The country’s banking regulators have responded to the home price (and lending) boom of the last year or so by tightening criteria for borrowers and lenders, and forcing lenders to be tougher in assessing their customers.
The move comes after a year or more of warnings from the regulators (including the Reserve Bank) about easing lending standards in the $US1.3 trillion home lending market.
But regulators have refused to follow the lead from New Zealand where limits have been imposed on the ability of the banks to make riskier types of loans where the loan to valuation ratio is above 80%.
Instead regulators want Australia’s banks, especially the big four, to use far more information and pricing to lend money for home purchases or investment, as well as targeting the serviceability of the loans.
Mortgage lending accounts for more than half the credit exposure of the Australian banking system and regulators are insisting this concentration means lenders should pay particular attention to the home mortgage business.
Riskier types of home lending look like costing the bank or lender more in higher capital requirements, and the borrower faces higher interest rates and repayments (with built in safety buffers in the event of unemployment or a slowdown in the economy).
Home loan lenders (more than 180 of them in this country) face having to spend more time and effort on lending for home buying in Australia after draft rules tightening up controls in the fastest growing area of their business, were released yesterday by the country’s main bank regulator, APRA.
APRA is the Australian Prudential Regulation Authority. Several weeks ago we warned you that the group were on the brink of tightening home lending rules after extensive discussion with banks and other lenders.
Yesterday’s release of the tougher draft rules will be discussed with the industry until July.
To ensure lenders remained prudent (and do not incur losses), APRA has issued guidance on key aspects of mortgage lending, including its expectations of boards, remuneration, banks’ credit policies and stress testing.
The upshot of the proposed changes is that for many types of home loan products, costs will rise both for the lender and the borrower. Nothing is prohibited outright or restricted – pricing and tougher assessments of credit risk and serviceability will be used to make sure banks do not ease standards too far.
The costs of the new rules are likely to crimp both home lending for a while and costs for borrowers. There could be a long process of many newer loans being re-examined as well.
The upshot could be some further downward pressure on the net interest margins of the banks, especially the big four, while they adjust to the new, tougher regime for home lending.
Along with tougher capital rules, the new requirements for mortgage lending will see banks face further downward pressures on earnings for a while.
The new rules are in draft form and further discussions will be held with what are called Authorised Deposit Taking Institutions (or ADI’s) which are involved in home lending. Loans with high loan to valuation ratios haven’t been ruled out, but they too will be harder to get and more expensive for the borrower.
If these proposed changes are fully implemented, some forms of home lending could be made more tougher, and expensive. For example, reverse mortgages and home equity letters of credit look like becoming more expensive, as well as tougher to obtain (and more expensive for the borrower).
APRA wants lenders to be tougher in assessing loans generated by orginators, especially those outside their geographic area (such, for example, Suncorp’s Metway Bank selling home loans in Melbourne or Adelaide, or even Sydney, from its Brisbane base). Valuations and credit profiles of the intended borrower will be strengthened.
APRA’s about-to-retire chairman Dr John Laker said in a statement yesterday, "Credit standards in residential mortgage lending have been a major focus of APRA’s prudential supervision of ADIs, particularly in the current environment of strong pricing pressures in some housing markets and very active competition between lenders.
‘In this environment, APRA is seeing increasing evidence of lending with higher risk characteristics and it does not want this trend to continue. The draft prudential practice guide reinforces the importance of maintaining prudent lending standards when competitive pressures may tempt otherwise’, Dr Laker said.
The New Zealand Reserve Bank, that country’s banking regulator, imposed tighter restrictions on what are called high LVR loans – or home loans with lending to valuation ratios above 80%, because of the rapid growth in home loans, especially those with high LVRs.
It limited the amount of loans a bank can make with LVRs of 80% or more to 10% of a bank’s total lending instead of the 30% level they were running at.
The RBNZ now says that move has slowed the boom in home buying and lending in the UK (although the regulations had been eased to allow high LVR loans to continue to be made to finance home construction).
But Australia’s leading banking regulator has eschewed following the Kiwi central bank’s move and opted for a wider spread of measures to force lenders to take more time to assess loans, those borrowing them and the valuations involved.
"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," the regulator told banks and other lenders in yesterday’s document.
The regulators take aim at a number of areas – such as valuation methods, the use of top up deposits from family members, lenders mortgage insurance (LMI). APRA has urged ADI boards to make themselves fully informed about not only the big picture of home lending such as interest rates and amounts/volumes, but to make sure the bank has detailed micro data on markets, borrower types, market conditions (which could see LVRs change) and more.
The use of top up loan from family members will become tougher to incorporate into deposits for home loans – it could be a controversial point.
"A prudent ADI would have limited appetite for taking into account non-genuine savings, such as gifts from a family member. In such cases, it would be prudent for an ADI to take all reasonable steps to determine whether non- genuine savings are to be repaid by the borrower and, if so, to incorporate these repayments in the serviceability assessment," APRA told the ADIs.
Higher interest rate and serviceability buffers (tipped in our recent story), will be required over time by banks making home loans. And banks are warned against being complacent and looking to rising property prices to improve their position.
"A prudent ADI would exhibit greater caution when relying on collateral values in periods of rapid growth in property prices. It may be appropriate for an ADI to strengthen its LVR constraints or re-assess its risk appetite in markets exhibiting rapid price appreciation," APRA warned.
On loans with high LVRs in Australia, APRA said in yesterday’s document:
"Although mortgage lending risk cannot be fully mitigated through conservative LVRs, prudent LVR limits help to minimise the risk that the property serving as collateral will be insufficient to cover any repayment shortfall.
"Consequently, prudent LVR limits serve as an important element of portfolio risk management. APRA emphasises, however, that loan origination policies would not be expected to be solely reliant on LVR as a risk-mitigating mechanism.
"Where an ADI’s risk appetite allows for higher LVR lending, good practice would provide that the additional risk in this lending would be mitigated by measures such as stronger serviceability- adjusted loan pricing and additionally, in the case of IRB banks, higher expected loss provisions and capital.
"And it will not be enough for banks, in the area of high LVR loans, to claim to be protecting themselves by pointing to the use of mortgage insurance.
"APRA does not consider the sole use of coverage of loans by LMI as a sufficient control to mitigate high LVR risk," the regulator announced.
A prudent ADI would exhibit greater caution when relying on collateral values in periods of rapid growth in property prices. It may be appropriate for an ADI to strengthen its LVR constraints or re-assess its risk appetite in markets exhibiting rapid price appreciation.
And even where banks are lending to people with large deposits (so-called low LVR) loans, APRA urges bank boards and management not to regard this as a safe form of lending.
"Lending at low LVRs does not remove the need for an ADI to adhere to sound credit practice or consumer lending obligations. A prudent lender would seek to ensure that a residential mortgage loan has reasonable expectations of being repaid without recourse to the underlying collateral.
"Interest only loans – used extensively by investors (and especially self-managed super funds in the past couple of years), will face closer scrutiny and banks will be encouraged not to offer these products willy nilly to people buying homes to live in them.
"Interest-only lending to owner-occupiers may indicate that an ADI is accepting a higher credit risk than for loans where repayments consist of both principal and interest. Any such willingness to accept higher risk would need to be reflected in the ADI’s risk management framework, including its risk appetite statement.
"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.
"An overall sound assessment would be based on the borrower’s repayment capacity at the time of loan origination rather than an overriding presumption that the value of collateral will appreciate,” APRA said.
Other loan products questioned by APRA include reverse mortgages and house equity lines of credit.
Banks will still be able to offer these products, but they will have to be far more cautious, check the borrowers more throughly and possibly hold more capital against these types of loans than a straight home loan with no bells and whistles.
"The revolving nature of home equity lines-of- credit loans may increase the risk of outstanding balances at default. As a generalisation, HELOCs can result in different delinquency and default outcomes compared to traditional principal and interest products. A prudent ADI would establish checks and limits for such loans as part of its risk appetite statement. Examples include portfolio limits and limits on the non-amortising portion of such loans.
"An ADI undertaking a material volume of reverse mortgages could, as a matter of supervisory discretion, be required to hold additional capital against the unusual risks associated with this product,” APRA said.
And with investment lending rising rapidly, especially to self managed super funds, APRA has taken aim at them and told ADIs they have to be far more conservative in their lending assumptions.
"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.
"In summary, an ADI would typically apply some or all of the following adjustments when assessing a loan application: a buffer for potential interest rate increases; an absolute floor on interest rates; a buffer above the HEM or HPI estimates (measures used by the banks) of living expenses; and a haircut /exclusions for uncertain income streams. Where an ADI chooses to apply only one buffer in lieu of the range of buffers described above, it would be prudent to use an appropriately larger buffer,” APRA said.
Buying a house or an apartment is about to become tougher for a while for all involved.
