women looking shocked at a house

How Will Tighter Credit Impact Investors?

Over the past few weeks, we’ve heard from the Australian Prudential Regulation Authority (APRA), who appears ready to crack down on lending.

Given that house prices are growing across the country at the fastest rate since 1989 on the back of record low interest rates, it’s not surprising that APRA has started to pay closer attention to ensure lending standards remain robust.

While the headlines in the media can at times be a little alarmist, in my opinion, these changes aren’t likely to derail things for investors all that much.

The main point that home buyers need to be aware of is that APRA has written to banks telling them to increase the buffer rate by 0.5 percentage points, from 2.5 per cent to 3 per cent by October 31.

What this effectively does, is reduce the amount of money a bank will lend to someone. The thinking behind the move is that with interest rates at record low levels, there is only one way they can go from here which is higher. APRA is simply trying to get in early to ensure greater financial stability and this may also cool the market in places that might be a little overheated.

We’ve already seen rates rise in New Zealand with the RBNZ lifting their official cash rate making it one of the first major central banks to do so. To put it in context, house prices in New Zealand have risen by nearly 30% over the past 12 months, while Australia is around 20% higher over that same period of time.

The Goal is Stability

The goal of APRA is to support the financial safety of banks and other institutions and the stability of the Australian financial system. Given the large exposure that Australian banks have to residential property as an asset class, it follows that creating financial stability in the housing market would be a very welcome outcome. They don’t want a situation whereby lax lending standards allow house prices to rise unsustainably and then crash as we saw in the US with NINJA loans during the GFC. An increase in the buffer for the serviceability rate also provides comfort to both banks and borrowers that they can withstand the impact of having to pay a substantially higher interest rate than they may be paying currently.

The key points worth considering at the moment are that if APRA is trying to create stability, they don’t need to do all that much to have an impact, given that house prices are currently at record high levels, and the corresponding mortgage debt level is also very high.

A small change in the serviceability assessment rate of just 0.5% might be all that is required to slow things down. It’s also probably a prudent thing to do if official interest rates are set to rise sooner rather than later. APRA has other macro-prudential levers it can utilise and we may see some of these being introduced next year, although banks are already reviewing their internal credit policies and this should allow a more nuanced approach by the regulators.

The second factor is that it is highly unlikely that we’re going to see a huge lift in interest rates from where they currently sit anytime soon. Given the amount of Government debt that is now circulating on the back of the pandemic stimulus measures, there really isn’t room for central banks to act in a super aggressive manner on rates without risking an economic policy mishap.

Therefore, we are more likely to see small steady increases in interest rates from late next year or early 2023, which is earlier than 2024 as the RBA has repeatedly stated, and we should expect any moves from APRA to be equally measured.

There was widespread criticism about the way APRA handled the previous housing boom and how their heavy-handed intervention had a severely detrimental impact on the housing market in 2017. It’s probably safe to assume, they learnt some lessons from their failings on the first go around and this time they are likely to take a far more nuanced approach.

The RBA will be hindered in raising interest rates too far in this cycle as Australia has a high level of personal debt linked to the residential housing sector, so the debt servicing ratio may well mitigate the need for a much higher cash rate in the future, relative to what we have seen over past cycles.

Impact on Investors

The reality for property investors is that these small changes will likely not have any meaningful impact for now and I see more of an impact on first home buyers who have been forced to stretch themselves to purchase the homes they desire.

APRA estimates that the net change to borrowing capacity might be around a 5% reduction, however, for investors this doesn’t really impact their ability to buy. If an investor is forced to borrow less, they simply have the option of purchasing a more affordable property in a different location. Generally speaking, it’s currently owner-occupiers who are most leveraged in comparison to investors, although investor lending has been rising over the past two quarters and I believe this trend will continue.

While some of the more overheated segments of the market might slow down modestly as a result of the APRA tightening, that might not be a bad outcome overall. We need to remember that APRA’s mandate does not directly cover the price of housing and that it is quite difficult to balance their intervention to reduce the risk of unintended economic consequences whilst protecting the financial system on a broad scale.

Fortunately, we are able to look back at 2017 as to how property markets responded to APRA’s use of macro-prudential credit tightening measures and we too can learn from these experiences.

For the time being, the impacts will be limited for investors, but we will continue to watch what happens with bond yields as a leading indicator of things to come, although financial markets are quite volatile with forward price expectations at present. The inflation genie continues to drive forward guidance and the global prints seem to point to higher levels which may be transitory but may also persist due to supply shocks and labour constraints which may not be able to be addressed rapidly enough.

We will await the release of the RBA minutes on the 19th October and the discussion on macroprudential policy will be of particular interest.

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