WEEKLY E-MAIL

14 November 2017

AUSTRALIA WATCHES CLOSELY AS CANADA TIGHTENS LENDING STANDARDS

By James Milliaros

Canada recently introduced additional macro-prudential measures for the overheated property sector. These are likely to have a material impact on mortgage pricing, housing affordability and property price growth in 2018. The hottest property markets in Canada – Vancouver and Toronto – are likely to be hit the hardest by these measures.

Like Canada, additional macro-prudential measures have been introduced in Australia this year, aimed at slowing investor and interest-only lending. While announced measures have already had an impact, the long term efficacy of macro-prudential controls remains unclear.

With household debt sitting at record highs, the Reserve Bank of Australia (RBA) is also facing a higher than normal degree of uncertainty about how consumer spending may respond to slowing house price growth. Monetary policy in expected to be tightened sometime in 2018, but like Canada the RBA is expected to move very gradually and with a keen eye on housing and consumers.

Australia and Canada – house price growth

Canada is arguably further ahead in both its economic and policy cycles, suggesting that watching developments there may be useful for those monitoring the Australian economy.

The Canadian government has been tightening regulation around the property sector for nearly a decade, attempting to quell swelling house prices and improve the quality of lending. They have been targeting loan to value ratios, debt servicing criteria and the quality of credit.

Most of these measures have been directed towards the “insured” mortgage market, leaving “uninsured” mortgages able to evade many of the rules – an insured mortgage has a loan to value ratio of greater than 80% (a “high-ratio” mortgage) and an uninsured mortgage has a loan to value ratio of less than 80% (a “low-ratio” mortgage).

The growth of the uninsured, low-ratio, residential mortgage market has been very strong since 2010 with average annual growth rate of 10.6% – this compares to the insured, high-ratio, mortgage growth of only 1.5% per annum since 2013. Uninsured mortgages make up roughly 46% of the market or nearly 26% of Canada’s GDP, so they are important in the scheme if things.

Under the new regulations both insured and uninsured mortgages will be subject to debt-servicing criteria, where previously only insured mortgages were subject to the stricter requirements to qualify for government insurance. The new regulations, which will come into effect on 1 January 2018, require uninsured mortgages to also pass debt servicing ratios at the prevailing interest rate +2%.

Purchasing power is set to diminish under the new regulations, which is likely to weigh heavily on house prices. Introducing an across the board +2% interest rate debt servicing ratio will most likely cause the maximum home value that a household could purchase drop by more than 10%. In cases where households are also servicing car loans and credit cards, this value could drop even further.

While there are some clear differences in the structure of the marketplace and regulation (such as the prevalence of variable rate mortgages in Australia) to Canada, we face similar issues around housing affordability, foreign investor purchases and financial stability.

One implication of slower house price growth that bears careful monitoring is the impact on the consumers. In Canada, housing related purchases have begun to slow, suggesting that consumption is vulnerable to expectations of slower house price growth. The BoC recently reported that the new macro-prudential measures “are expected to subtract 0.2% off the level of GDP by 2019”.

Although wage growth has picked up recently in Canada, it has been running below consumption growth for the better part of two years and therefore it is likely that private consumption growth will slow, unless there is a material pick-up in wage growth.

In Australia, private consumption is also a key risk to the economic outlook. Household leverage is at record highs, indeed household debt is almost 200% of disposable income. Moreover, consumption growth has been running faster than income growth, an imbalance which arguably needs to recalibrate in the face of low wage growth, sharp price rises for a several non-discretionary expenses (such as electricity and gas) and, of course, weaker house price growth.

It will be interesting to monitor how Canadian consumers fare in the face of slowing property prices and higher interest rates, issues that Australia will most likely face in the near future.

James Malliaros
Senior Financial Planner
SMSF Specialist Advisor™
Authorised Representative No. 291633

If you have any questions or comments, please email me at james@gfmwealth.com.au

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