The chairman of the prudential regulator has called on the finance industry to “devote more effort to the collection of realistic living expense estimates from borrowers” and give “greater thought” to the construct and appropriate use of benchmarks.
Speaking at the Australian Securitisation Forum 2017 on Tuesday (21 November), the chairman of the Australian Prudential Regulation Authority said that the regulator had been “increasingly focused on actual lending practices” and “confirmed there is more to do… to improve serviceability measures, particularly in relation to the assessment of living expenses and the identification of a borrower’s existing debts” to ensure that borrowers can afford their mortgages.
Chairman Wayne Byres told delegates that it was “no secret” that the regulator had been “actively monitoring housing lending by the Australian banking sector over the past few years” in a bid to “reinforc[e] sound lending standards in the face of strong competition that… was producing an erosion in lending quality just at a time when standards should be going in the other direction”.
Noting that mortgages represent more than 60 per cent of total lending within the banking sector, My Byres said that APRA’s goal is to ensure that regulated lenders are “making sound credit decisions which are appropriate, individually and in aggregate, in the context of broader housing market and economic trends”.
The chairman said: “We have consistently called out a number of factors that are contributing to an environment of heightened risk, many of which have been with us for quite some time now. Household indebtedness is high; perhaps more importantly, the trajectory is clearly for it to rise further.”
Mr Byres pointed to figures that show that the housing debt-to-income ratio is near 200 per cent — an all-time high.
“This trend is underpinned by a sustained period of historically low interest rates, subdued income growth and high house prices,” Mr Byres warned. “Combined, they describe an environment in which lenders need to be vigilant to ensure that their policies and practices are both prudent and responsible.
“In short, heightened risk requires heightened vigilance: certainly by APRA, but also — and preferably — by lenders (and borrowers) themselves.”
The APRA chairman said that while APRA’s crackdown on interest-only loans has been helping moderate this type of lending, he warned that there were still metrics that continue to “track higher than [what] intuitively feels comfortable”.
Question of reliability of HEM as a ‘realistic’ benchmark
One such metric was non-performing loans, which Mr Byres said were growing at an overall rate that was “drifting up towards post-crisis highs, without any sign of crisis”.
As such, the regulator is paying “particular attention” to lending to those with a low net income surplus (NIS), those who are “vulnerable to shocks”. According to APRA, NIS lending relies on the lender’s assessment of the surplus income borrowers would likely have left over each month, after taking into account living expenses, debt repayments and adding in some buffers.
“Over recent years, we have been challenging lenders to ensure that their serviceability methodology is robust, and includes adequate conservatism to ensure that borrowers are not unduly exposed if their circumstances were to change,” the chairman said.
Mr Byres went on to state that while the upward trend in low NIS lending “appears to have moderated over the past few quarters”, there is still a “reasonable proportion of new borrowers [who] have limited surplus funds each month to cover unanticipated expenses or put aside as savings”.
He therefore highlighted that as measures of NIS are dependent on the quality of the lenders’ assessment of borrower living expenses, if those expenses are “understated”, then measures of NIS are “overstated”.
Touching on the fact that many banks use the Household Expenditure Measure (HEM) as a benchmark of living expenses, Mr Byres echoed thoughts from the broking industry that this benchmark actually paints a “modest level of weekly household expenditure”.
He called on lenders to do more to ascertain a borrower’s expenses, saying: “It is open to question whether, even if it is higher than a borrower’s own estimate, such a benchmark always provides a realistic assessment of a borrower’s genuine expenditure needs.
“From APRA’s perspective, we would like to see the industry devote more effort to the collection of realistic living expense estimates from borrowers and give greater thought to the appropriate use and construct of benchmarks in instances where those estimates are deemed insufficient.”
Several banks have already introduced tighter policies around expenditure, with AMP announcing that it would not progress loan applications if it did not include a new monthly living expenses form, which covers both basic living and discretionary living expenses.
The APRA chairman also called out the fact that there had only been a “slight moderation” in the proportion of borrowers being granted loans that represent more than six times their income (which would require borrowers to commit more than half of their net income to repayments if interest rates return to their long-term average of just over 7 per cent). He also warned that “high LTI lending is well north of what has been permitted in other jurisdictions grappling with high house prices and low interest rates, such as the UK and Ireland”.
Lastly, Mr Byres highlighted that while lenders utilise a loan-to-income ratio to understand the extent to which a borrower is leveraged, he said that this can be problematic as it does not capture a borrower’s total debt level.
He therefore outlined his belief that the introduction of mandatory comprehensive credit reporting (CCR) from next year will help “strengthen credit assessment and risk management” as it will enable lenders to see a borrower’s full financial commitments, including those from others financial institutions (which has previously been “something of a blind spot” for lenders).
The APRA chairman said: “[T]he government’s recent announcement of mandatory comprehensive credit reporting beginning from next year will facilitate a switch from LTI to debt-to-income (DTI) metrics and strengthen credit assessments and risk management. This will undoubtedly be a positive development for the quality of credit decisions.”
APRA will 'devote a large portion of supervisory resources to housing' in 2018
Mr Byres conceded that APRA has “certainly been more interventionist than [it]would normally wish to be”, but added that as risk within the lending environment has increased, he believed the regulator’s actions have “helped to strengthen lending standards to compensate”.
He said: “We will need to continue to devote a large portion of our supervisory resources to housing in 2018. The broader environment of high and rising leverage, encouraged by historically low interest rates, requires ongoing prudence. It is easy to run up debt, but far harder to pay it back down when circumstances change.
“It is in everyone’s long-term interest to maintain sound standards when times are good – that is, after all, when most bad loans are made. Moreover, sound lending standards are an essential foundation on which the health of the Australian financial system is built, regardless of whether the loans are held on balance sheet, or securitised and sold.”