If evidence of “mortgage mis-selling and irresponsible lending” is found during the royal commission, the banks could be subject to “very costly” class actions, researchers at an investment bank have warned.
In an Australian Banking Sector Update, UBS researchers Jonathan Mott and Rachel Bentvelzen welcomed the news that the first public hearing of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry will look at home lending.
At the commission’s initial hearing, held last week, senior counsel assisting Ms Rowena Orr QC, said that the focus for the first round of hearings will be on consumer lending and practices.
Ms Orr said: “The commission will hear evidence of events involving certain financial services entities in the context of home lending that suggest that consumers have not always enjoyed the right to be treated honestly and fairly when it comes to home loans.
“Some of these events may have involved breaches of the law, while others may have involved departures from community standards and expectations.”
Ms Orr continued: “Each of these events gives rise to important questions for consideration by the commission, not least of which are: how and why were such events permitted to occur and what steps, if any, were taken at the time or have since been taken in response to those events, including steps to ensure that they do not occur again.”
The analysts at UBS said that they believed mortgage lending was a “logical starting point” for the commission hearings “given the size and scale of the mortgage industry and its importance to the Australian economy”.
They highlighted several of UBS’ own (widely panned) reports that flagged concerns with mortgage lending practices, but they warned that “while it is difficult to predict the findings of the royal commission… this is a material risk point for the banks”.
“If the royal commission finds evidence of mortgage mis-selling and irresponsible lending, we believe it could potentially open the banks up to class actions,” the analysts warned.
While conceding that “such actions are very difficult to qualify”, it was noted that class actions could “potentially prove to be very costly” for the banks.
Indeed, several of the major banks have in the past year paid millions of dollars for bank errors, responsible lending breaches and mis-selling of products, including CBA’s $10 million fine for mis-selling consumer credit insurance on its loans and NAB’s $1.4 million refund to 966 home loan customers after it failed to properly set up mortgage offset accounts.
Further, the UBS analysts stated that the findings of the royal commission could also “lead to a further tightening of mortgage underwriting standards by the banks to ensure they fully comply with responsible lending requirements going forward”, which would also have material ramifications for the house market”.
The update concluded: “While we understand investor complacency into the potential lasting impact of the royal commission, especially following the 73 ongoing and completed inquiries and investigations into the banks since the financial crisis, we believe the royal commission is material and has the potential to have a meaningful impact on the future earnings outlook of the banks.”
According to the analysts, these risks could make it “hard for the Australian bank to outperform”, and UBS has therefore downgraded its share price targets across the major banks.
ANZ, NAB and Westpac have all been downgraded by 5 per cent, while CBA has been downgraded by 6 per cent.
This would make the new share price targets $78 for CBA, $31 for Westpac, $29 for ANZ and $27.50 for NAB.
“[T]he focus of the royal commission on responsible lending and mortgage mis-selling is extremely important,” the analysts said.
“We believe that if the royal commission finds the banks have not lent responsibly, this could potentially open the banks up to class actions which may have material consequences. However, following 73 investigations into the banks since the financial crisis, we can understand investor complacency into these risks.”
Concluding, the update said: “If investors believe the royal commission will have ‘more bark than bite’, then the banks appear fairly priced. However, if the housing market slows faster than anticipated or the royal commission leads to mis-selling class actions, then risks are skewed to the downside.
“We believe it will be hard for the Australian banks to outperform in this environment. We have downgraded our price targets across the major banks to incorporate the increasing risks.”