Banks on notice over $500b in ‘liar loans’

Generic pictures of banks in Melbourne CBD today. ANZ. Picture by Wayne Taylor 17th July 2017Bank Up to $500 billion of mortgages on n banks’ books are based on factually incorrect loan applications – or liar loans – and the problem appears to be getting worse despite recent crackdowns on lending standards, according to a report by UBS.

This prospect puts both the banks and their regulator, the n Prudential Regulation Authority, in the frame for falling down on the job of improving the robustness and safety of the financial system.

It is even more extraordinary that when lending conditions should be getting tighter, the report from the UBS banking team found that the percentage of loan applicants misrepresenting their financial position in 2017 was up on the previous two years.

And despite the banks promising to be more stringent in assessing the financials of borrowers, only 17 per cent of applicants said it was harder to get a loan, with 46 per cent saying it was easier.

“As the value of mortgage approvals has been broadly stable over the last 12 months and customers are not finding it harder to get approval, it is difficult to conclude underwriting standards have been tightened from a customer’s perspective,” UBS noted.

Indeed, it could provide further ammunition to the federal government in its regular sport of belting the banks.

The UBS survey, based on detailed interviews with people who had successfully applied for loans, found almost a quarter had lied to get a loan – typically by overstating their income and/or the value of their assets, and underestimating other loans and living costs.

Some respondents said they understated their expenses by 30 per cent although the median understatement was about 10-12 per cent.

The latter is the most dangerous because borrowers are more vulnerable, and could have insufficient buffers, if interest rates rise or their income falls. Mortgagors ‘stretched’

Summarising its findings, UBS said: “Given the rising level of misstatement over multiple years, we estimate there are now ~$500bn of factually inaccurate mortgages on the banks’ books (ie ‘Liar Loans’ – a term used in USA during the financial crisis for mortgages where documentation was not accurate). While household debt levels, elevated house prices and subdued income growth are well known, these finding suggest mortgagors are more stretched than the banks believe, implying losses in a downturn could be larger than the banks anticipate.”

This analysis also suggests any significant fall in the housing market would be exacerbated if the true level of stress is underestimated by the banks and regulators.

The recent crop of borrowers are also more vulnerable because they have borrowed at what now appears to be the height of property market values. Spotlight on mortgage brokers

The report also puts a particularly unflattering spotlight on mortgage brokers, finding a higher proportion of factually incorrect loan applications have come from this channel.

“Of the 2017 vintage, 37 per cent of respondents who used the broker channel and were not completely factual and accurate stated that their mortgage broker suggested they misrepresent the application,” the report says.

Of those who received a mortgage directly from their banks, about 2 per cent said they were encouraged to be inaccurate in their application.

UBS says its findings dovetail with an ASIC review of mortgage broker remuneration, released in March, which observed: “We identified significant numbers of loans across several lenders where the consumer expenses were stated to be equal to the Household Expenditure Measure (HEM) benchmark.

“While lenders and brokers may be able to use benchmarks such as HEM as part of their process for verifying consumers’ expenses, they are still required to make inquiries into the consumer’s actual expenses. The proportion of loans we reviewed where the consumer’s expenses were equal to or very close to the HEM benchmark suggests that these inquiries were not occurring properly.” ANZ customer misstatements up

Of the major banks, ANZ seems to have the poorest record of customer misstatements.

Of those who took out loans with ANZ in 2017 (directly or through a broker), 55 per cent of respondents stated their application was completely factual and accurate (implying 45 per cent of customers misstated their application), down from 66 per cent in 2016.

The other major banks were roughly in line with the industry combined numbers.

An ANZ spokesman said the bank had processes in place to ensure its home loans were assessed “conservatively”, including applying an interest rate floor of 7.25 per cent and using the higher of either the customer-stated expenses or a benchmark based on Melbourne Institute data.

The UBS analysis, which has been undertaken since 2015, found the level of “completely factual and accurate” mortgages by survey respondents has fallen from 73 per cent in 2015, to 72 per cent last year and 67 per cent this year.

“We do not have accurate data on the level of factual accuracy of mortgage applications prior to this time. However, we believe it is fair to assume that mortgage misstatement has been an ongoing and growing issue in the banking system,” UBS concluded.

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