In a recent speech APRA Chairman Wayne Byres discussed the results of an APRA survey which indicated differences in credit assessments and lending standards in some of the larger housing lenders (including a few mutuals).

APRA concluded that there were clearly examples of practice that were “less than prudent”. APRA has indicated to lenders that serviceability assessments could be strengthened.

In the survey the ADIs were asked to provide their serviceability assessments for four hypothetical borrowers that it invented (two owner-occupiers, and two investors).

While he denied that APRA is trying to standardise mortgage risk assessments or impose a common ‘risk appetite’ across the industry he said that ADIs should adopt prudent estimates of borrower’s likely income and expenses.

He accepted that different ADIs can have different risk appetites but “making overly optimistic assessments of a borrower’s capacity to repay does not seem a sensible or sustainable basis on which to attract new customers or retain existing ones”.

APRA’s analysis focussed on the likely long term success of a lender rather than the responsible lending obligation under the National Credit Act.

In his speech Mr Byres made the following observations:

Amount of loans and living expenses

” The first surprising result from our review was the very wide range of loan amounts that, hypothetically, were offered to our borrowers. 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.”

“One significant factor behind differences in serviceability assessments, particularly for owner occupiers, was how ADIs measured the borrower’s living expenses … As a regulator, it is hard to understand the rationale for large differences in what should be a relatively objective, and extremely critical, metric.

Of major concern were a few ADIs who opted to make their credit assessment based on a lower level of living expenses than that 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. In fact, best practice (and intuition) would be to apply minimum living expense assumptions that increase with borrower incomes; this was a practice adopted by only a minority of ADIs in our survey.”

Treatment of other income sources

“The treatment of other income sources (such as bonuses, overtime and investment earnings) also played a large role in credit decisions …. 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. Unfortunately, common sense was sometimes absent.

Another area of interest was the discount or ‘haircut’ applied to declared rental income on an investment property. The norm in the ADI industry seems to be a 20% haircut, but we noted in our exercise that some ADIs based their serviceability assessment on smaller, or even zero, haircuts. Bearing in mind that the cost of real estate fees, strata fees, rates and maintenance can easily account for a significant part of expected rental income, and this does not take into account potential periods of vacancy, the 20% norm itself does not seem particularly conservative. 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. ”

Interest-rate buffers

“Variations in assessments were also driven by the size of interest-rate buffers applied to the new loan …. For investor lending, this issue was more pronounced: a major driver of differences across ADIs was whether an interest-rate buffer was applied to both the investor’s existing debts (such as loans outstanding on existing owner-occupied or investment properties), as well as to the proposed new loan. As of earlier this year when the survey was conducted, only about half of the surveyed ADIs applied such a buffer to existing debts (all applied some form of buffer to new debts). I confess to struggling to see the logic of such an approach – 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.

….if the buffers are being applied to overly optimistic assessments of income, or only to part of the borrower’s debts, they do not serve their purpose.”

Interest only loans

“Our test included one borrower seeking a 30-year loan, with the first 5 years on an interest-only basis. Only a minority of surveyed ADIs calculated the ability to service principal and interest (P&I) repayments over the residual 25 year term. 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 5 per cent.”