With the tightening of lending criteria over recent years by lenders there is increasing use of the phrase ‘credit crunch.’ A formal definition of ‘credit crunch’ is inherently loose, however, looking at the data and commentary from the banking regulator APRA, although dwelling values are falling and credit growth has reduced, the term ‘crunch’ might be a little overzealous.
Since late 2014 Australia’s banking regulator APRA along with the Council of Financial Regulators have introduced a series of macroprudential policies which have seen a number of changes to the lending environment. Some of these major changes include:
- A 10% pa speed limit for lenders on investment credit growth (recently lifted for lenders who qualify)
- Lenders having to calculate mortgage serviceability on a mortgage rate of 2% above current rates or at least 7% whichever is the greater
- A limit of 30% of new mortgage originations for interest-only products along with limits of new interest-only lending on an LVR above 80%
- Restrictions on lending growth in higher risk segments of the portfolio (e.g. high loan-to-income loans, high LVR loans and loans for very long terms)
- Improved capture and increased scrutiny of borrowers actual expenses rather than using benchmark measures
- Stronger verification of borrowers existing debt commitments and income
- Reduced risk appetite for new lending at high debt to income levels (greater than 6 times)
As a result of all these changes, the mortgage market has changed. While the last two decades have largely been about credit becoming more freely available, accessing credit has become less straightfoward. The amount borrowers can borrow relative to their income has generally been reduced, investors and interest-only borrowers are being charged interest rate premiums and the flow of higher LVR lending has reduced. But has all of this actually led (or is it leading to) a credit crunch?
As at the end of May 2018, the value of outstanding housing credit to Australian lenders was recorded at a historic high of $1.762 trillion. This represents the total value borrowed for housing and as the chart above shows, growth is certainly slowing but it is still expanding. Over the 12 months to May 2018 housing credit has increased by 5.8% which is its slowest annual growth since February 2014. This is split between a 7.9% increase in owner occupier credit and a 2.0% increase in investor credit. While owner occupier credit growth has slowed marginally over the past few months, the annual growth rate is actually a bit higher than a year ago. The annual rate of growth in investor credit is historically low, highlighting that investor mortgage demand is being impacted more so than owner occupier demand in light of the tightened credit policies.
Another potential reason for the slowing of credit growth for investors is that an increasing number are switching from interest-only mortgages to principal and interest because of the mortgage rate saving. As a result the principal is now being repaid and outstanding credit is reducing whereas in the past there was no reduction of the principal.
Unfortunately outside of switching (ie voluntarily transitioning from interest only payments to principal and interest payments) data which most big banks report quarterly to the market there is no regular publicly available data on switching across the whole market.
While total housing credit is important to consider when looking at any ‘credit crunch’ scenario, so too is the flow of new lending. Each month, the Australian Bureau of Statistics (ABS) publishes housing finance commitments data which highlights the flow of new lending by Australian ADIs. Unfortunately, only owner occupier data is shown by volumes so in order to look at the whole market, measuring the value of commitments is the only way to do this. Of course as the cost of housing rises borrowers need to take out larger loans so you do see a strong increasing trend in the value of lending over time.
Based on the monthly data there was $31.9 billion worth of housing finance commitments in May 2018 which was the highest monthly value in three months. The $31.9 billion was -5.5% lower than its historic high monthly value of $33.7 billion in August 2017. Looking at the three components shown in the above chart, in May 2018 there was; $14.9 billion in commitments to owner occupiers (ex-refinances), $6.3 billion for owner occupier refinances and $10.7 billion for investors. Investor housing finance commitments were the only one of these categories to record a fall over the month. Compared to their historic monthly peaks, owner occupier (ex-refinance) commitments are -1.8% lower than their peak in November 2017, owner occupier refinances are -13.1% lower than their peak in December 2015 and investor commitments are down -27.5% from their peak in April 2015.
Focussing on the two major sources of demand (owner occupier ex-refinances and investors) it is interesting to go back and look at what has happened during other recent periods of lending contraction.
For owner occupier (ex-refinance) housing finance commitments, the value of lending fell by the following percentages during the following periods:
- From April 1994 to April 1995 lending fell -29.4% (cash rate moved from 4.75% to 7.5%)
- From February 2000 to October 2000 lending fell -25.9% (cash rate moved from 5.5% to 6.25%)
- From September 2003 to January 2004 lending fell -15.8% (cash rate moved from 5.0% to 5.25% while Sydney and Melbourne housing markets were starting to slow)
- From June 2007 to August 2008 lending fell -31.0% (cash rate rose from 6.25% to 7.25%)
- From September 2009 to March 2012 lending fell -27.9% (cash rate rose from 3.0% to 4.25%)
Looking at investors, the value of lending fell by the following percentages during the following periods:
- From January 2000 to October 2000 lending fell by -33.0% (cash rate moved from 5.0% to 6.25%)
- From October 2003 to June 2004 lending fell by -27.3% (cash rate moved from 5.0% to 5.25% while Sydney and Melbourne housing markets were starting to slow)
- From June 2007 to February 2009 lending fell by -32.2% (cash fell rose from 6.25% to 3.25% but not before rising to 7.25%)
- From May 2010 to April 2011 lending fell by-16.8% (cash rate rose from 4.5% to 4.75%).
- Clearly there have been previous periods when credit dropped sharply and materially, however the current trend in credit is not as severe.
When analysing the current flows in credit data it is fair to say that there has been a credit crunch for investors but a credit crunch is not really evident for owner occupiers. Another point to consider for investors is that this cohort have been most active in Sydney and Melbourne; as values have begun to decline in these cities investor demand has waned and has not really increased elsewhere. What is unknown is whether it is market conditions that have led to the fall in in investor demand or is it the fall in investor demand that has led to the decline in values, in reality it is probably a combination of both.
While investor demand could be characterised as experiencing a crunch at the moment, owner occupier demand, for now, remains quite solid. Keep in mind that in terms of outstanding credit to lenders, owner occupiers account for 66.5% so a crunch in investor demand has less of an impact on overall credit demand than a crunch in owner occupier demand does. Nevertheless, the expectation is that dwelling values in Sydney and Melbourne will continue to fall over the coming months which will continue to place downwards pressure on the headline growth rates, given the significant weighting applied to Sydney and Melbourne due to the larger number of dwellings in these cities. Given this, the overall value of housing finance commitments is anticipated to fall and the expansion in housing credit will likely continue to slow.