APRA mandates 30% limit on interest only resi lending

The Australian Prudential Regulation Authority (APRA) is today initiating additional supervisory measures to reinforce sound residential mortgage lending practices in an environment of heightened risks.

The latest measures build on those communicated to authorised deposit-taking institutions (ADIs) in December 2014 aimed at improving the quality of new mortgage lending generally and moderating the growth of investor lending in particular. As was the case previously, these latest measures have been developed following discussions with other members of the Council of Financial Regulators (CFR).

Since December 2014, APRA, together with CFR members, has closely monitored residential mortgage lending trends and the resulting impacts on the resilience of lenders, as well as the household sector more broadly. This increased scrutiny has been in response to an environment of heightened risks, reflected in an environment of high housing prices, high and rising household indebtedness, subdued household income growth, historically low interest rates, and strong competitive pressures.

Given this environment, APRA has concluded that further steps to address risks that continue to build within the mortgage lending market are appropriate.

APRA has written to all ADIs today advising, in summary, that APRA expects ADIs to:

• limit the flow of new interest-only lending to 30% of total new residential mortgage lending, and within that:
  • place strict internal limits on the volume of interest-only lending at loan-to-value ratios (LVRs) above 80%; and
  • ensure there is strong scrutiny and justification of any instances of interest-only lending at an LVR above 90%;
• manage lending to investors in such a manner so as to comfortably remain below the previously advised benchmark of 10% growth;
• review and ensure that serviceability metrics, including interest rate and net income buffers, are set at appropriate levels for current conditions; and
• continue to restrain 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).

APRA chairman Wayne Byres said APRA believes the 10% benchmark for growth in lending to investors continues to provide an appropriate constraint in the current environment, balancing the need to continue to moderate new investor lending with the increasing supply of newly completed construction which must be absorbed in the year ahead.

“APRA expects ADIs to target a level of investor lending growth that allows them to comfortably manage normal monthly volatility in lending flows without exceeding this benchmark level.”

However, additional supervisory measures, particularly in relation to the high level of interest-only lending, are warranted. Byres said: “Our objective with these new measures is to ensure lenders are recognising the heightened risk in the lending environment, and that their lending standards and practices appropriately respond to these conditions.”

Mr Byres said lending on interest-only terms represents nearly 40% of the stock of residential mortgage lending by ADIs – a share that is quite high by international and historical standards.

“APRA views a higher proportion of interest-only lending in the current environment to be indicative of a higher risk profile. We will therefore be monitoring the share of interest-only lending within total new mortgage lending for each ADI, and will consider the need to impose additional requirements on an ADI when the proportion of new lending on interest-only terms exceeds 30% of total new mortgage lending.

“APRA has chosen not to set quantitative limits in relation to serviceability assessments at this point in time. However, APRA considers it important that borrowers retain some level of financial buffer to allow for unexpected events, especially for borrowers that have high levels of indebtedness.

“APRA will therefore continue to scrutinize serviceability assessments, and ADIs continue to need to advise APRA should they propose to change their existing methodologies or policies,” Byres said.

APRA has advised ADIs that it is also monitoring the growth in warehouse facilities provided by ADIs to other lenders. These facilities allow lenders to build a portfolio of loans that will eventually be securitised. “APRA would be concerned if these warehouse facilities were growing at a materially faster rate than an ADI’s own housing loan portfolio, or if lending standards for loans held within warehouses are of a materially lower quality than would be consistent with industry-wide sound practices,” Byres said.

He said that APRA also continues to monitor the prevalence of higher risk mortgage lending more generally, including lending at high loan-to-income ratios, lending at a high loan-to-valuation ratios, and lending at very long terms or with long interest only periods (eg beyond 5 years). 

APRA will continue to observe conditions in the residential mortgage lending market, and may adjust the above measures, or implement additional ones, should circumstances warrant it.