The Federal Treasurer announced in September the government’s intention to abolish or roll back the recently implemented responsible lending laws for ADIs thus removing the banks from their legal obligation to ensure borrowers have the financial capacity to repay any loans granted. The rationale for the decision was described by Josh Frydenberg as to “increase the flow of credit to households and businesses”.
Shares of the major banks rallied by between 3% and 4% despite consumer rights groups being “flabbergasted” by the decision which is the exact opposite of the recommendations emanating from the Hayne Royal Commission. The decision seems strange given the major banks themselves had not publicly agitated for such a relaxation and Westpac had recently won a high profile case against ASIC testing the existing laws. The judgement in this case set a strong precedent allowing banks to use the Household Expenditure Measure (HEM) index rather than do an extensive investigation of a borrower’s finances when considering them for a mortgage and still be operating within the law.
The likely effect of the repeal will be that more marginal borrowers can access credit and obtain a home loan as banks will be less concerned by the likelihood of legal repercussions if the borrower has lied on their application or not disclosed their true financial position properly. All parties (banks, consumer advocacy groups and the government) appear to agree these measures will lead to riskier borrowers being able to obtain credit far more easily. In the mortgage market, these extra home buyers will likely put an upward pressure on home prices and provide support to the housing market.
The need to provide this support to the economy and particularly the housing market is a concern so the action may be justified. At the end of July, Australian ADIs had 414,430 home loans on deferral with a total value of $167 billion. While many borrowers have begun repayments, adverse selection is clearly at work and those borrowers who are continuing to defer are most likely the borrowers who cannot afford to re-start repayments. It is also reported that one in five deferred borrowers are “ghosting” their lenders by not replying to letters or phone calls regarding their loans. It is a reasonable assumption many of these borrowers cannot afford their mortgages as this is the obvious reason for them not to speak to their lender.
With the reduction in JobKeeper and JobSeeker from the end of September and the more stringent criteria for qualification for these programs, it is likely many borrowers who have effectively lost their jobs will be put under additional financial stress. A recent survey by investment bank UBS indicated one in five borrowers will ask for an extension of their loan deferrals beyond the expiry period in September, while half will resume normal repayments. The remainder will ask for their loan to be restructured to make it more affordable with the most common variation being moving to interest only repayments.
Separate analysis by Equifax shows nine out of the ten areas with the highest percentage of mortgage deferrals are in Queensland tourist destinations (the tenth area is Tullamarine the suburb in which Melbourne’s airport is situated). This suggests it is lower socio-economic areas (for locals) that rely on tourism and hospitality (or those with investment properties that are unlet) which are the most affected and ultimately their fortunes will be determined by how quickly the tourism and travel industries recover.
Within Australia, house prices were largely unchanged in September on a national basis and have fallen only 1.1% over the quarter following a 0.8% decline in the June quarter. Internationally, house prices have been rising due to the further lowering of interest rates, support packages for workers and those who can afford it looking to trade up from units to houses to get more space as they work from home. The difference is potentially due to Australian house prices already being elevated before the pandemic compared with many other countries.
Potentially the decision by the Federal Treasurer to relax the lending laws is being implemented so those who can no longer afford their mortgage repayments are given time to sell their houses in an orderly manner. The buyers will ultimately be those who can now get a larger mortgage because of the changes. If this process is undertaken in an efficient manner without forced sellers causing a fall in prices, then this will be a positive result for all concerned including the lending banks who can substitute loans that are less likely to be repaid with those that are more likely to be repaid. More negatively, there is also clearly an element of “kicking the can down the road” as while the ultimate borrower profile will be improved, the original credit quality of borrowers will be far poorer than before COVID and before the relaxation of the responsible lending laws.
The housing market will remain far more susceptible to a future price crash with elevated prices and risky borrowers as compared with a situation where prices fall now and those who cannot meet repayments are forced out of the market with less marginal borrowers taking their place at lower prices with more affordable mortgages. UBS described the strategy of allowing further periods of deferrals as “extend and pretend” suggesting that by providing further relief to borrowers the banks were simply being allowed to ignore the issue the borrowers cannot ultimately repay. It appears Mr Frydenberg is looking to buy time to solve this issue.