Macquarie Tightens Mortgage Underwriting Standards

From Australian Broker.

Macquarie Bank is about to bring in strict new credit rules forcing borrowers to disclose their household and discretionary spending in 12 different categories.

Fairfax Media reports that from today, borrowers will have to provide a detailed list of household expenditure including clothing, personal care, groceries, transport, utilities and other household rates.

Information about other expenses such as childcare, education, insurance, medical costs, investment property outlays, recreation and entertainment, telephone, internet and media streaming subscriptions will also be collected.

Applicants for interest-only loans will also have to supply a reason for the application and explain why they have opted for an interest-only loan as opposed to a principal and interest loan.

In processing these applications, brokers will also have to explain to borrowers how interest-only repayments work and what their impact is on principal and repayments once the interest-only term is finished.

New APRA guidance on lending will hurt home owners when it should be the banks

From The Conversation.

The Australian Prudential Regulation Authority (APRA) has moved away from its non-prescriptive “principles based” regulatory approach to a one size fits all explicit guidance but it doesn’t appear to be encouraging lenders to be more prudent.

The housing market may be getting away from APRA and the Reserve Bank of Australia (RBA). In late 2015, both regulators voiced concerns about the “horribly low” standards of the mortgage lending sector and the risks to financial stability. Even bankers are getting jittery.

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There has also been well-publicised problems with brokers originating dodgy mortgages that lenders have not picked up. In its existing guidance (which has not been changed in the latest version), APRA requires lenders to have all sorts of procedures to catch dodgy mortgage applications from brokers including procedures to verify the accuracy and completeness of provided information.

But APRA has not named and shamed the lenders who failed to catch dodgy mortgage applications, not imposed capital sanctions or reprimanded directors and management. It hasn’t required that lenders change their broker process.

What APRA is asking is that banks slug first time buyers even more. In the new rules, home buyers are now required to prove they can service a 7% mortgage interest rate on a loan to value ratio of less than 90% with less income being taken into account. This is on top of trying to save a deposit that is disappearing every day as house prices boom.

It is going to take a lot more than forgoing a few smashed avocado toasts to make up for the additional burden imposed by APRA.

There are a few important questions raised by APRA’s sudden conversion to pragmatic rather than purely principled regulation.

First, the numbers. Where did the 7% come from? APRA doesn’t disclose this, but in an era of almost zero interest rates, it’s big. And maybe in time, when the RBA announces its changes to interest rates, the 7% may be changed in-line and economists will begin to bet on whether it will go to 6.5% or 7.5%.

In looking at a borrower’s income, APRA notes that it is “prudent practice is to apply discounts of at least 20% on most types of non-salary income”. No explanation also on why this particular percent. It’s also not specific on what “most” means.

If banks are indeed lending imprudently surely the banks themselves should suffer. First by naming and shaming, then if necessary, requiring additional capital buffers, thus driving down dividends – a real market based solution.

APRA is changing the way it regulates

Throughout the turmoil of the global financial crisis and the regulatory mayhem that followed, APRA held fast to its “principles based” approach to regulation:

To be principles-based is to give emphasis to the achievement of sound prudential outcomes in setting regulatory requirements and expectations, without necessarily seeking to specify or prescribe the exact manner in which those outcomes must be achieved

In short, APRA lays out the high-level principles that it will use to supervise the banks and insurance companies that is responsible for, and then will check that those principles are being adhered to. It did not believe in a “one size fits all” approach.

But this week, there appears to have been a back-flip. In a consultation paper for an update to APRA’s guidance on mortgage lending, the regulator has been very specific indeed. It notes:

“Prudent serviceability policies should incorporate a minimum floor assessment interest rate of at least seven per cent.”

This very specific guidance replaces an earlier guidance that was more general. From a regulatory perspective, an important question is why abandon principles-based regulation? If it hasn’t worked in the past, then a rethink of the role and approach of prudential regulation is needed.

This has happened overseas, where the UK Financial Conduct Authority, while retaining 11 principles that firms should adhere to, has become much more intrusive. Unlike our regulators, the authority has even going so far as to impose massive fines for misconduct. It states:

“We also adopt a markets-focused approach to regulation, both in our work as a competition regulator and more broadly to deliver regulation that works with the market to improve consumer outcomes. Interventions at the market level are an effective and powerful way of tackling and mitigating problems across a large number of firms, which in turn benefits a large number of consumers.”

Rather than APRA slipping in such a major change like this latest one into a consultation paper, it might be appropriate to have a transparent debate about such a potentially significant change in prudential regulation in Australia.

Author: Pat McConnell, Honorary Fellow, Macquarie University Applied Finance Centre, Macquarie University

 

Risks within the housing and residential development markets remain elevated – APRA

APRA Chairman, Wayne Byres in his Opening statement to the Senate Economics Legislation Committee highlighted again the regulators views that there are elevated risks in the housing sector, despite tightening of underwriting rules in the past year. They are looking at additional ways to embed better and sticky lending standards into the banks. Some would say better late than never!

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Our supervisory work on housing lending standards continues. Given the environment of heightened risks, our objective has been to reinforce sound lending standards, particularly in relation to the manner in which lenders assess the capacity of borrowers to service their loans. Over the past year, we believe the industry has appreciably improved its lending standards. But risks within the housing and residential development markets remain elevated. We are therefore giving thought to how best to have improved standards firmly embedded into industry practice, such that they are not eroded away again over time.

He also discussed the risk culture information paper which we featured yesterday.

Earlier this week, APRA published an information paper on risk culture – a topic that we have given greater attention to over the past few years. The paper focusses, amongst other things, on how Boards of regulated institutions have gone about the task of assessing the risk culture within their organisations, given the introduction of specific prudential requirements in this area from January 2015. Assessing risk culture is no easy task. But, as the global financial crisis showed, if an organisation has a poor attitude to risk-taking and risk management, it can ultimately threaten an institution’s financial viability. So one of our key messages is the need for continued investment of time and attention by senior leaders on this issue.Just as regulated institutions will refine and improve their own practices, we will continue to refine our approach and methodologies for making assessments of risk culture within regulated institutions. We will also, in particular, be looking more closely at the influence of remuneration arrangements on that culture.

As the Committee knows well, there have been some serious allegations of inappropriate and unfair treatment of life insurance claimants by The Colonial Mutual Life Assurance Society Limited, trading as CommInsure. While ASIC has been dealing with the specific customer cases, APRA takes an interest in what these cases tell us about the strength of an institution’s governance, risk management and risk culture.Our work with CommInsure has targeted two main issues. First, APRA has engaged with the Board and senior management of CommInsure to gain assurance over the robustness and completeness of the independent reviews commissioned to investigate the allegations, and ensure to stakeholder and community expectations are considered through this process. We have also met with the whistleblower who brought the issues to light, and are considering whether the whistleblowing provisions in the Life Insurance Act designed to prevent the identification and victimisation of whistleblowers have been adhered to.

Earlier this year, APRA also wrote to the Boards of all active life insurers, as well as to a selection of superannuation trustees, seeking information on the effectiveness of their governance and oversight mechanisms for matters such as claims handling, benefit definitions, rejected claims and customer complaints. Based on the responses received, we issued a report last week identifying areas in which insurers and trustees can improve their management of life insurance claims.

APRA and ASIC have been working closely on all of these matters, which remain ongoing.

 

Canada Mortgage Rules a Step Toward Cooling Home Prices

Fitch Ratings says new Canadian Department of Finance mortgage rules to reduce speculation in residential real estate are a step toward cooling the housing market in major cities including Toronto and Vancouver. The new rules could result in improved credit quality in certain residential covered bond programs.

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The rules include applying an interest rate stress test for all insured mortgages starting on October 17; previously, this was only required for homebuyers with a down payment of less than 20% of the home purchase price or for mortgages of less than five years. Tightened mortgage insurance eligibility requirements for “low-ratio” mortgages – mortgages for less than 80% of a home’s purchase price – will also be applied from Nov. 30. The government has also proposed to no longer exempt non-residents from paying capital gains taxes on income from selling a property.

Fitch believes that the new measures may temper the housing market, especially in cities that are significantly overvalued. According to a Fitch study published earlier this year, home prices across Canada are estimated to be about 25% above their sustainable value with major regional variations.

The income tax rule change in particular should reduce housing demand from foreigners. In Vancouver, this will reinforce the effects of the 15% tax on foreign home purchases put in place by the British Columbia government in August. Data from the Real Estate Board of Greater Vancouver indicate that average sale prices of detached houses have already dropped by roughly 16%, led by higher priced properties.

The new mortgage insurance guidelines could improve portfolio credit quality in the Canadian registered covered bond programs. While insured mortgage loans are prohibited from securing this subsector of the covered bond market, changes to insured mortgage loan underwriting requirements could influence non-insured mortgage loan underwriting requirements. Any tightening of non-insured mortgage loan underwriting requirements would further help to cool the housing market and also help to address the concern of heightened borrower leverage.

Canadian Banks To Hold More Mortgage Loan Risk

Moody’s says Canada’s Department of Finance announced that it will launch a consultation process with market participants this fall on lender risk sharing, a policy that would require mortgage lenders to absorb a portion of loan losses on insured mortgages that default. Currently, banks are able to transfer virtually all of the risk of insured mortgages to mortgage insurers, and indirectly to taxpayers through a government guarantee.

Any changes to the provisions of mortgage insurance to impose risk sharing on mortgage lenders would be credit negative for Canada’s six large banks, which account for approximately 72% of mortgage lending in the country, because it would reduce their asset quality and risk-adjusted profitability. The six banks are The Toronto-Dominion Bank, Bank of Montreal, Bank of Nova Scotia, Canadian Imperial Bank of Commerce, Royal Bank of Canada and National Bank of Canada.

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The details of the Department of Finance’s plan have yet to be released, and it may be some time before they emerge. Possible approaches include imposing first-loss deductibles on banks, whereby the lender would be responsible for an initial portion of the loss, with the insurer only bearing losses beyond that deductible amount. Another option would be to divide losses between the lender and insurer on a pro rata basis, or to charge the lender a fee for a defaulted mortgage. In any case, the concept of the lender retaining some risk on insured mortgages will support stability in the housing market in Canada by encouraging prudent underwriting standards.

Canadian banks’ high asset quality is largely the result of their significant holdings of government-insured residential mortgages, uninsured mortgages, securities, cash and deposits with financial institutions, which comprise about half the aggregate system’s balance sheet. Canadian mortgage portfolios and home equity lines of credit have performed well historically, owing to the high use (approximately 50%) of government backed mortgage insurance, and conservative underwriting practices. Government-supported insured mortgages make up 12% of total assets. This insurance is primarily sold either directly to the borrower, who is legally required under Canada’s Bank Act to obtain insurance if the loan-to-value of the mortgage exceeds 80%, or is held by the lenders themselves on a portfolio basis as a liquidity and capital management tool.

Canadian banks currently make a solid margin on insured mortgages for which they bear no risk and have no regulatory capital requirements. Under any risk-sharing arrangement, depending on the degree of loss shared and any offsetting concession on insurance premiums paid, profitability on a significant asset class will change. On balance, we expect that risk-adjusted profitability will decline, although a detailed analysis at this point is not possible.

Lending changes make property more attractive for SME owners

From Australian Broker.

Lending changes by Australia’s major banks could soon result in a surge of property purchases by small and medium-sized enterprise (SME) owners.

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Westpac this week announced they would increase their loan to value ratio (LVR) from 80% to 90% of a property’s value self-employed borrowers after the Commonwealth Bank announced similar changes earlier this year.

The last 12 months have also seen Westpac, CBA and St. George announce they would only require one year of financial records as income verification for self-employed borrowers. Previously they had required two years of financial records and tax returns.

Joel Wyld, director of mortgage broker Peasy, said the lending changes indicate lenders’ perceptions of SME borrowers are evolving.

“In the past banks have viewed the SME demographic as risky despite many owners coming from strong corporate or trades backgrounds with a long successful working history in addition to strong equity in various investment classes,” Wyld said.

“In the past, many SME owners have had to settle for low doc loans for a two year period which has deterred them from purchasing property,” he said.

While some of the lending changes have been in force for some time, Wyld said a large number of SME owners are unaware of the more lenient lending criteria and with more than two million SME owners across Australia it could provide brokers with an excellent opportunity to extend their client base.

“The time is now ripe for SME owners to capitalise on the new lending rules to secure either a dream home or business premises,” he said.

“The number one piece of advice given to SME owners when applying for a property loan is to ensure financials are up-to-date. Inaccuracies in financial records and book keeping will delay the settlement process and could ultimately determine if the loan application is accepted or declined.”

Wyld said there has also been a growing trend towards establishing property trusts and partnerships using property as vehicle for SME owners, though he said while those structures have a place in the market, brokers need to be careful when assessing income of a business if multiple owners are involved and should recommend those involved seek legal advice.

APRA Releases Draft Prudential Practice Guide On Residential Mortgage Lending

APRA has today released today released a draft Prudential Practice Guide 223 Residential Mortgage Lending that provides guidance to authorised deposit-taking institutions (ADIs) on sound risk management practices for residential mortgage lending, including owner-occupied and investment properties. This provide guidance on APRA’s view of sound practice in particular areas and frequently discuss legal requirements from legislation, regulations or APRA’s prudential standards, but do not themselves create enforceable requirements.

According to APRA, this PPG aims to outline prudent practices in the management of risks arising from lending secured by mortgages over residential properties, including owner-occupied and investment properties. It applies to authorised deposit-taking institutions (ADIs) as well as to other APRA-regulated institutions that may have exposures to residential mortgages. This PPG summarises prudent lending practices in residential mortgage lending in Australia, including the need to address credit risk within the ADI’s risk management framework, sound loan origination criteria, appropriate security valuation practices, the management of hardship loans and a robust stress-testing framework.

Interestingly, it underscores the responsibilities of an ADI Board:

“Where residential mortgage lending forms a material proportion of an ADI’s lending portfolio and therefore a risk that may have a material impact on the ADI, APRA expects that the Board would take reasonable steps to satisfy itself about the level of risk in the ADI’s residential mortgage lending portfolio and the effectiveness of its risk management framework. This would, at the very least, include:
(a) specifically addressing residential mortgage lending in the ADI’s risk appetite, risk management strategy and business plans;
(b) seeking assurances from senior management that the approved risk appetite is communicated to relevant persons involved in residential mortgage lending and is appropriately reflected in the ADI’s policies and procedures; and
(c) seeking assurances from senior management that there is a robust management information and monitoring system in place that:
(i) tracks material risks against risk appetite;
(ii) provides periodic reporting on compliance with policies and procedures, reasons for significant breaches or material deviations and updates on actions being taken to rectify breaches or deviations; and
(iii) provides accurate, timely and relevant information on the performance of the residential mortgage lending portfolio.”

ADI’s according to APRA require an overarching statement expressing the level of credit risk an ADI is willing to accept. They also highlight the necessity for processes relating to the oversight and review and supporting management information processes. I highlight a number of potentially significant observations:

  • A history of low defaults does not justify under-investment in management information systems.
  • MIS reporting needs to include exception reporting including overrides, key drivers for overrides and delinquency performance for loans approved by override, and reports on broker relationships and performance
  • In Australia, it is standard market practice to pay brokers either an upfront commission or a trailing commission, or both. Experience has shown that commissions paid upfront tend to encourage less rigorous attention to loan application quality. Trailing commissions are more likely to provide incentives for brokers to retain and monitor customers. A prudent approach to the use of third parties for residential mortgage lending would include appropriate compensation measures for brokers. Such measures include the ADI being able to end or claw back commissions where there are high levels of delinquency or process failures on loans originated by third parties.
  • Good practice would be for an ADI, rather than a third party, to perform income verification. However, if a third party does perform such a role, an ADI would be expected to implement appropriate oversight processes covering income verification.
  • When an ADI is increasing its residential mortgage lending at a rate materially faster than its competitors, either across the portfolio or in particular segments or geographies, a prudent Board would seek explanation as to why this is the case. Rapid relative growth could be due to an unintended deterioration in the ADI’s loan origination practices, in which case APRA expects that an ADI’s risk management framework would facilitate rapid and effective measures to mitigate any consequences.
  • Loan serviceability policies would include a set of consistent serviceability criteria across all mortgage products. A single set of serviceability criteria would promote consistency by applying the same interest rate buffers, serviceability calculation and override framework across different products offered by an ADI. Where an ADI uses different serviceability criteria for different products or across different ‘brands’, APRA expects the ADI to be able to articulate and be aware of commercial and other reasons for these differences, and any implications for the ADI’s risk profile and risk appetite.
  • A prudent ADI would include various buffers and adjustments in its serviceability assessment model to reflect potential increases in mortgage loan interest rates, increases in a borrower’s living expenses and decreases in the borrower’s income available to service the debt.  APRA’s expectation is that the combination of buffers and other adjustments in these models would seek to ensure that an individual borrower, and the portfolio in aggregate, would be able to absorb substantial stress, such as in an economic downturn, without producing unexpectedly high loan default losses for the lender.
  • Self-employed borrowers are generally more difficult to assess for borrowing capacity, as their income tends to be less certain. Accordingly, a prudent ADI would make reasonable inquiries and take reasonable steps to verify a self-employed borrower’s available income.
  • In the case of investment property, industry practice is to include expected rent on a residential property as part of a borrower’s income when making a loan origination decision. However, it would be prudent to make allowances to reflect periods of non-occupancy and other costs.
  • it would be prudent for an ADI to retain complete documentation of the information supporting a residential mortgage approval, including paper or digital copies of documentation on income and expenses and the steps taken to verify these items. This documentation would be retained for a reasonable number of years after origination.
  • There are varying industry practices with respect to defining, approving, reporting and monitoring overrides. APRA expects an ADI to have a framework that clearly defines overrides. For example, a sound framework may clarify that overrides include escalation to a higher delegated lending authority (DLA), where standard policy requirements are not being met in a loan application.
  • APRA expects that an ADI would only approve interest-only loans for owner-occupiers where there is a sound economic basis for such an arrangement and not based on inability of a borrower to qualify for a loan on a principal and interest basis.
  • APRA expects that an ADI will recognise, in its risk appetite, portfolio limits for loans that may be more vulnerable to serviceability stress and possible material decreases in property value in a housing market downturn, and may therefore generate higher losses.
  • Techniques such as desk-top assessments, kerbside valuations, automated valuation models (AVMs) and reviews of contracts of sale are all acceptable valuation assessments, in the appropriate context. As the risk associated with collateral increases, or the coverage of a given loan by collateral decreases, the need for specialist valuation also increases.
  • A prudent ADI would monitor exposures by LVR bands over time. Significant increases in high LVR lending would typically be a trigger for the Board and senior management to review risk targets and internal controls over high LVR lending. APRA has no formal definition for high LVR lending, but experience shows that LVRs above 90 per cent (including capitalised LMI premium or other fees) clearly expose an ADI to a higher risk of loss. Lending at low LVRs does not remove the need for an ADI to adhere to sound credit practice or consumer lending obligations.
  • APRA expects that an ADI, as part of its credit risk appetite framework, will define its approach to resolving troubled loans, both individually and under conditions where an unusually large number of borrowers are distressed at the same time.
  • In addition to enterprise-wide stress tests, portfolio-level and risk-specific stress tests of residential mortgage lending portfolios are considered good practice.
  • A prudent ADI would, notwithstanding the presence of LMI coverage, conduct its own due diligence, including comprehensive and independent assessment of a borrower’s capacity to repay, verification of minimum initial equity by borrowers, reasonable debt service coverage, and assessment of the value of the property. LMI is not an alternative to loan origination due diligence.

This document offers good advice to ADI’s and APRA’s stance is welcomed. From our industry experience, whilst many ADI’s will be mostly compliant, some of the smaller organisations, and non-banks would not be. We expect there will be some industry reaction, and we will be watching to see whether this changes lending habits in the market. The interesting question is, why has APRA issued these draft guidelines now? Is this a reaction to the recent warnings from the RBA, or are they aware of more specific risks and issues? Because supervision is not transparent, we probably won’t know. What we really need is public data by ADI as to level of compliance as highlighted by the recent Financial Stability Board review.

Mortgage Underwriting Disclosure in Australia

Often when we raise comparative issues between mortgage industry practices in Australia and overseas, we find that people leap to the defence of the Australian market, as world’s best practice. So today I wanted to highlight gaps which exist in the Australian market environment, and suggest that there is indeed room for improvement, according to recent global research.

To do this, I refer back to the Financial Stability Review documentation on mortgage industry practice. It is a valuable resource, containing peer review data and recommended best practices. One table in the Thematic Review of Mortgage Underwriting and Origination Practices from 18 March 2011 caught my attention.

“As the global crisis showed, the consequences of weak underwriting practices in one country can be transferred globally through securitisation of mortgages underwritten to weak standards. Thus, it is important to have sound residential mortgage underwriting practices at the point at which a mortgage loan is originally made. Internationally agreed principles that build on the Joint Forum recommendations could help to strengthen residential mortgage underwriting practices, and the peer review draws lessons from current practices to illustrate some potential principles that could guide future standard-setting. However, given that the underlying risks can differ across jurisdictions and within countries, the findings of the review suggest that such principles would best be high-level rather than aimed at detailed international standards”

On Annex B.7 page 64, they outline a review of data collection and disclosure practices across 23 countries, including Australia. Here is a summary version, from which I removed some of the less significant members:

Underwriting1The assessment covers the collection of relevant data, the disclosure of relevant data and the publication of relevant data for trend analysis. Australia seems to have s significant blind spot relating to underwriting practices. We do not collect data from lenders at a detailed level relating to underwriting practices; we do not disclose data on outstanding loans and credit portfolio performance, or credit risk portfolio data, and we do not publish trend data on underwriting practices. The UK, US and Japan have significantly more sophistication in their data capture and reporting, so why is Australia not doing the same?

Some will say, we do not need to, because our loss rates are low. Others will say its confidential data which the banks should not disclose because it would be commercial in confidence. I expect someone will also cite the cost of data collection. But I am left with the distinct impression there is a gap which should be filled, especially as we are seeing LVR’s rising, and the property market displaying bubble like behaviour.

One other insight relates to their views of sound practice, as outlined in the FSB report Principles of Sound Residential Mortgage Underwriting Pracitces 2012.

6.2  Jurisdictions  should  ensure  that  lenders  consider  more  conservative underwriting criteria to compensate for situations where the underlying risks are higher.  For example, more conservative underwriting standards (e.g. LTV ratios or servicing requirements) could be considered where:

  • there are considerable risks that an asset price bubble is building up in the property market as a whole or in specific segments or geographical areas;
  • the loan is in a market segment that, compared with other mortgage loans in that jurisdiction, tends to perform worse than average in a property downturn (depending on the jurisdiction, examples of such a market segment might include luxury apartments, buy-to-let investors, second homes, cash-out refinancers, etc.);
  • there is a lack of full recourse against borrowers; or
  • other aspects of the underwriting standards are looser than the typical setting in the jurisdiction.

I agree, so where are the local regulatory interventions in the current environment in Australia? Oh, I forget, the RBA says everything is fine!