Here comes the mortgage standards tightening

Via the AFR:

From April 17, Westpac and its subsidiaries, BankSA, St George Bank and Bank of Melbourne, are increasing the number of expense categories from six to 13 to enable “more detailed conversations to better understand their financial situation”.

Customers will also have to produce more documentation with their local applications to support their stated outgoings and debts.

In addition, a ‘financial acknowledgment’ form the customer will be asked to sign that details their income, expenses and liabilities.

Mortgage brokers, who act as intermediaries between borrowers and the banks, are being asked to make detailed enquiries from their clients and capture the response.

They are also asked to provide “acceptable verification documents” for applicable outgoings and debts.

This is the thin end of the wedge if there was ever one. As UBS wrote this week about the consequences of the Royal Commission:

What could be the implications?

Mortgage (and other consumer credit product) underwriting standards in Australia seem to have been lax for some period of time. APRA is moving to tighten underwriting standards. However, given the evidence presented so far to the Royal Commission we believe there is a material way to go to ensure the banks fully comply with the National Credit Act regarding Responsible Lending. This is exacerbated by the rollout of Comprehensive Credit Reporting (CCR) which ensures all customer liabilities are disclosed to potential lenders (from 1 July 2018).

While a tightening of mortgage underwriting standards is prudent, especially as the banks move to fully complying with Responsible Lending, it has a material impact on the economy. It must be remembered that house prices are determined by the demand and supply of credit (not the demand for and supply of housing).

As a result we believe there are two potential scenarios

(1) As the banks tighten underwriting standards assessed household income is reduced. The banks will need to undertake more detailed analysis of customers’ individual living costs and the Household Expenditure Measure (HEM) benchmark is increased slowly over time. As the banks gradually move towards fully complying with the Responsible Lending laws the flow of credit is steadily constrained and the housing market slowly deflates;

(2) The Royal Commission sets a strict definition of the “reasonable inquiries” and lenders are required to immediately comply with Responsible Lending obligations (eliminating ‘predatory lending’). Income assessment is tightened, the banks are required to undertake a full review of each borrower’s living costs The back-up HEM benchmark is increased to realistic levels which borrowers could be expected to live off during the full life of the loan (including ‘lumpy’ items). This leads to a sharp reduction in the Net Income Surplus and false applications are largely eliminated. However, in this scenario fully complying with Responsible Lending laws would result in a sharp reduction in credit availability ie a ‘Credit Crunch’ especially for lower income households. RBA rate cuts would not help credit availability as borrowers are assessed using the 7.25% interest rate floor. This could potentially result in a significant economic downturn.

I still think we’ll see the easier scenario from our captured regulators. The open question is will they lose control of the process as markets take over? As Credit Suisse has been arguing:

AUD interbank credit spreads have widened very aggressively, and this widening cannot be explained by conventional macro factors. But we have looked at something unconventional – the excess of credit growth relative to banks’ reported lending standards. We find that when credit growth is excessive, interbank spreads tend to rise, presumably because excessive credit growth brings about default risks. And over the past few years, credit growth has been well ahead of our proprietary credit conditions index. Widening USD LIBOR-OIS spreads may not be systemic – but it is an open question as to whether widening AUD spreads might be.

Regardless of why credit spreads are widening, they are likely to have a negative impact on Australian growth via the cost, and availability of credit.

…This sort of macro environment carries with it de-leveraging risks. And de-leveraging risk undermines the efficacy of naïve value factors. Earnings, dividends and book values stop anchoring asset prices during de-leveraging episodes. Rather, asset prices drive fundamentals. Perversely, higher multiple stocks may actually do well to the extent that they carry strong quality, or defensive characteristics.

Either way points house prices down.

Houses and Holes
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  1. I remember growing up in the 80s and there were ads for home loans on the TV during the cricket. They universally featured an ecstatic happy couple waltzing around the bank manager’s office because they had been lucky enough to FINALLY get a home loan. Because (I presume) if you were the kind of person who needed a loan, loans were HARD TO GET.

    I was too young to know if the ads reflected reality. But maybe they were foretelling our coming future…!

    • To get a loan you once had to demonstrate some fiscal discipline. Nowadays, all you need is to do is demonstrate a willingness to throw the dice (and take the risk away from the banks).

      No doubt, after a very long time, and a trail of decimated bears made to look awfully stupid for pointing out Strayas bubble-singularity, the specufestors and the banks will burn.

      B U R N

      • Decimated? Why? Unless you actively short the market there is no reason to be decimated. Mind you, they are still holding auctions out there, so the number of potential buyers still exceeds the number of potential sellers. Still too early to short.

        It doesn’t cost you to remain on the sidelines.

      • Look how much debt the plonkers are supporting on their consumption asset, the family home.

        Imagine diverting a solid 10 per cent of income to principal repayments. To erase a $500.000 debt one would have to earn $5m.

        Wages are stagnant; rents are stagnant.

        The scale of the risk they are taking staggers me.

        Don’t Buy Now!

      • @David – you are right of course but up till now there has been no cost to being so reckless. Rising mortgage rates will take care of that in time soon enough, especially if you believe the narrative around conversion from teaser interest only mortgages to principal and interest.
        Bring the collapse on. It’s ruined this country, we need a societal reset.
        Edit: Under NO circumstances any bailouts!!

      • @travis

        “you are right of course but up till now there has been no cost to being so reckless”

        It is akin to keep flying in unmaintained aircraft because the tickets are offered for free. As the risk-takers brag about how many wonderful places in the world they have traveled for free, more and more will join them to take the same risks. And somewhere along the way the risks will be forgotten.

        There will be no cost to being reckless until there is. And by then it will be too late to avoid what comes next.

    • Why was it harder to get a home loan in the 1980s?

      Back in the “olden days” there was still a very good understanding of the economic significance of private bank credit creation. Not just in Australia but right around the globe. Those regulations reflected the understanding that how banks exercised their extraordinary privilege …extended by government….required very close and careful regulation.

      Rather than leave the banks free to create it for whatever purpose took their fancy and the fancies of their borrowers, regulations deliberately sought to encourage and discourage credit creation depending on the purpose.

      In Japan the banks were given credit creation quotas to ensure that some purposes….creating factories, industries etc had greater access to private bank credit creation while others like residential housing received less. Japanese home sizes reflected those policies.

      The combinations of deregulation…… abandoning that approach…. and changes to CGT policy by Howard effectively simultaneously boosted demand and supply of credit for residential housing.

      Accompanying the credit creation deregulation was the rise of the philosophy that the economy should be now driven on private bank credit … Monetary policy…. rather than fiscal policy.

      Exploding levels of household debt and asset price bubbles were to be expected though it took the cynicism of Howard and Costello to really put the process on booster rockets.

      In such a debt-ogenic environment is it really any surprise that all manner of sharp practices and dodgy dealings energed in the “credit creation process”.

      After all we are talking about a franchise to effectively create public money with a bailout on offer if you get too greedy.

      Is it really any surprise that immigration of fresh supplies of debt serfs and bodies needing housing would explode?

      This is all about the role of private banks.

      And don’t get conned by the private bank apologists. The banks have spent a fortune on minions and advertising spends to make sure the policies were adopted and maintained.

      • Yep, sums up my experience.

        We bought the “last of the affordable housing” pre-2000. As borrowers, even though we were young I still thought we ticked all the boxes – two stable, permanent jobs at the coalface of basic public service provision (education – the kind of jobs that don’t dissapear during a recession), good savings record, no bad credit etc. But we still had to virtually scrape and bow to every lender in the place until when we were at the point of despair, one finally agreed to extend us a loan of a size that would be considered pretty trivial by today’s standards.

        Yet just a few years later, it seemed that banks were just throwing swimming pools full of money at anybody with a heartbeat. And unsurprisingly, boom! went the price of housing.

        We were right on the cusp of the neo-liberal transformation of private debt substituting public money.

      • @lef-tee that’s exactly right… Loose credit is what has allowed a house price boom. Credit tightening is now happening because Chinese money is disappearing..

    • Banks don’t care because they will be bailed out by government if it all turns to shit! In the mean time let’s make those commissions and excessive bonuses!!!

  2. Tassie TomMEMBER

    “It must be remembered that house prices are determined by the demand and supply of credit (not the demand for and supply of housing).”

    Poor UE – he’s been telling us that the only factor pushing house prices up is immigration.

      • Probably, but lending standards would limit the amount of credit available to bid up the houses. If we could all only borrow $100,000 could Sydney’s median price reach $1,000,000?

        At the same time we have tens of thousands of houses and apartments sitting unused in the major cities due to tax incentives (it’s making money and there’s no disincentive like an effective LVT) and poor regulation of foreign purchasing.

      • Restrictive or inelastic land supply coupled with high immigration is the primary driver. Such asymmetry creates perceptions that land will be in short supply and hence incentives to land bank.

        Loose credit helps in multiplying the effect, but that cannot explain why house prices in Houston remained low with all the low-doc loans floating around before the GFC or why the local share prices do not blow out to comparable earnings multiples as the local residential properties.

      • “Restrictive or inelastic land supply coupled with high immigration is the primary driver. Such asymmetry creates perceptions that land will be in short supply and hence incentives to land bank.

        Loose credit helps in multiplying the effect, but that cannot explain why house prices in Houston remained low with all the low-doc loans floating around before the GFC or why the local share prices do not blow out to comparable earnings multiples as the local residential properties.”

        Agree that those are highly significant factors – but how does everybody bid up and then pay what they are unable to borrow?

        If you can’t borrow that much, then you can’t spend that much.

      • Adelaide, Perth, Darwin house prices have remained quite flat compared with Sydney and Melbourne and yet.. where do all the migrants go?

      • As I stated, the supply–demand imbalance is the primary cause. Easy credit is a secondary effect that amplifies the primary cause. The evidence is clear.

        It is said that 1/3 of Australian households are outfight owners, 1/3 are mortgaged and 1/3 are renters. The first 1/3 can use their equity in their PPOR to borrow. They can choose to use the borrowed money to buy investment properties or shares (or luxury cruise trips). Despite the abundance of credit, local shares haven’t regained the stratospheric valuations they achieved before the GFC – not even close. Shares are inelastic in supply, even more so than properties – corporations do not issue new shares just because their shares are in high demand (that is why perpetual booms and busts are the norm in share markets). But the presence of short sellers mitigates the temporary imbalance between the demand and the supply of shares at the margin – something property markets lack. The result is what you see today.

        And the prices of cruise trips?

        The same goes for Houston properties. Despite the abundance of credit, their prices remained low. The reason is that the imbalance between the demand and the supply of Houston properties was never out of whack.

      • You cannot have a housing bubble without loose credit, you can have a housing bubble without high immigration. Note that house prices are going down, not because of any non-existent cut in immigration, but because of a change in the credit environment. Credit is by FAR the biggest determinant in out of control house price inflation.

      • Spot on Brenton.

        Again, the factors mentioned by Dumpling are very important contributers to the overall mess but we should not overlook the fact that when a particular asset (thing, call it what you will) is broadly purchased very heavily if not almost entirely with credit, how far the price can expand is closely tied to how easy it is for everyone to obtain said credit.

        Just because an abundance of credit does not necessarily mean prices shoot up everywhere, that does not not mean that prices can simply inflate wildly as they have when credit is tight just because immigration may be high or zoning restrictions may be onerous.

        You cannot have runaway inflation in something if most buyers cannot access the money to feed it. Prices may go up because of forementioned factors but there are limits. That limit is how much more credit they can access in order to pay more.

        Way back when I bought, credit was bloody tough to obtain for John and Jane Average, certainly compared to today. Then I watched credit become much easier…..and prices went boom!

      • Or you can sell the country’s houses to lots of well-heeled foreigners who can afford to pay more than the average local, while denying that it is occurring.

      • Yep, so high demand via immigration will add some form of “floor” to prices falling, provided those immigrants have the money or credit.. It just so happens that Chinese folks migrant to wealthy suburbs (in Sydney and Melbourne) and were therefore pushing prices in those areas up, but without them being able to move money out (most can’t easily now) prices will collapse in those areas, to a point where locals who can obtain credit can afford it and wish to buy or are willing to buy.

      • @ Lef-tee

        I don’t think we are disagreeing.

        “how far the price can expand is closely tied to how easy it is for everyone to obtain said credit”

        Isn’t this precisely what I have been stating (multiply / amplify)?

        You must have supply / demand imbalance. Without it credit would have nothing to multiply / amplify.

        Prices of items whose supply is elastic (cruise tickets, SUVs, etc.) do not inflate no matter how much credit is available because any supply / demand imbalance will be promptly redressed. And nobody would try to “bank” cruise tickets or SUVs by outbidding each other because of the knowledge that any supply / demand imbalance of these items will be promptly redressed.

        In contrast, prices of rare collectibles, e.g., classic cars, arts, etc. can easily inflate for the same reason.

      • drsmithyMEMBER

        Phil used to post a couple of examples of countries with tight credit controls and property bubbles.

        From memory South Korea was one of them.

      • “Phil used to post a couple of examples of countries with tight credit controls and property bubbles.”

        drsmithy smoking crack on the the public dime (again).

        The chief determinant of housing bubbles is credit expansion, EVERY TIME. Looking for other bogeymen is pointless and demonstrates an extraordinary level of economic and financial illiteracy. Stick to commenting on something you actually know about … rather than commenting on something you THINK you know about.

        It is not possible to have a housing bubble without egregious credit expansion. Period.

    • Jeez. They are both factors Tom. If you want an excessive house price at auction, you need both an oversupply of bidders AND stupidly big loans.

      • As Jordan Peterson said to that idiotic Cathy woman from the BBC on a different subject, complex situations demand multivariate analysis.

      • The Traveling Wilbur


        A little programmatic specificity will do in a pinch if nothing else is available.

      • oversupply of bidders

        Bidders for much of the last 15 years have been specufestors. It has not been a shortage of dwellings, but a shortage of speculative assets; see rental yields.

      • drsmithyMEMBER

        As Jordan Peterson said to that idiotic Cathy woman from the BBC on a different subject, complex situations demand multivariate analysis.

        Any suggestion here that complex problems have complex causes generally attracts little more than abuse.

      • There can only be an oversupply of bidders IF there’s an oversupply of credit. One is contingent on the other.

        Exhibit A: only a few thousand Ferraris are sold every year here in Straya (maybe a few hundred) but the potential demand is much higher. If, as a Ferrari dealer, I were to advertise new Ferraris for the “price of a Holden (something or other)” there’d be queues round the block (multiple times) to buy one.

        The bottom line: demand is potentially infinite but is contained by affordability. When banks extend credit as loosely as they have done in recent times demand can certainly ‘look’ infinite.

    • FiftiesFibroShack

      Many factors at play. Credit demand and supply are the most significant, though what determines credit demand is complex.

    • Given the collective wisdom of MB, I find this whole debate about which single factor is responsible quite bewildering. Loose credit, corrupt regulators and pollies, tight supply, tax policies, nimbys, immigration, laundering, boomers — all these factors are responsible in different degrees, have affected different segments at different times. Both HnH and UE have countlessly commented on all of them. Frankly I find this discussion quite unhelpful.

      • Yep, just as there is no single solution there is no single cause. Some have a greater effect than others but merely doing one thing like reducing immigration, or introducing an LVT won’t fix Australia up.

    • demand (net +ve immigration and investors (domestic and international)) comes first and then supply (credit availability).
      No demand = no credit
      that is the way it works for pretty much ever commercial arrangement ever undertaken, witness street corner drug sales in the US as an example. No buyers means no sellers.
      So you are both right in an iterative way. Demand causes looser credit driving more demand driving even looser credit…….

  3. A la the UK…….after we destroy the federal budget for a generation by bailing out the banks during the crash, there will be a borrowing limit of 4.5 times income strictly verified. But we are too smart to do it beforehand in increments.

  4. How will new migrants be able to buy unless they have the cash or a big deposit? Will the government back off immigration…I think not. Is this just a smoke screen or will the banks really go ahead as their profitability relies on credit creation. What is the new source of revenue? Or does this mean they’ll scale back to be mainly online (few staff, and more AI = big cost cutting). Anyone in banking out there willing to make a comment?

    • not in banking but my view is spin off the regional banks they all acquired eg. Bank of Melbourne and St George (regional banking servicing more costly) and increase in all fees across the board. Increased streamlining e.g. closing of physical branches and continued removal of ATMs. Continued movement to everything online.
      Diversified ledger technology (eg. crypto currency advancement) a bigger risk to profits going forward, again in my view.

  5. Going to be fascinating to see how the authorities engineer credit growth in this environment. RBA, APRA et al must know they need it to be at a certain level of growth (6-8% p.a.?) to avoid a crunch in asset prices.

    And at the same time they need to tighten lending standards (or give the appearance of doing so) in response to the RC.

    Can they do both?

    • The Traveling Wilbur

      Rabbits. Hats. Super.

      It is all going to be appalling. And it’s already started with the 30% faster adds.

  6. The sanest way for the RBA/APRA to force this is to slowly reduce the maximum term on a mortgage.

    Who’s for 25year max?

    A Million dollar mortgage over:

    30yrs = 5430/m
    25yrs = 5905/m
    20yrs = 6655/m

    Those are some big numbers.

    For a more “middle class” loan of 500k you’re looking at

    • Jumping jack flash

      The 500K loan is still far too expensive when actual income and expenses are properly considered for the types of people who would take on this sized debt mountain.

      • I agree. It would certainly put the brakes on, wouldn’t it?

        Let’s go with median household wages of ~80k and a ~3.8 multiple = 300k

        30y=1629/m (19548/y)
        25=1722/m (20664/y)
        20=1997/m (23964/y)

      • @Myne – looks ways better to me… Sadly the punters have access to too much money and credit.

  7. kiwikarynMEMBER

    Demand and supply is a far bigger determinant of house prices than credit is. Compare Auckland and Christchurch. Credit is readily available in both cities, interest rates are the same for borrowers in both cities. Yet one has had a housing price boom of epic proportions while the other has had falling house prices. If price was solely (or even majority) determined by the availability of credit then every place on the planet would have had a house price boom. Clearly price booms are located in distinct pockets, and is not widespread. The reason house prices have fallen in Christchurch is because supply is overwhelming demand – and demand there lacks the immigration driver that Auckland has.

    • So when something is purchased almost entirely with credit, how does the price runaway wildly when credit is not readily available?

      • kiwikarynMEMBER

        If you had 100 houses and gave 100 people a 100% loan to buy them, would prices go up? What about if you had 100 houses and gave 200 people a 100% loan to buy them? Credit is not the problem, its too many people bidding against each other for too few houses that drives up prices.

      • Jesus kiwikaryn! You just disproved your own argument. 200 people wouldn’t be chasing 100 houses if they weren’t offered cheap, loose credit. It’s the credit that creates the demand in your example, leading to a bubble.

        Thanks for pointing it out so clearly.

      • I am afraid kiwikaryn’s example wasn’t a very good one. As I stated above with examples, the supply / demand imbalance is at the core of any bubble.

        Easy credit should actually prevent bubbles from forming in a properly functioning market because a progressively greater fraction of the new credit will be directed to increasing of the supply side (e.g., construction for residential property markets) as the prices go up. If anything, the time lag in the supply side of the equation should shorten and the elasticity increase with the easing of the credit. That the Australian housing market is not functioning properly cannot be attributed to the easy credit.

        Besides, credit is not an essential ingredient of a bubble. Many people here think that our housing market is in a bubble territory and crashing of the prices by 50% would bring it back to its fair value – so let’s use the definition of a bubble as an asset overpriced by 100% (twice the fair value).

        If you spend some time in a share market, you will notice that an illiquid stock is more susceptible to becoming a bubble than a liquid one – and the reason is clear. It does not take much money to push an illiquid stock to a bubble territory. Take BKL for example. There are only 17m shares in issue. It will be in short supply if everyone in Australia wants to own a single stock (not counting the super). Single stock costs about $130 today so you wouldn’t need any credit to buy one unless you are extremely poor.

        During the frenzy, many stocks fetched outrageous valuations that would make the valuations of Sydney residential properties look reasonable. A number of them were penny stocks with no revenue, no profit and no assets. Again, one would not need any credit to bid them up to a bubble territory.

      • @All – why don’t you change your thinking from everything occurs at once to iteration? If you do, you’ll find all circumstances raised by both sides can be accounted for. To get the ball rolling how about Higher demand (net+ve immigration plus investors both domestic and foreign) begets higher credit availability begets higher demand begets looser credit begets….
        That would explain Auckland (higher immigration and increased investors) to Christchurch (looser credit and no increase in immigration)
        In my view you are all trying to attribute to an independent variable ie. a starting point which you’ll never be able to do

      • @travis

        It is iterative and interactive.

        What credit does is to magnify / multiply / amplify. After all, there shouldn’t be any bubble if credit flows equally to both sides of a supply / demand equation. My above examples make this point abundantly clear. Credit flows to both sides of the equation for an SUV market whereas credit only flows to the demand side for a Picasso painting market (auction).

        In other words, the malfunctioning nature of the Australian housing market, which was previously hidden under the tight credit conditions, came to light after the asymmetric flow of money was magnified by the easy credit.

  8. Jumping jack flash

    We can only hope.

    When they start actually considering other risk metrics than LVR, that will be the clincher.