Future of the housing bubble goes to court

Via the ABC:

Westpac and the corporate regulator have returned to court for the first day of a potential eight-day hearing on responsible lending, which could have wide ramifications for other banks and the home loan market.

The Australian Securities and Investments Commission (ASIC) accused Westpac of breaking the law when it approved loans using the Household Expenditure Measure (HEM) — a relatively low estimate of basic living expenses — rather than customers’ actual declared living costs in its automated loan approval system.

The regulator also alleged Westpac failed to properly assess whether applicants could afford to repay interest-only loans after the loans switched to higher principal and interest repayments.

Both parties reached a settlement last year, with Westpac admitting it breached the National Consumer Credit Protection Act and agreeing to pay a record $35 million civil penalty.

But the Federal Court, in a highly unusual move, refused to approve the settlement, forcing both sides to re-litigate their case.

ASIC’s lawyers delivered their opening arguments today, saying Westpac breached the law in relation to 261,987 home loans approved through its automated system between December 2011 and March 2015.

Of those loans, 154,351 were interest-only.

And ASIC alleged that all uses of the HEM benchmark, instead of customers’ declared expenses, were a breach — not just the instances where customers’ declared expenses were higher than the benchmark and could have led to the loan not being approved.

The regulator also argued that all of the more-than-260,000 loans breached the law, regardless of whether customers’ declared expenses were above the benchmark or not, as use of the HEM did not count as a proper assessment as required under the Credit Act.

‘The elephant in the court room’

When he rejected the settlement in November, Justice Nye Perram’s main criticism was that ASIC and Westpac did not actually agree on how the law had been broken.

Specifically, both sides were unable to agree on how many breaches Westpac had committed, and failed to adequately explain why the $35 million penalty was appropriate.

“Admirable ingenuity has been applied by the parties’ advisers to the task of drafting the consent orders so as to gloss over the very real differences which exist between them,” Justice Perram said in his decision.

“The court should not be expected to approve a (record) penalty without being told why the HEM benchmark was used by [Westpac] in preference to declared living expenses.

In the ultimately rejected settlement, Westpac had admitted that about 100,000 loans used the HEM in instances where customers’ living expenses were higher than the benchmark, or incorrectly assessed interest-only repayments.

Of those 100,000, Westpac agreed it should not have automatically approved 10,500 loans, which should have instead been referred for manual assessment.

While the regulator acknowledged Westpac did gather other information about a customer’s expenses and financial situation during the period, it said it did not count as a proper assessment, as it was only the HEM that was used in the automated calculation of whether a customer could service a loan.

Delivering the bank’s opening arguments, Westpac’s lawyer said ASIC’s case was based on a “19th-century” notion of loan assessments being a simple formula of income minus expenses and argued that the bank’s “21st-century” assessment system was more complex.

Westpac also argued that for 80 per cent of the 261,000-odd loans, the customer’s declared expenses were lower than the HEM benchmark, meaning the loans would have been even more likely to be approved if HEM was not used.

The hearing is scheduled to run until mid next week.

More at the AFR:


Justice Nye Perram asked whether the HEM benchmark can be used to pinpoint where customers might encounter financial hardship, because some customers might be able to cut back on non-essential items such as holidays in exotic resorts and business class flights in order to make mortgage repayments.

…However, Mr Clarke said the HEM benchmark was an “generic figure” that did not take into account individual circumstances.

…He said the HEM was a frugal measure. He said the HEM benchmark for a family with two dependents was “extraordinarily similar” to the Henderson Poverty Line, which estimates the expenses of households living in poverty.

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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