Lenders point the finger at everyone else in the industry for poor practices, says APRA, but its research has indicated that they aren't all as prudent as they claim to be. Speaking at the recent Customer Owned Banking Association (COBA) CEO & Director Forum in Sydney, APRA Chairman, Wayne Byres, hinted at a lack of self awareness among authorised deposit taking institutions (ADI).
"One of the interesting challenges of assessing serviceability practices has been that, just as the vast majority of motor vehicle drivers believe they are above average in driving ability, ADIs invariably claim their lending standards are at the more conservative end of the spectrum, and that it is their competitors that are the source of poor practices," he said.
"As with everyone claiming to be an above-average driver, not every ADI can be right."
He explained that APRA recently conducted a hypothetical borrower survey to uncover the truth behind these claims.
The survey asked several of the larger mortgage lenders to provide serviceability assessments for four hypothetical borrowers: two owner-occupiers and two investors. And some of the results were concerning.
"The outcomes were quite enlightening for us, and, to be frank, a little disconcerting in places," he said. "It was not uncommon to find the most generous ADI was prepared to lend in the order of 50 per cent more than the most conservative ADI."
Risk assessment disparity
He said that APRA gained an insight into what the key differences are between lender risk assessments. Significant differences in the treatment of the borrower's living expenses, for example, was a cause for concern.
"As a regulator, it is hard to understand the rationale for large differences in what should be a relatively objective, and extremely critical, metric," said Byres. In some cases, he explained that credit assessments were based on living expenses that were lower than those declared by the borrower.
"That is obviously a practice that should not continue, and ADIs should be making reasonable inquiries about a borrower’s living expenses," he said.
"In fact, best practice – and intuition – would be to apply minimum living expense assumptions that increase with borrower incomes." APRA found, however, that this best practice was only adopted by a minority of ADIs.
Byres said that there was also a worrying absence of 'haircutting' of the more unreliable income sources, such as bonuses, overtime and investment earnings.
"Common sense would suggest it is prudent to apply a discount or haircut to these types of income, reflecting the fact they are often less reliable means of meeting regular loan repayments," he said. "Unfortunately, common sense was sometimes absent."
Haircuts also fell short in some cases when it came to declared rental income on an investment property. Byres noted that the industry norm appears to be to apply a 20 per cent haircut on this type of income, but that some ADIs based their serviceability assessment on smaller haircuts – or none at all.
Even those ADIs that subscribed to the 20 per cent norm weren't being particularly conservative, he said, given that real estate fees, strata fees, rates and maintenance can easily account for a significant part of expected rental income before periods of vacancy are even taken into account.
"We also came across a few instances in which ADIs were relying on anticipated future tax benefits from negative gearing to get a borrower over the line for a mortgage," he added.
Byres also noted that there were variations in the size of interest rate buffers used by lenders – an issue that APRA had already flagged in its December letter to ADIs.
This issue was more pronounced in the investor lending space, he said, noting that all of the surveyed ADIs applied some form of buffer to new debts – but only about half did so for existing debts.
"I confess to struggling to see the logic of such an approach," he said. "After all, any rise in interest rates will at some point in time affect the borrower’s other debts just as they will for the new loan being sought."
The treatment of interest only loans also came under the APRA spotlight, with the survey examining how a borrower would be treated if they were seeking a 30-year loan, with the first years being interest only.
"Only a minority of surveyed ADIs calculated the ability to service principal and interest - P&I -repayments over the residual 25 year term," Byres explained.
"Despite the contractual terms, the majority assumed P&I repayments over the full 30-year term, and hence were able to inflate the hypothetical borrower’s apparent surplus income by, in our particular example, around five per cent."
He made it clear that Australia isn't facing a subprime situation, but that the hypothetical borrower exercise had shown that there were "clearly examples of practice that were less than prudent".
" As a result, we have shown ADIs that participated in the exercise how they compare to their peers and where their serviceability assessments could be strengthened," he said. "We expect to see changes to practices across a range of ADIs."
Robin Christie, firstname.lastname@example.org
May 15, 2015