The Reserve Bank has revealed a funding squeeze on New Zealand's big four banks has frustrated attempts to ramp up housing supply in Auckland this year, and the squeeze is set to get worse before it gets better.
The bank regulator detailed in its half-yearly Financial Stability Report how a tightening of lending standards, higher mortgage rates and more cautious bankers had slowed mortgage lending over the last six months, particularly to the property developers that the Government and the Auckland Council are relying on to create the housing supply needed to fill a shortage estimated at over 40,000 and growing.
The irony is the Reserve Bank is at least partially responsible for the squeeze and deliberately set out to tighten standards and reduce risks for banks with its 40 percent deposit requirement for landlords last year. At the same, it has warned that housing supply is growing slower than population growth, and the resulting housing shortage is pumping up an already over-valued market to the point where a housing correction could worsen stress for heavily indebted new borrowers.
"They're on the horns of a dilemma," Finance Minister Steven Joyce remarked this afternoon when asked about the funding squeeze and the Reserve Bank's concerns about housing supply.
The sharp ends of those horns popped up in various places in the Reserve Bank's report, which it has to produce every six months to assess the stability of the banking and insurance systems, which it regulates.
Governor Graeme Wheeler reported that risks to the financial system had reduced in the last six months, in part because of the third round of Loan to Value Ratio controls that were introduced in the second half of last year. That change, along with a half a percentage point increase in mortgage rates, had reduced lending growth to households to around seven percent from around 10 percent.
He pointed to a variety of factors at play, including the need for banks to find more funding from household savers in New Zealand, and their worry that the sector is getting riskier.
"In light of the current funding environment and heightened risks in some sectors, some banks have tightened lending standards over the last six months," the RBNZ said in the report.
"In particular, banks are being more selective about their lending for residential property developments as capacity constraints in the construction industry and rising costs have contributed to increased credit risk in the sector," it said.
"This moderation in risk appetite for property development appears relatively measured, but may have broader implications for the level of residential construction activity in the economy."
Wheeler acknowledged in the news conference that home consent issuance in Auckland had slowed in recent months, but he said banks were telling him they were still approving quality developments. The trend for monthly consent issuance in Auckland has fallen 13 percent since September.
The irony for Wheeler was that he still sees housing supply as growing too slowly to keep up with demand. He referred to the need for around 13,000 extra homes to be built each year in Auckland, but said just over 10,000 were consented over the last year, adding to a shortage he said the Council had estimated at 25,000 to 35,000. The Independent Hearings Panel for the Auckland Unitary Plan estimated last year that the shortage was 40,000, and that Auckland needed to build 14,000 houses a year for the next 30 years to keep up with demand.
Wheeler pointed to the housing shortage in another warning about over-valued property in Auckland and the risk of a correction.
"While residential building activity has continued to increase, the rate of house building remains insufficient to meet rapid population growth and the existing housing shortage," he said.
"House prices remain elevated relative to incomes and rents, and any resurgence would be a concern."
Getting tighter and tighter
The Reserve Bank also detailed how the squeeze on lending is likely to continue, and could be further tightened if there was any sign of a resurgence in house prices.
It explained how bank lending had been growing faster than local term deposits over the last year, forcing the banks to go into overseas markets to borrow more.
However, banks are nearing their limits for overseas borrowing and therefore are having to compete harder for term deposits.
Increasing both term deposit and mortgage rates has the effect of encouraging more saving and discouraging borrowing, which in turn narrows that gap between deposits and lending. The gap between deposit growth and mortgage growth grew from $0.5 billion in March 2015 to an eight year high of $5.7 billion in the September quarter of 2016. It improved slightly to $4.7 billion in the December quarter of 2016.
The Reserve Bank noted that banks had increased their reliance on overseas borrowing in the last six months and would need to both encourage local term deposits and use more expensive long term wholesale borrowing overseas to keep within their Core Funding Ratio requirements. These were set by the Reserve Bank in 2010 to reduce banks' reliance on 'hot' short-term funds on overseas markets. These markets froze during the Global Financial Crisis in 2008 and 2009, forcing the Reserve Bank to lend the banks money.
These higher funding costs are likely to keep upward pressure on interest rates here, and thus make it harder for the buyers and developers of new homes to build new supply.
"Banks report they have tightened lending conditions across a number of sectors, which should help dampen credit growth," the Reserve Bank said, adding that some banks had hit their internal limits for offshore funding.
Another potential pressure on bank funding may come from the Reserve Bank itself through its current review of capital requirements. It has indicated it expected banks to hold more of their capital against all loans, which could increase funding costs and mortgage rates again.
Deputy Governor Grant Spencer later told a select committee that the bank's initial analysis of potential capital changes suggested it would not significantly increase costs, but he acknowledged any larger increase in capital requirements would increase costs.
A DTI limit would add to the squeeze
Elsewhere in the commentary around the report, the Reserve Bank confirmed it would soon send out a consultation document on a Debt to Income (DTI) limit tool. Wheeler said a document was sent to Joyce in the last week or two and was expected to be issued by Joyce publicly soon. Joyce later said he expected to release it within the next week or so.
The Reserve Bank repeated that even if it had the tool in its macro-prudential tool kit, it would not be using it at the moment, given a slowdown in Auckland's annual house price inflation rate from 18 percent eight months ago to minus two percent now.
The bank highlighted that more than 50 percent of new lending to rental property investors was still being done with a DTI of over five, while 42 percent of owner occupiers were borrowing more than five times income.
Wheeler and Spencer were wary of publicly setting a threshold for any DTI, but noted a British DTI tool was set at 4.5 times income. They said any DTI tool would be structured in a similar 'speed limit' way to the LVR limit. That means that banks would still be able to lend a certain percentage (say 15 percent) at above a threshold of, for example, 4.5.
Wheeler told the Finance and Expenditure Select Committee that the Reserve Bank wanted the DTI tool in its kit and any resurgence of house prices could prompt the bank to use it. He said the bank would use the DTI well before the house price inflation rate returned to 18 percent.