Brakes on lending as repayments near tipping point

UBS banking analyst Jon Mott yesterday said renewed out-of-cycle mortgage rate hikes by lenders should take some of the heat out of the market, staving off any need for the central bank to intervene. 

Given rising political pressure, regulators must have breathed a sigh of relief following National Australia Bank and Westpac’s decision to reprice their investment property lending book by 25 basis points last week, the analyst said in a note.

“With the other banks lacking the capacity to absorb much of NAB and Westpac’s lost business - without breaching the 10 per cent growth cap - we expect them to follow the lead and reprice." 

UBS has upgraded earnings per share for the big four banks by as much as 3 per cent to reflect the home loan rate hikes but admitted it was hard to predict the outcome of any policy changes

A resurgence in house prices and a growing disillusionment in parts of the community means a policy response cannot be ruled out. However, Mott largely discounts the likelihood of an official cash rate hike in the near term given low inflation. 

Alarmingly, UBS has estimated that mortgage repayments have lifted to 27 per cent of income - the highest level since 2011 and way above the long-run average of 23 per cent since 1978.  

“Importantly, with record low interest rates, repayments are nearing extreme historical tipping points where prices fell. Indeed, if mortgage rates rose by only 100 basis points, this measure of affordability would approach the worst on record and like 1989 and 2008.”

Of course, while an increase in interest rates would theoretically be positive for the banks' margin, it would likely be bad for sentiment and consumer confidence. 

“Fears of further hikes and the implications on the credit cycle would come into play. Thus, it is unlikely banks would perform well despite a modest earnings boost from higher rates," Mott argued.
 

Mortgage misrepresentation

Running through the macroprudential policy options, lowering the cap on investor home loan credit growth from 10 per cent to 7 per cent makes the most sense as does putting limits on the 'problem’ cities.

"A cap of around 7 per cent would still be twice the level of household income growth and a logical step to reduce the risk to financial stability," said Mott. 

"The banks would be likely to increase investor mortgages to both slow credit growth and insulate earnings. As a result, we do not believe this would be a material earnings driver, although it could increase negative sentiment towards the banks.”  

While postcode limits were introduced in Auckland, Mott is unsure that bank systems are sophisticated enough to have differentiated pricing at a geographical level. 

One thing Mott is adamant about is a new rule demanding tax returns will be introduced for those seeking a home loan. And they should be in his view given that mortgage misrepresentation is endemic in Australia. 

“One of the most unusual elements of the mortgage application process here," he went on to say, "is that tax returns are not required to be provided as proof of income - just pay slips and group certificates.”  

A UBS study revealed 28 per cent of mortgagors stated they were not factually accurate in their application. This was especially evident through the mortgage broker channel where 18 per cent of people admitted to overstating their income.  

Also, tightening up the mortgage application process will likely lead to a slowing of investment property and owner-occupied credit growth. Clearly, an increase in capital requirements for investor home loans is a potential option for the prudential regulator but that would most likely be a last resort, according to Mott.

That said, he acknowledged it was one of the Basel 4 proposals where the borrower was materially dependent on the rental income to service the loan. 

"This would be a clear negative for the banks and put further pressure on their capital position at a time when they are required to accumulate additional capital to reach their 'unquestionably strong'."

Mott is discounting he political option of eliminating negative gearing since this has been rejected on several occasions by Canberra.

“While such a policy would slow down Investment property credit growth, there is a risk that it may lead to property sales and a large supply coming onto the market.” 

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