The residential mortgage loan books at Aussie banks are huge, but at least regulators are remaining vigilant in their efforts to monitor the sector.
That’s the view of UBS in a research note called Housing Bubble Watch, which provided some historical perspective on the incredible growth of household mortgage debt in Australia.
The bank also assessed statements made by APRA yesterday about fostering strength in the sector and raising capital ratio requirements for Aussie banks.
UBS cited the Basel 1 Accord in 1988 as a key event which kick-started the upward spiral in mortgage debt.
This chart shows the growth of household debt since then, and in the words of UBS “a picture tells a thousand words”:
The Basel 1 Accord prescribed a minimum capital requirement for banks amounting to 8% of all risk weighted assets (RWA). As part of the RWA calculation, residential mortage assets were given a risk weighting of 50%.
UBS said that, “from this time banks could leverage their mortgage books more significantly than other lending products, and allocated a greater proportion of their book to mortgages”.
The introduction of Basel 2 in 2007 allowed major banks to bring risk-weighting measurements in-house. This saw the risk-weights for mortgages reduced to the “mid-teen levels”.
With lower capital requirements, risk weightings at those levels implied that banks could leverage mortgage assets at around 80 times the value of their loan book, UBS said.
In 2015, Aussie banking regulator the Australian Prudential Regulation Authority (APRA) enforced a ruling that Aussie banks had to increase the risk-weighting of their mortgage books back to 25%.
Cut forward to the present, and UBS notes that APRA chairman Wayne Byres made a speech yesterday outlining an Information Paper to be released around the middle of this year.
The statement comes after APRA announced tighter restrictions last week, led by a limit in interest-only lending to 30% of new loans.
The paper will consider the need for further increases in the risk-weighting of mortgage books. In Byres’ words (emphasis ours):
“The biggest issue we will need to resolve in ensuring capital is appropriately allocated is whether and how we adjust the risk weights for housing-related exposures. Put simply, the capital adequacy framework needs to address the concentration in housing lending that has built up in the banking system over time: if we are going to put an increasing number of eggs into a single basket, we’d better make sure that basket is a (unquestionably) strong one.”
According to UBS, an increase in the risk-weighting will require the big Aussie banks to raise a bit more capital in order to meet APRA’s definition of “unquestionably strong”.
The analysts considered the 2015 ruling, which required banks to raise around an extra $5 billion each. In view of that, they noted guidance in APRA’s latest statement which said “that should not be taken to imply that there will be a dramatic increase in capital requirements for housing lending: APRA has always imposed capital requirements for housing exposures that are well above international minimum standards, so we do not start with glaring deficiencies.”
Given APRA’s statement, UBS expects that banks will have to add to their capital positions by around $3-4 billion dollars each when the new measures come out.
UBS said that for that level of capital, each of the big four banks (excluding ANZ) are likely to use fully underwritten dividend reinvestment plans as the vehicle. Dividend reinvestment plans allow banks to raise capital by selling excess shares that haven’t been taken up by shareholders.
UBS said that “ANZ is unlikely to need to raise fresh capital to meet this shortfall given the expected capital release from its recently announced divestments”.
Overall, UBS applauded the move in increase risk-weightings as a prudent decision. The bank’s analysts expect that (not including any changes to risk-weightings by APRA) capital requirement ratios for the sector will increase from their 2016 levels of 9.3% to 10.5% by 2019.