Mortgage rules, lending cyclicality and the housing market

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Yesterday’s data release by the Irish Banking and Payments Federation showed that lending increased dramatically in August when compared with the same period last year. This has been interpreted in some quarters as an indication that mortgage lending is growing robustly, despite the lending rules introduced by the Central Bank in early 2015. This view is mistaken. Instead, what we are seeing is a cyclicality being introduced to the lending market as a result of the Central Bank rules.

While mortgage approvals and values increased by 25.7% and 37.2% respectively in the three months to August 2016 vis-a-vis the same period last year, the year-to-date data shows that the volume and value of mortgage lending rose by just 0.7% and 5.5% respectively. The data therefore shows that the volume of lending has essentially remained unchanged this year while lending value growth is estimated to be approximately in line with the general residential market price growth for the year-to-date. This reality debunks the narrative of a recovering lending market with the August spike in lending instead reflective of a cyclicality that has been introduced to the Irish mortgage market as a consequence of the Central Bank lending rules.

In the presence of market expectations of rising prices, as is the case for the Irish market, lenders have the incentive to delay mortgage approvals until the latter half of the year so that they can lend at a higher average value than they would be able to earlier in the year when prices were lower. The other factor that may cause a spike towards the latter half of the year is the incentive for the banks to use-up before year end their 15%-20% discretionary control over the total value of mortgages issued for a calendar year which they can issue without being subject to the loan-to-value and loan-to-income constraints. Because total lending by a particular bank is only likely to become clear as the year-end approaches, much of these discretionary mortgage decisions are being delayed until the latter half of the year. This behavior introduces cyclicality to the market and adds a further complicating dynamic to an already extremely problematic housing market thus further exacerbating uncertainty.

There is no doubt that the Central Bank is in a very difficult position when it comes to the lending restrictions. On the one hand, it is keen to set stable market expectations by avoiding continual tweaking of the regulations, while on the other hand, it is being blamed by home buyers, sellers and builders for all the ills that have befallen the housing market. However, the noises coming from the Central Bank this week, indicating that the regulations will remain unchanged, runs counter to market expectations, where the consensus was that there would be some form of adjustment to reflect that such a restrictive counter cyclical policy may have been inappropriate for this stage of the housing recovery. Given Central Banks are masters at setting expectations, it should be recognised that the market, in the main, had expected a change of policy. The benefits of tweaking the rules slightly would be to lift a number of areas where construction is on the verge of being viable to a level whereby construction becomes economical and building can begin again.

Whether the measures even reduce the risk of the residential market to the banking system – their raison d’etre – is debatable. The reality is that the main housing bubble currently exists not in the ownership market but in the rental market, where rents in Dublin are now above pre-crisis peak levels but prices remain approximately 35% below peak on the ownership side. Such a bubble increases the percentage of household income spent on housing, weakening the strength of the household balance sheet and by extension, the banking system. Meanwhile, the lack of supply continues with 2,081 housing commencements in Dublin in the year to end of August, just two more than the 2,079 commenced at the same period this time last year and well below the 10,000 required annually to alleviate the housing shortage crisis.

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