RBNZ prepares to add debt-to-income limit to property toolkit - doesn't expect to use it

Reserve Bank Governor Graeme Wheeler. Photo / Mark Mitchell

New Zealand's central bank expects to publish a consultation paper within the next couple of weeks to add debt-to-income limits to its suite of macroprudential tools but it may not actually need them.

"The paper is with the finance minister at the moment and he has a couple of weeks to look at the paper and express any views. I suspect the paper will be released in the next couple of weeks," Reserve Bank Governor Graeme Wheeler said at a media conference to present the bank's twice-yearly financial report.

He reiterated, however, "We wouldn't use them if we had them at this point in time," given the recent easing in house price inflation.

When the idea was first floated in mid-2016, Auckland house prices had risen by 85 per cent in four years, taking the average price to around nine times the average household's disposable income, fuelled by record-high migration, low interest rates, and housing under-supply. Prices were also rising quickly in other regions.

Today, however, annual house price inflation has slowed to 8 per cent from 14 per cent in October with the market "particularly subdued in the past six months," the central bank said. Reserve Bank Governor Graeme Wheeler told journalists that annualised house price inflation is currently running at 2 per cent, down from 18 per cent in the prior period. It has come off "very significantly" and the bank is "very pleased about that," he said.

He pegged part of the slow down to the introduction of loan-to-valuation ratios on borrowing for housing. The LVR policies have been in place since late-2013 to address financial stability risks arising from rapid growth in house prices and strong housing credit growth. LVR restrictions were tightened in October 2016, in response to renewed housing market pressure and increased activity property investors.

Against that backdrop, Westpac Bank acting chief economist Michael Gordon doesn't expect the bank to need to the tool. "Regardless of the merits or otherwise of this policy tool, we don't think there will be a case for applying DTI limits anytime soon," he said.
"The housing market has slowed significantly as mortgage rates have risen from their lows, and our view is that the slowdown will 'stick' this time," he added.

ASB Bank was also skeptical the tool would be needed. "Our expectation is that future price growth will be constrained up and down the country. And that means little urgency for further macro-prudential action," he said.

Wheeler said, however, "the fact is we don't know if house price inflation will increase again," which is why the bank is keen on having a debt-to-income ratio tool should it be needed. The factors driving house price inflation haven't gone away, he said.

The report noted that while LVRs have helped insulate the banking system from a housing downturn, low mortgage interest rates have encouraged an increase in high debt-to-income lending.

"Borrowers with high DTI ratios are typically more exposed to a rise in interest rates or a decline in income," it said.

According to the central bank, if mortgage rates were to increase to 7 per cent, around 4 per cent of all borrowers and 5 per cent of recent borrowers would not be able to "meet their essential expenses" or would be under severe stress. It noted that stress would be much higher at 9 per cent, with 7 per cent of all borrowers and 18 per cent of recent borrowers expected to face severe stress.

Wheeler said the debt-to-income ratio tool would likely include "speed limits," where banks could only lend a certain amount to people who were above a certain threshold.
Deputy Governor Grant Spencer said that while nothing has been determined a debt to income ratio of five times gross income was possible as "if we get over five, that's pretty high and tends to be the area were potential stressors emerge."

Bernard Hodgetts, head of macro-financial stability, told BusinessDesk "upward of 30 per cent of the new borrowing that has been occurring is attributed to borrowers with DTIs greater than five. It's a reasonably significant proportion and it has been growing."

Hodgetts said interest rates of 7 per cent - roughly 200 basis points from where we are now - isn't "beyond the realm of possibility." He said 9 per cent would be "quite a stretch" although New Zealand was over 9 per cent in 2007 so it's not "out of living memory."

"The analysis is telling us that 7 per cent there are some recent borrowers who would find that pretty tough and could potentially default," he said.

He underscored, however, that people with the highest debt-to-income ratios tend not to be first home buyers but rather investors or people who have been in the market for a while.

He said the central bank is pushing the banks to obtain the required data and "they still have some way to go in terms of having the systems in place internally to monitor and comply with any debt to income restriction if it was ever to be brought in."

He said the upcoming consultation will draw those issues out and get a sense from the banks what would be required for them to operate a DTI tool.

Hodgetts said the consultation will likely last until early August - if it kicks off in the next few weeks - and the ban will then re-assess all submissions and it will put a final recommendation in front of the minister.

"The ball will be in the minister's court," he said.

Hodgetts also underscored "there's a distinction between having it in the toolkit and actually using it. Given where the market is now we wouldn't be recommending actually using it," he said.