ASIC throws darts at the HEM bubble

Via The Australian comes further snippets of ASIC versus Westpac on responsible lending standards yesterday:

Jeremy Clarke SC, for ASIC, argued that from 2011 to 2015 Westpac didn’t make an adequate assessment of customers’ ability to repay mortgages when they changed from interest-only to principal and interest.

Westpac’s Robert Love, head of credit risk optimisation, admitted the bank had been an outlier in how it assessed those loans but noted the process had changed following an internal review.

Mr Clarke asserted that many bank customers used interest-only loans to accommodate other cash flows, such as buying furniture, and were extending the interest-only period because they couldn’t otherwise afford the loan repayments.

“It is a possibility, yes,” Mr Love said in response.

He added that almost a third of interest-only borrowers were less than one payment ahead on their mortgage, but that given interest rates were at historic lows, delinquencies weren’t dissimilar to those seen on principal and interest loans.

If that does comply with the law then it needs to change! More from Banking Day:

  • Around a third of interest-only mortgage customers at Westpac are as little as one month ahead with their loan repayments, Robert Love, head of credit optimisation for the bank told a Federal Court hearing in Sydney yesterday, The Australian reports. ASIC and Westpac have returned to court to try and resolve a responsible lending settlement that was thrown out of court last year. ASIC has amended its claim, and this week told the court the bank improperly relied on the HEM income measure more than 260,000 times.
  • “The amount of non-compliance, there was a real recognition, certainly at my bank, that there had to be a much, much greater focus on non-financial risk, on conduct risk as a subset of that, and on compliance,” Westpac chair Lindsay Maxsted told the Australian Council of Superannuation Investors conference in Melbourne yesterday. Cash earnings at Westpac fell 22 per cent to A$3.3 billion, the bank reported on Friday. The fall was almost entirely due to customer remediation and restructuring costs of $753 million.

No shit. This is a key moment as to whether the bubble keeps deflating or is allowed to return. As Endeavour Equities has pointed out:

1. Downgrading our outlook for residential property in 2019; expecting peak to trough falls of 25-30% – the worst since 1890.

i) We are downgrading our outlook for residential property in 2019 with peak to trough falls of 25-30% – the worst since 1890. We expect -10 to -15% % in 2019 in addition to falls of -15% in 2018.This means 2014 vintages will see significant losses while many from 2015, 2016 and 2017 will experience negative equity.

ii) Key insights from Endeavour’s 2018 Report “Credit Crunch 2018 as HEM/ NonPrime Bubble Busts” of June 2018 are driving credit and property prices into a major slump. The key revelation that emerged late 2018; all (or almost all) mortgages were based on the HEM as a default from 2012 to 2016, and this has driven a Non-Prime bubble in terms of DSTI ratios.

iii) The key driver of our current property price downgrade is the late 2018 revelation (ASIC vs Westpac) that Westpac and likely other ASX banks did not collect, or certainly did not input, actual borrower expenses into loan serviceability calculators. Instead they applied their own downwardly biased HEM expenses of $32k at all income levels as the default or policy driven input. This upwardly biased Debt Service to Income ratios by 10-15%+. We note ASIC has alleged that this has made all such loans irresponsible lending (all 260,000 mortgages written to 2016 in Westpac’s case).

iv) We expect a continuation of the 2018 Credit Crunch well into 2019 as the HEM/ non-prime bubble busts due to the combined impact of i) real expenses shifting sharply towards a ABS HES Survey reality and ii) amortization of Interest Only loans. Together these impacts are expected to hit loan borrow sizes for aggressively geared borrowers by 46%+, savaging borrowing capacity for the marginal price setter of housing in the boom to 2016 – the highly IO borrower using HEM expenses. The last phrase of this doesn’t make sense in the sentence

2. The size of the Credit Crunch will be directly proportional to the unreasonable of the HEM – very large!

i) The Size of the Credit Crunch is directly proportional to the unreasonableness of the HEM expenses benchmark. Since HEM expense estimates are unreasonably low, the credit crunch will be significant and ongoing as it is increasingly replaced with reasonable expenses that are consistent with Responsible Lending Laws.

ii) The Median Borrower on a HH income of $144k HEM understated expenses by $48k p.a. leading to loan sizes 30%+ or $380k larger than if HES based survey expenses were used. For the median debt which is owned by households on $180k+, the understatement of expenses is considerably larger – up to a total of $80k. This led to loan sizes $640k larger than if HES expenses had been used.

iii) Failure to amortize Interest Only Loans over the non IO periods in serviceability calculators has also inflated loan sizes 20-30%+


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