate in their application,” it says.

“Given systemic mortgage misrepresentation, we believe this is no longer effective and it is likely APRA will begin to require the banks to check tax returns as a form of income validation.

“This would also allow the banks to see all deductible debt and other tax deductions claimed by the applicant which could be factored into mortgage serviceability calculations.”

On the prospect of increasing capital risk weightings for investor loans, it says that while APRA may introduce this, it’s “most likely be used as a last resort”, noting that it would place further pressure on bank’s capital positions.

Outside of a macroprudential response to cool housing market activity, aimed to reduce financial stability risks and, perhaps as a consequence, help to address affordability constraints, UBS says that will likely require a political response, rather than rate hikes from the RBA.

“This seems like the most obvious way to stem house price inflation in Australia,” it says.

“We believe the RBA is unlikely to hike rates near term given low levels of CPI, with the RBA’s commentary indicating a preference for more macrorudential initiatives by APRA.”

Higher interest rates, and quite possibly a higher Australian dollar, would do little to assist the Australian economy outside of the Sydney and Melbourne property markets, particularly at a time when unemployment is moving higher with labour market underemployment at the highest level on record.

It certainly would not help Australia’s trade-exposed sectors such as tourism and education — two sectors many are relying upon to help bolster economic activity in the year’s ahead.

That leaves a political response to help take heat out of the east coast property markets.

Tax changes

On that front, UBS sees a reduction in the capital gains discount as the most likely outcome.

“Given the yields on most residential properties are low, new property investors are more reliant on future capital gains,” it says.

“By reducing the CGT discount from 50% to 25% this would reduce the incentive to gear into the housing market and would increase revenue for the government over time.”

With gross rental yields so low, and investor activity accelerating, it does suggest that expectations over continued capital gains may be influencing current demand.

UBS does not think that negative gearing will be eliminated in the near-term given it has been rejected on several occasions by the ruling Liberal-National Coalition.

However, it does see grounds for capping negative gearing deductions.

“We believe a policy of capping negative gearing to a set number of investment properties or a dollar value deduction cap is more likely,” it says.

“Given the government has stated on several occasions that many people who use negative gearing are middle income earners, capping deductions would not impact these constituents.”

UBS also sees the introduction of higher stamp duty charges on foreign investors as likely, especially in New South Wales and Victoria.

It doesn’t believe the idea of allowing Australian first-home buyers to access their super for a housing deposit will help to address housing affordability, saying it would only fuel house price inflation.

“We believe allowing FHB to access their superannuation would effectively lead to a direct transfer of retirement savings from younger FHB’s to downsizing baby-boomers and would do little to nothing to address affordability,” the bank says.

Plenty to digest, and an interesting look at what policy options are available.

The one thing that seems more likely than not is that some form of tighter restrictions on investors appears likely to be introduced.

The key, of course, is to ensure that the measures deliver what they supposed to do — contain risks in the housing market — rather than creating an even bigger risk from a subsequent market response.

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