In September’s bi-annual Financial Stability Review the RBA conceded that lending standards had been weaker than it had first envisaged, led by the prevalence of interest-only mortgages, along with poor documentation and verification:
…recent investigations by regulators have revealed that standards were somewhat weaker than had originally been thought. As a result, some borrowers have had less of a safety margin against unexpected falls in income, increases in expenses or increases in interest rates…
In some cases, practices have not met prudential expectations, potentially placing lenders at risk of breaching their responsible lending obligations under consumer protection laws. In particular, poor documentation and verification by lenders in many instances suggests that some borrowers may have been given interest-only loans that were not suitable for them. Serviceability assessments also seem to have been especially problematic…
The increased prevalence of interest-only lending has been a concern for regulators… Anecdotal information also suggests that some owner-occupier borrowers may be using interest-only loans as a means of affording a larger loan.
Shortly afterwards, Australian Prudential Regulatory Authority (APRA) head, Wayne Byres, gave testimony to the Senate Standing Committee on Economics in Canberra, whereby he admitted that APRA had acted too late in addressing lending standards, which in some cases had fallen to “horribly low” levels that lacked “common sense”.
Then in November, the Australian Securities and Investments Commission (ASIC) announced that it would launch a belated inquiry into the mortgage broking industry, which has accounted for the lion’s share of investor loans:
Assistant Treasurer Kelly O’Dwyer has written to ASIC commissioning the inquiry after the [mortgage broking] industry helped fuel a surge in investment property lending and booming house prices in Sydney and Melbourne…
ASIC has been asked to look into the ownership structure of the industry and remuneration offered by the big banks and smaller lenders.
It will also investigate the proportion of loans written by brokers to their owners versus those of other lenders.
And it will consider whether remuneration is paid in line with the loan amounts written…
Since announcing its inquiry, LF Economics’ detailed submission to the 2016 Parliamentary Inquiry into Penalties for White-Collar Crime has been released, which provides compelling evidence showing that Australia is a haven for white-collar criminality and control fraud.
In particular, this report found evidence of 21 Australian lending institutions and more than 1,000 examples of where people’s loan application forms had been fudged.
Now, The AFR is reporting that ASIC will seek data on banks’ payments to mortgage brokers in a bid to identify any wrongdoing and systemic risks:
Within the next fortnight, ASIC will send requests to 12 lenders, including the Big Four banks, requesting full details on the various payments that banks make to mortgage brokers, as it tries to assess how these incentives influence broker behaviour…
Mortgage brokers arrange more than half of all new home loans, and ASIC wants to determine how banks’ payments of commissions and other incentives affect outcomes for customers.
Alongside the up-front commission of about 0.65 per cent of a loan’s value and a trailing commission of 0.15 per cent a year until the loan ends, the watchdog is looking at other incentives, such as bonuses for writing a large number of loans with a certain bank.
Let’s recall the hedgie tour of Western Sydney brokers reported by Variant Perception:
One of the most popular programs in Australia last year was Struggle Street, a series about the poor Sydney neighbourhood of Mount Druitt. It beat other reality TV shows and was the most-watched show in Sydney. It depicted poverty, alcoholism and drugs. The show was condemned by some as “poverty porn” before the broadcast but received a strong response upon broadcast and trended on Twitter around the country. Prices in Mount Druitt are up over 50% since 2012 and in neighbouring Rooty Hill they are also up 50% since 2012.
In Australia, even the poor and drug-dependent can be property millionaires.
So how do people on modest incomes afford such expensive houses? Poor underwriting is the answer.
The Reserve Bank of Australia and the Australian Prudential Regulatory Authority (APRA) all insist that there are almost no low-doc or no-doc loans. They also insist there are few high loan-to-value ratio loans. The truth is much worse.
Underwriting standards are poor in banks. The regulators trust the big four banks’ statistics, but we’ve seen that underwriting standards are much worse than advertised.
In our due diligence, we told mortgage brokers and bank managers that we required a 95% loan-to-value mortgage at 10x our gross household income to buy our dream house, and we were consistently told it was not a problem at all. All we needed were two payslips and mortgage insurance. We asked if the bank would call our employer, and both reputable and disreputable brokers said banks rarely verified payslips. Also, “most of the people checking documents are in Indian call centres.” Furthermore, we were told that as long as the payslips had the right Australian Business Number (ABN) and the business checked out, that was enough.
This is not how it has to be. In the UK, for instance, after the credit crunch, banks are far more thorough when verifying income. The bank cross-checks payslips with one’s bank account to see the net amount received corresponds to the gross amount paid. A lengthy affordability questionnaire must be filled out to make sure that pay is sufficient to cover mortgage payments, that are also stress-tested for higher rates. Bonuses, once nonchalantly taken as regular income, are much more strictly dealt with. No-deposit and minimal-deposit loans are much rarer and harder to obtain. Similarly, the US has tightened lending standards since the financial crisis.
But in Australia, more alarmingly, we were informed from various sources that disreputable brokers had software to make authentic looking tax returns for clients who needed mortgages. We were encouraged to lie about our incomes by multiple brokers in order to get dodgy loans past bank loan officers.
It should come as no surprise that lending standards have fallen as third-party origination of mortgages has risen. This was typical of standards in the US in 2005-07. Today, almost half of new housing loans are originated by third parties.
But our biggest surprise came when we visited a building society (a thrift). The bank manager told us her lending standards were conservative compared to the big banks. She would check our income more thoroughly. She then encouraged us to take a 95% loan to value ratio at 10x our gross income because, “It isn’t worth saving another 5% when house prices will rise more than 5%. By the time you save the 5%, prices will rise exponentially.” Those were her words, not ours.
Needless to say, John Hempton of Bronte Capital and your dumbfounded analyst from Variant Perception wandered around Sydney in shock and amusement after every meeting.
ASIC’s moves are welcome, but all too little too late I’m afraid. The horse has already well and truly bolted and tightening up now will only be pro-cyclical to the downside.
