Investors could generate risks to future health of economy

In its Financial Stability Review published on Thursday last week, the Reserve Bank of Australia noted that investor credit has risen “noticeably” over the past six months, with investor demand particularly strong in Sydney and Melbourne.

It also pointed out that higher-risk mortgage lending, namely interest-only loans, have remained prevalent and increased lately, despite some tightening of lending standards since 2014.

“I/O loans also enable investors to maintain a higher level of leverage and so magnify potential gains or losses if housing prices rise or fall,” it said.

The RBA explained that the risks associated with strong growth in investor credit and increased household indebtedness are “primarily macroeconomic” in nature, rather than direct risks to the stability of financial institutions.

“Indeed, some evidence suggests that investor housing debt has historically performed better than owner-occupier housing debt in Australia, though this has not been tested in a severe downturn.

“Rather, the concern is that investors are likely to contribute to the amplification of the cycles in borrowing and housing prices, generating additional risks to the future health of the economy.”

According to the bank, periods of rapidly rising prices can create the expectation of further price rises, drawing more households into the market, increasing the willingness to pay more for a given property, and leading to an overall increase in household indebtedness.

“While it is not possible to know what level of overall household indebtedness is sustainable, a highly-indebted household sector is likely to be more sensitive to declines in income and wealth and may respond by reducing consumption sharply,” it said.

Further, the RBA pointed out that a further risk during periods of strong price growth is that it may be accompanied by an increase in construction that could result in a future “overhang” of supply for some types of properties or in some locations.

“In this environment, as well as amplifying the upswing for such properties, any subsequent downswing is likely to be larger and more likely to see prices and rents fall if the vacancy rate rises. This poses risks to the whole housing market and household sector, not just to the recent investors.”

Noting that in this environment of heightened risks, APRA has announced further measures to “reinforce sound housing lending practices”, the RBA highlighted that prudent mortgage lending standards indeed “help to offset” these risks.

It noted that over the past six months, lenders have further tightened lending terms in order to contain investor credit growth within APRA’s 10 per cent benchmark.

Further, it underscored that recent non-price measures introduced by banks include tighter serviceability and maximum LVR restrictions on new residential projects or postcodes considered to be riskier.

“Overall, the share of new lending with LVRs greater than 90 per cent has fallen. In addition, the price of mortgage finance has increased of late, and loan pricing is becoming more granular. For example, major banks’ advertised margin between investor and owner-occupier lending rates has risen to around 50 to 60 basis points after narrowing during 2016.

“Furthermore, all of the major banks will have introduced higher I/O pricing by April, resulting in an average I/O premium of 18 basis points for owner-occupier loans and 15 basis points for investor loans.”

[Related: IO crackdown may have “bigger impact on owner-occupiers”]