Mortgages 2017: Finding focus in a complex market
James Hickey, Partner at Deloitte Actuaries & Consultants, discusses affordability and mortgage pricing based on the Deloitte Mortgage Report 2017.
The predictions for the Australian mortgage market in 2017 from Australia’s leading lenders and mortgage brokers are for an increasingly personalised, subdued market, dominated by issues of availability and affordability, and international regulation.
While market participants remain confident about the fundamentals, they can see signs of growth slowing to a modest 1-5% for new lending. Over the 12 months to December 2016, total new lending, including refinancing, was flat at $384 billion.
This was the first year since 2012 that settlements did not grow, due to:
- APRA’s sound lending benchmark of 10% new annual growth to investors, which reduced lending to investors in 2015 and the first half of 2016 (although it has is grown since the second half of 2016)
- More stringent serviceability criteria, especially around non regular and offshore income sources, and borrowers’ capacity to repay in times of higher interest rates.
- Greater pricing for risk, particularly for higher Loan to Value Ratio (LVR) lending, investor lending and interest only repayments.
- More selective lending e.g. reduced participation in certain parts of the market, such as lending to property developments or off the plan.
The Deloitte Australian Mortgage Report 2017’s key themes for mortgages in 2017 build on this background of moderated growth, and are dominated by affordability, pricing, funding costs and conduct.
It is important to draw a distinction between ‘affordable housing’ and ‘housing affordability’. While affordable housing is vitally important in assisting households of lower socio‑economic standing be able to have appropriate housing, it is housing affordability that is often discussed around the inability of otherwise financially able households to afford property, especially in the Sydney and Melbourne property markets.
However there is more to Australia than just those markets. Across the other states and regional areas of NSW and Victoria, the affordability issue is quite different. It is not so much property prices, but rather employment and availability of jobs and certainty of income which is the concern.
This creates a dilemma for regulators and policy setters in that any lever to dampen demand in Sydney and Melbourne may have unintended consequences on other capital cities and regional areas.
The report points out that the debate around solutions to affordability and availability in the short and longer term needs to broaden and cover both demand and supply. The beneficial role of property ownership and investment from a tax and pension eligibility position is well justified to be debated. Certainly negative gearing benefits many average Australian households, however there are significant advantages it has for the more wealthy and speculative investor such as concessional capital gains tax and no limit on the amount of deduction which can be claimed. The role of a land tax versus stamp duty, while giving limited short term benefit to affordability, may be a longer term structural change to assist future generations.
There is also a whole area to be explored around the greater release of existing supply particularly if retirees are encouraged to downsize without any adverse impact on their pension eligibility. They could also be further incentivised by not having to pay stamp duty on their repurchase.
Mortgage Pricing & Capital
While most Australians may struggle to understand why a change in the cash rate does not correlate to an exact change in mortgage rates, the pricing of mortgages is heavily dependent upon the mix of funding required to be sourced by lenders together with managing net interest margins to ensure economically sustainable returns.
Banks have an economic duty to make sure their Net Interest Margins are healthy given the global focus on capital. They need to balance social and reputational issues, as well as those fiscal ones of deposit management. Also around 70% of banks’ wholesale funding is from international investors and so vulnerable to offshore geopolitical uncertainties.
In 2015 the Murray Report specified that banks needed to be ‘unquestionably strong’. And in July 2016, APRA implemented higher risk weights on Australian mortgages measured under the IRB approach. This is estimated to have increased the bank’s capital requirements by up to 100bps. These increased capital demands have meant that banks are under pressure to cover the cost of the increased capital requirements.
Differential pricing has now emerged in mortgages. Where for the past several years rates for owner occupier and investor were rarely different, differential pricing for investor lending, higher LVR loans and interest only loans are now commonplace. This reflects risk returns on capital, together with enforcing prudential regulatory desires around slowing down lending to certain parts of the market viewed as being of longer term structural risk to the sector.
Although prudential regulation will continue to pose challenges for lenders, conduct risk regulation is a becoming a much bigger focus. Concern from politicians and regulators about banking culture, holding executives to be more accountable, toughening whistleblower protection and targeted conduct and risk culture reviews being undertaken all highlight the direction for conduct risk.
Good conduct is not just about making sure that a mortgage product, or its recommendation, is suitable for today. It is about making sure that recommendation, or that product, remains suitable throughout the life of the loan.
The full report can be found at https://www2.deloitte.com/au/en/pages/financial-services/articles/mortgage-report-2017.html
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