The Reserve Bank governor spoke during the week on the economy including some important hints around monetary policy.
For those folks expecting an imminent rate hike the following passage would have been rather discouraging: "There are sufficient spare labour resources such that we could probably enjoy a couple of years of non-mining sector growth somewhat above its trend rate before we needed to worry too much about serious inflation pressure".
On the other hand, for those expecting a rate cut, consider: "A high level of construction, maintained for a longer period of time, is vastly preferable to a very sharp boom and bust cycle. That alternative outcome might give us a higher peak in the near term, but then a slump in the housing sector at a time when the fall in mining investment is still occurring". The clear implication behind this comment is that lower rates might bring forward more housing activity only to see the downturn exacerbated when rates do rise.
There was also considerable uncertainty about exactly whether the RBA 'likes' investor housing activity. Consider: "It is not to be assumed that investor activity is problematic, per se. A proportion of the investor transactions are financing additions to the stock of dwellings, which is helpful".
Nor does the governor see these dynamics "thus far as an immediate threat to financial stability". Finally, "for accommodative monetary policy to support the economy most effectively overall, it’s helpful if pockets of potential over-exuberance don’t get too carried away".
The dynamic that the RBA would be concerned about would be if banks became overexposed to unsound loans with the risk that a substantial lift in losses would reduce the availability of credit to the rest of the economy.
But consider, for example, the 'quality' of Westpac’s investment property portfolio. Investment property loans (IPLs) are 45.2 per cent of Westpac’s Australian mortgage portfolio.
- Compared to owner–occupier applicants, IPL applicants are older (75 per cent over 35 years); have higher incomes and higher credit scores.
- 65 per cent of IPL customers are ahead on their repayments and 90 days delinquencies are 0.37 per cent compared to 0.47 per cent for the full housing portfolio.
- Westpac has an interest rate buffer approach to lending linking loan approvals to serviceability at a rate at least 180 basis points above the standard mortgage rate (5 per cent).
- All IPLs are full recourse and specific policies apply to holiday apartments and single industry towns.
Such lending practices, which are likely to be widely practised right across the Australian banking system, should fully allay the governor’s concerns implied in his comment: "after all we have seen around the world over the past decade" (i.e. referring to the lending excesses in housing markets, exemplified by the US).
Even comparing the growth in investor lending activity to previous investor-driven cycles suggests that the RBA should be patient. In May 2000 investor credit growth peaked at 32 per cent (six month annualised) and again at 33 per cent in October 2003. That compares with the current pace of investor credit growth of 10.4 per cent.
Now, the RBA argues that the current pace of growth is all the more worrying because overall leverage is starting from a higher base. That assertion also warrants some scrutiny.
There are two ways of looking at household debt – gross debt; and net debt calculated after subtracting liquid assets (which we describe as cash and bank deposits, including term deposits and offset accounts) from gross debt.
Gross debt has risen from 96 per cent of disposable income (June 2001) to 125 per cent (September 2003) to 150 per cent (2007) and has held around those levels since then.
In contrast net debt has increased from 40 per cent of disposable income (2001) to 61 per cent (2003) and 65 per cent (2014) having peaked at 90 per cent in 2007.
If we compare 2003, when investor credit was growing at 33 per cent p.a., to 2014, when investor credit is growing at 10.4 per cent p.a. with broadly comparable net debt ratios, the current situation should hardly qualify as disturbing for the authorities.
Finally let’s examine the rationale behind the decision to diversify into investor housing. The margin between the standard variable mortgage rate and the residential property yield is much narrower than we have seen in previous periods of strong investor lending growth. Whereas in the 2001-03 period the mortgage rate peaked at 300 basis points above the rental yield, current margins are around 50 basis points. That spread implies that investors do not need to rely on significant capital gains to justify investing in property. Furthermore, the shape of the Australian yield curve (with rates priced to be on hold until 2017) allows investors to lock in term funding around the current variable mortgage rate.
Alternative investment opportunities also favour investment property. The margin of rental yields above the term deposit rates is near record highs.
Overall, lenders are adopting prudent lending practices and the investment proposition does not rely on speculative price gains to justify investment decisions.
The case for Australia’s property markets being unbalanced due to excessive investor activity is not strong. In time I expect that the RBA will also reach such reasonable conclusions.
Bill Evans is a chief economist at Westpac.