3 Ways APRA Can Slow Down the Real Estate Market

Reports are already rolling in on our forum from investors finding it more difficult to qualify for investment loans. So what’s changed?

The Australian Prudential Regulation Authority (APRA) is an independent government agency that oversees banks, other bank-like deposit-taking institutions, insurance companies and superannuation funds. It’s been around since 1998 for the purpose of holding the financial services industry accountable.

While the stated objectives of APRA are to protect Australia’s depositors, insurance policyholders and superannuation fund members, the truth is, APRA is a source of significant power for the government.

In short, by enforcing certain requirements upon banks, the government can work through APRA to speed up or slow down the supply of money, in the form of credit, into the economy.

In many nations, this power is in the hands of the central bank, but the RBA surrendered their bank-oversight authority to APRA when it was established. Nonetheless, these two regulatory agencies continue to work closely together.

One Big Happy Regulatory Family

On the record, an independent board determines APRA’s policies without direct oversight from a government department. But the Treasurer appoints this board and communicates regularly with the members. In fact, all of our financial regulatory agencies – the RBA, APRA, ASIC and the Treasury – are all in bed together through a council that meets at least every three months.

As if the bed wasn’t crowded enough, you can also add the International Monetary Fund (IMF) to the party. The IMF was started in 1945 to foster global growth and economic stability. But since the economic crisis of 2007 to 2008, this international organisation has increased in influence, acting more like a global financial authority. This power, resting in the hands of a relatively small number of unelected officials, may be a worthy topic for a future article.

Just last month, Treasurer Joe Hockey and RBA Governor Glenn Stevens caught up in Washington with an IMF official to discuss our current predicament.

As I mentioned here, the RBA has been seeking to boost our economy by devaluing the Aussie dollar, an outcome that’s easy enough to achieve by lowering interest rates. But property investors keep spoiling Glenn’s plans by accessing cheap credit to buy houses.

So to breathe life into the economy without also ballooning property values, Glenn will need a little love from Joe. The Treasurer has two ways he can help. He can change some tax laws to disincentivise property investors – think negative gearing or CGT – or he can use APRA to force banks to slow down the flow of credit. Actually, there is a third option – he could do both.

But Joe will also need a little love from the IMF, because no matter what Joe does, it will probably upset some people. If you’ve heard Steve McKnight teach on negotiation, you’ll recall his “blame the absent third party” principle. If you’re an elected politician who needs to make an unpopular decision, who better to blame than the world authority on money and economics?

It just so happens that the IMF has already been talking about our predicament in its most recent Regional Economic Outlook. On page 28 of their report, they suggest “greater reliance on macroprudential policies may be needed… To avert overheating or overinvestment in real estate.” They even bring up the Holy Grail that Tony Abbot promised wouldn’t be touched, “eliminating the preferential tax treatment of real estate.”

Expect to hear more about the IMF in the coming weeks. From June 11 to 25, IMF officials will be in Australia for an annual examination of the local economy.

A Lesson From New Zealand

Aussies aren’t the only ones that the IMF has been advising. The world economic regulators have been encouraging New Zealand to step up macroprudential controls for the past few years.

The RBA’s trans-Tasman counterpart, the Reserve Bank of New Zealand (RBNZ) doesn’t need an APRA to slow down the flow of money into real estate. There, the regulation of banks still lies with the central bank.

As Steve McKnight wrote about here, the RBNZ has already taken action to slow the home price momentum of Auckland property, which has spiked 17 percent in the last 12 months. No doubt, if Treasurer Joe Hockey needs to dip into his bag of tricks, he’ll want to be able to point to the Kiwi’s macroprudential successes.

APRA’s Power to Manipulate the Real Estate Market

While APRA should not technically be motivated by a desire to devalue property prices, it is tasked with preventing banks from taking on excessive risk. Regardless, the current lending environment gives ample opportunity to paint a picture of concern.

According to APRA’s most recent figures, investor lending is rising at close to 11 percent a year. They’d like to see a growth rate no higher than 10 percent. We shouldn’t be surprised if they adjust this target down in the coming months.

Bank chiefs have ensured us all that they are taking steps to cool things off, but regulators are not waiting to see what happens. APRA is already putting pressure on lenders to slow the growth of their investor business.

This is just the beginning. According to John Symond, the founder and chairman of Aussie Home Loans, available funds will be cut back “by at least a third” within weeks.

How exactly will APRA slow down the flow of credit into real estate? Here are three likely scenarios:

1. Loan-to-Valuation Caps

Bankwest has already imposed a loan-to-valuation ratio (LVR) cap of 80 percent on investor mortgages. This means that property investors will need to pony up more cash, in this case 20 percent of the purchase price of the property.

As cash is a significant constraint for property investors, the greater the required cash to get into the deal, the smaller the number of potential investors there will be in the market.

Do not be surprised if APRA places this same 80 percent restriction on all banks in the near future, at least for property purchases in Sydney, and possibly Melbourne. And if that doesn’t produce the desired goal, or if the RBA lowers its target cash rate again, the restriction could go to 70 percent.

2. Debt-Service-to-Income Ceilings

Lenders obviously want to make sure that borrowers can repay their loans. This is why they look at the amount of debt a potential borrower is already carrying, versus the income available to make the debt repayments.

They set an in-house ceiling or required ratio that becomes their objective standard for determining whether one can afford to borrow or not.

Banks set varying required ratios of debt to income, but APRA has the power to force lenders to change their standards, making it more difficult for investors to qualify for loans. This, in turn, could slow down the flow of money from lenders into the real estate market.

ANZ and NAB have both announced that they will no longer offer interest rate discounts to new property investor borrowers.

Westpac has also said it is now applying tougher tests to new investor clients when considering the impact of future interest rate rises. All of these, in effect, impact borrower serviceability, making it more difficult for them to qualify.

These debt-service-to-income controls have one advantage over LVR caps. It’s possible that LVR restrictions may not limit borrowing in a rising market, because as house prices rise, borrowing can grow with it. But a debt-service-to-income ratio is not impacted by home values, potentially leading to a greater impact in the property market.

3. Higher Bank Capital Requirements

One way that APRA regulates the banking industry is through capital requirements. Banks must hold a certain amount of liquid assets as a buffer against the risks associated with their lending activities.

It’s not unlike the capital requirement the bank forces upon you when you want to borrow money from them to buy a property. The bank requires you to put up a certain amount of your own money. In the same way, APRA puts an LVR requirement of sorts upon lenders.

That way, APRA can force banks to take on less risk by increasing the amount of capital that they are required to hold. This means that there is less money to lend out to consumers, which slows the flow of money into real estate.

To get even more technical, APRA boosts capital requirements by adjusting the risk weightings for assets on a bank’s balance sheet.

Rather than having a static requirement for the amount of capital banks must hold, APRA requires a certain level of capital that is dependent upon the riskiness of the assets the bank holds.

While the money you borrow from a bank is considered a liability on your balance sheet, it’s considered an asset on the bank’s balance sheet.

An unsecured loan held by a bank would be weighted riskier than a mortgage loan that is secured by a house. Some mortgages may be weighted riskier than others, dependent upon the credit rating of the borrowers.

The higher the risk weight of the asset, the more capital APRA requires a bank to hold against that asset. By increasing the risk weight requirement, regulators can decrease the amount of money available to lend out, and thus diminish the flow of credit into real estate assets.

APRA chairman Wayne Byres has been saying for the last month that we can expect “higher, tougher capital requirements” to be enforced upon lenders, but we shouldn’t feel too sorry for the banks. While investors are now whining about banks requiring a 20 percent deposit, Westpac recently revealed it only holds “capital of 1.32 per cent” against $468 billion of home loans. To quote this Financial Review article, “Imagine how Westpac would react if you told them you could only provide a 1.3 per cent deposit for your home.”

Conclusion

There’s never been a more important time to keep yourself at the top of your investing game. We’re entering times when those who can only rely upon the opinions of so-called “professionals” may find themselves left behind. Before you buy, invest in your education.

By Jason Staggers

Jason was a personal mentor working with Steve McKnight's Property Apprentices. He helped hundreds of investors apply Steve's teachings in the real world and achieve greater results on their journey to financial freedom. Jason now lives in Perth, WA where he leads Neuma Church.