Analysis: How lending curbs reshaped the industry in 2016

We have entered a new era in Australian lending. Some brokers are struggling to survive by specialising in once-booming segments like non-resident lending, apartment lending, property investment loans, developer finance or SMSF lending. Their point of difference vanished overnight as lenders pulled out of these areas. Meanwhile, regional brokers say that customers who once qualified for a home loan are no longer able to — purely due to higher serviceability requirements and lower LVRs.

The landscape has changed. The market today represents a new frontier for mortgage broking; there is no doubt that writing a home loan today is far more complex than it was a year ago. Brokers are doing more work for the same result. These lending changes have come at an interesting time for the third-party channel.  

When APRA’s 10 per cent speed bump for investor loans began to hit the market in the form of pricing and policy changes last winter, brokers were told to look at the opportunity. It was viewed as a chance to educate their clients and potentially carve out a niche for themselves among the mayhem; a strong yet simple message could cut through the confusion. For some brokers, the new lending landscape has been a blessing. For others, it has been far from ideal. And all this set against the backdrop of a government-initiated ASIC inquiry into commissions.

What exactly has changed?

It’s worth giving a brief summary of how home lending has continued to change over the last 12 months. Most major changes occurred in late 2014 through to mid-2015. These include higher serviceability requirements, differential pricing and APRA’s 10 per cent cap on investor mortgage growth for ADIs.

In recent months, a range of new developments have impacted mortgage lending. Notably:

• Lenders imposing greater restrictions on the number of non-resident pre-sales for developers;
• Lenders tightening credit policy or pulling out of non-resident lending following instances of fraud;
• Greater reliance on income verification;
• Lenders tightening credit policy or pulling out of property development lending;
• Ongoing LVR and policy changes; and
• More lenders pulling out of home lending for property investment (AMP Bank left the investor space in mid-2015 and returned before year end. Teachers Mutual withdrew from new investment lending in May and returned in August).

According to Sydney-based broker Effie Nie of Ayers Home Loans, the frequency of policy change has severely undermined the credibility of Australian banks. 

“Speaking of foreign income transactions, which are a minimal percentage of our business, the policy has gone from relatively relaxed to overly rigorous in a very short space of time,” she says.

The crackdown on home lending to overseas borrowers began at the top of the food chain and quickly swept through to smaller lenders within a few months.

In late April, CBA became the first major bank to change its non-resident lending policy, followed by ANZ, Westpac and NAB (in that order). A handful of non-majors and mutuals followed suit. Non-banks have been the last to join them.

The chain reaction was triggered by a series of mainstream media reports regarding the suspected fraudulence by mortgage customers relying on overseas income.

Ms Nie believes it might also be a business reaction towards recently discovered unethical conduct by some brokers.

“The scale of fraudulent activities has made any broker begin asking the question: have the banks and regulators properly fulfilled governance duties in past years? And more importantly, who is liable for the social responsibility as a result of irresponsible lending across these banks?”

These questions pose serious headaches for mortgage providers, particularly those with a high exposure to non-residents.

When lenders effectively slammed their doors on foreign borrowers back in May, the reverberations rippled through third-party distribution.

Yellow Brick Road’s trading update for the three months to June 30 highlighted that Vow Financial’s settlement growth had flattened over the quarter — a direct result of lending changes: “Lending conditions have deteriorated as government policy reduced foreign borrowings and historically-low rates increased refinance activity,” the group said.

“Investment lending policies remained tight. This impacted the Vow Financial business, flattening settlement growth this quarter versus the prior corresponding period.”

But brokers like Ms Nie are able to look beyond the negative headlines and strengthen their value proposition as change becomes the only constant in a mortgage market marred by complexity.

“Brokers nowadays are much more adaptive and resilient,” she says. “Through our practice we have come to the conclusion to form in-depth relationships with clients by adding value throughout the entire transaction, proactively exploring diversification opportunities to enhance the overall service proposition, pursuing quality clientele rather than quantity, and undertaking comprehensive training to be better equipped.

“The industry still attracts many young talents who long to turn into true mortgage professionals,” she says.

“The lending landscape is changing rapidly; as always the great tide washes out the sand and leaves the gold on the shore.”

Non-resident lending

Brian Seth, a broker with Mortgage Australia Group, has experienced first-hand the disruptive force of lenders pulling out of a certain segment.

The Perth-based broker has a long-term relationship with Malaysian clients who provide mortgage leads for high-net-worth purchasers, typically self-employed clients, of new apartments and house and land packages.

“The changes in non-resident policy that rippled through the lenders cost me a lot of time and tested this relationship,” Mr Seth explains. “With one deal it was approved, then declined, with policy changes by two lenders.

“Being non-resident and self-employed, each application was a lot of work resulting in no commission at the end. I have preserved the relationship with them, however the current non-resident lending policies leave us with few options and only a limited number of their clients will qualify.

“It’s disappointing, as they can clearly afford the loans, and there is nothing hidden or fabricated with their paperwork.”

He makes a good point about non-residents being able to afford the loans. In fact, that was Westpac’s first defence when the fraud allegations hit the headlines in April. But unlike Mr Seth’s clients, Westpac did have a few issues with the paperwork.

At that time, a Westpac spokesperson told The Adviser that the bank had identified an issue with some loans that rely on foreign income, which it is currently investigating.

“We take any allegation of fraud very seriously. Any potential fraud is thoroughly investigated,” the spokesperson said.

“This will involve contacting customers to seek further information and to verify the information they have provided in their application. We also liaise with the appropriate regulator and the police as required.”

However — and this is the important bit — Westpac said its delinquency rate on foreign income loans is lower than the portfolio average, and a large proportion of these loans are ahead on repayments. “Overseas borrowers are also well secured. It is important to note that LVRs on these loans are 70 per cent,” the bank said.

The bigger question, which no bank wants the gruelling task of answering, is how apparently low-risk mortgages, based on allegedly fraudulent income documents, were approved in the first place.

So they have closed ranks, and in doing so left a whole host of potential problems for Australia’s booming apartment market.

Mr Seth can see that the changes will only increase developers’ costs.

“Rather than the mooted decrease (at least in the Perth market) it will lead to an increase in purchasing costs as developers seek to pass on the increased funding costs caused by a slower sale process — because non-resident purchasers provided the sales momentum,” he says.

The off-the-plan fiasco

In addition to shutting out foreign borrowers, Australian lenders have grown increasingly nervous about the number of cranes in the sky, and their LVRs have tightened accordingly.

Bank of Sydney executive general manager of commercial banking, Fawaz Sankari, says the lender has been receiving an “enormous amount” of enquiries about construction finance.

“There is a huge increase and reliance on foreign investment purchases on the pre-sales side. We have noticed that, on the local front, a lot of our long-term solid developers are really struggling to get pre-sales locally,” Mr Sankari told the Vow Financial Commercial Conference in the Gold Coast in June.

“There have been a couple of clients who we have had on 50 per cent pre-sales and they are yet to achieve those. Yes, we want to mitigate our risk, but we also want to help the client mitigate their own risk in terms of biting off more than they can chew.”

“I think a lot of the banks and lenders out there are very concerned about what is going to happen in the next 12 to 18 months.”

Several lenders, including Australia’s big four banks, have tightened their lending to non-residents in recent months. Meanwhile Queensland and NSW have announced that they will hit foreigners with surcharges on all residential property transactions.

Luxcon Group managing director Ilya Melnikoff, a relative of Australia’s richest man, Harry Triguboff, says restricting local developers and foreign buyers has a very real potential of sparking a chain reaction of unintended consequences.

The property developer says recent restrictions on both developers and foreign buyers could actually lead to price rises by curbing the supply of new units.

Mr Melnikoff, a nephew of Meriton founder and billionaire property tycoon Mr Triguboff, told The Adviser that in addition to a crackdown on lending to non-residents, banks are also adding additional restrictions on the amount of pre-sales developers can accept from foreigners.

“Foreign buyer pre-sales have gone from 30 to 35 per cent accepted to 20 per cent. There are talks of restricting it even more,” Mr Melnikoff says. “If projects can’t get the pre-sales, they can’t get started, leading to higher housing prices due to a lack of housing stock — housing demand will in fact increase.

“It’s a real problem because some areas are heavily dominated by Asian buyers, such as Chatswood, Macquarie Park and Epping. So, you are really slowing down the production. There are a lot of local buyers, but there is a tremendous amount of foreign demand there. Now with the 4 per cent stamp duty on foreign buyers, that has the potential to put brakes on the whole thing altogether.”

The issue is amplified by the fact that foreign buyers are typically more comfortable purchasing off-the-plan, whereas local buyers tend to wait until construction has commenced before purchasing, as they want assurance that the project is going ahead.

Mr Melnikoff’s Luxcon Group is a medium-density developer with a number of projects in Sydney currently in the construction or DA phase.

The group has established relationships with the banks, which has (so far) meant it can continue securing funding. However, stringent requirements around pre-sales and LVR restrictions are becoming a concern for the company.

“Even though we are existing clients [of the banks], there are more and more requirements being asked of us,” Mr Melnikoff says.

“Banks are now asking for 100 to 120 per cent of the debt coverage in pre-sales. On top of that they lower the LVRs in terms of how much they lend for construction costs. On top of that they have added restrictions to foreign buyers. What that does is slow down the pre-sales, and it substantially delays the projects from getting started or not be able to start at all,” he says.

“That effectively limits the production of the units. When there is a shortage of something there are obviously price rises. There is a real danger in all these restrictions actually creating higher housing costs as a result of lower production of units. There is a great potential of this happening as the result of developers not being able to complete their projects.

“All of these restrictions could create a chain reaction and a situation that these policies were designed to prevent.”

The central bank has also flagged concerns. The Reserve Bank’s financial stability department chief, Luci Ellis, warned that property developers are one of the ‘vectors of distress’ that have historically triggered financial crises.

Ms Ellis says markets tend to see housing booms ahead of banking crises, however, it is “usually not the mortgage book that brings the banks down”.

“If we find a way to cause a disaster in the mortgage book in Australia […] that would be the thing that could be very problematic for the banks, precisely because it is so big. But as the banks have said publicly before, it is important because it is big, not because it is particularly risky,” she says.

Ms Ellis made the comments at the Centre for International Finance and Regulation Research Showcase in Sydney in June.

“The things that have tended to be the causal agents in a banking crisis, even though you saw something go wrong in housing prices, were the property developers and the commercial real estate,” she says.

“These are the vectors of distress that actually cause a problem for the banking system historically.”

However, when it comes to settlement risk, Sydney developer Mr Melnikoff said foreign buyers are less likely to walk away from off-the-plan properties.

“While we understand the mitigation of these risks, there has historically been less drop-out rate among foreign buyers than with local buyers,” he says.

One of Australia’s top brokers and Elite Business Writer Ren Wong, who manages a growing (and ASX-listed) diversified mortgage brokerage in Sydney, has seen an influx of enquiries in recent months.

“At times like these it gives brokers the opportunity to focus on educating the existing client base, doing more retention work instead of going out on the road to grab new clients. Quality retention will lead to existing clients bringing in word-of-mouth referral leads,” Mr Wong says.

“Lenders shying away from foreign lending certainly has its impact on the market but overall it accounts for less than 1 per cent of the loan book as per banks' comments. I think it just means lenders and brokers lost a growth spot, but it probably doesn't have as much of a material effect on lenders and brokers than off-the-plan developers,” he says.

“It would be like a plane flying with a downed engine, but it will still get to where it wants to be with three of the four engines up and running.”

The opportunists

The lending environment has certainly been challenging over the last 12 months. But for smart brokers like George Karam of BF Money, the new frontier represents a real opportunity. He says it’s a great time for BF to reinforce its value proposition to existing clients. He also sees the new landscape as a positive for the broking industry in general.

“Anything is viewed as an opportunity by me if we are on the same playing field as the banks. I only see threats where the bank plays by different rules than they allow us to play by.”

Mr Karam specialises in commercial broking, offering developer finance, commercial mortgages and asset finance as well as home loans.

Operating out of the western Sydney suburb of Parramatta, his business has been bolstered over the last year by a renewed focus on training and education, driven by the shifting regulatory landscape and informed by changing lending policies.

 In short, the changes Mr Karam has made include:

• Strengthening relationships with new lender partners that were not as prominent in the business previously;
• Substantially increasing new clients, particularly those using a broker for the first time;
• Investing in staff training and upskilling;
• Significantly investing in IT systems to allow the group to better communicate with clients and increase engagement; and
• Increasing its back office capacity as the brokerage prepares for growth 

“The business is still being shifted strategically and this is still being documented and the flow-on effects are still in planning and exploitation,” Mr Karam says.

“As always, it will involve a clearly articulated value proposition to our core customers, which is being formulated in light of the current market conditions, and those we expect to operate in for some time to come.”

Similarly, Robert Krol of Eagle Finance in Melbourne has sharpened up on his knowledge of the ever-changing mortgage market.

While he admits that his business has never been actively involved in loans for off-the-plan properties, foreign borrowers, nor concentrated solely on investors, the group has adapted to the new terrain.

“We ensure we attend information sessions to learn what the new requirements of APRA are ASIC are, or will be,” he says, adding that the brokerage spends more time digesting new policies, particularly around investment loans and interest-only products. 

The company has also been educating its existing customers on the various changes, the new rules for investment loans and the resulting impact on their borrowing capacity. 

Being across the lenders’ increasingly picky appetites means the broker has also adopted a strategy of turning away certain deals. 

“We don’t work with customers who decide to purchase off-the-plan, unless it is a small-scale development, in a suburb, outside the restricted postcodes, and provided the timeframe from loan approval to completion of construction will not exceed 12 months,” he says. 

It’s important to remember that the decision to curb investor lending didn’t come out of thin air. Towards the end of 2014, property investors accounted for more than half of all mortgage settlements in Sydney and Melbourne. The macroprudential measures were necessary in that regard.

Broker groups heavily skewed towards property investors have had a tough time keeping track of all the pricing and policy changes.

Multifocus Properties & Finance CEO Philippe Brach is one of them. The group specialises in investor loan structures. While CEO Philippe Brach says his business model has not changed in the last year, the group has had to review which lender it works with, based on its change in policy.

“For example we used to write 30 per cent of our loans with Westpac as they were really investor friendly,” he explains.

“When APRA got involved, Westpac reduced investor lending to 80 per cent and did not allow negative gearing in its servicing calculator. As a result, our volume with Westpac dropped to almost zero.”

This business went to CBA, various mortgage managers and smaller lenders, Mr Brach says.

“Now that Westpac has reversed these changes, Multifocus has started using them again.

“The biggest challenge has been to keep up with changes that are still occurring almost daily,” Mr Brach says. “Before APRA’s involvement, changes were slow and majors pretty much moved in the same direction. As soon as APRA intervened it was a bit of a surprise to see them all go in different directions with their changes.”

The Sydney-based broker says this is ultimately a great result for the third-party channel as lenders now offer quite different products with different hurdles.

“Any borrower would be crazy to go to every bank themselves when brokers can do the work for them at no cost.”

However, he adds that it now takes him longer to find a solution for a client, which impacts productivity.

“Lenders are still trying to find their footing in this new environment, hence all these frequent changes,” he says.

“By ‘footing’, I mean they have to find a balance between delivering profit for shareholders while at the same time having APRA slowing them down.”

Mortgage broker Brad Quilty of Tungsten Home Loans believes the initial reaction to the APRA curbs on investment lending “seemed somewhat knee jerk and ill-thought-out.”

While the former Aussie loan consultant accepts that the 10 per cent speed limit was designed to reduce investor lending in Sydney and Melbourne — which has worked a treat — he believes that, 12 months on, the measures have had a hard consequence on any investor looking to buy elsewhere in Australia. 

“It definitely affected clients that I saw in Canberra and Brisbane looking to get into investing,” he says.

Blake Buchanan, general manager of aggregation group eChoice, says the industry has and will continue to work through the peaks and troughs that result from ongoing regulation and market conditions.

“Regulation is part and parcel of our industry — so brokers that are here to stay understand that and in terms of fortifying their business, are well-prepared for any scenario.”

He says brokers are resilient to changing environments by swaying volume flows (purchase to refi), embracing diversification programs and improving their overall processes, which allows more time for business development and servicing of existing clients.

“The brokers that have really thrived over the past year have been able to quickly identify market trends and plan for the future by maximising the full suite of tools provided by their aggregator and capitalising on the specialist knowledge and experience of the support teams around them.”

REGIONAL BROKER PROFILE

Robert Trewin, Bairnsdale, Victoria

Award-winning regional broker Robert Trewin has grown his business by 60 per cent and is spending much more time educating his clients about the new lending environment.

Have you changed your business model as a direct result of lending changes? 

Personally I have not changed my business model in the past 12 months. I had taken on another broker 24 months ago, so with all of the upheaval this resulted in a lot of education — not only for our clients but also within the business.

Being regionally located, we do not often get to our aggregator personal development days and being four hours away we have to glean our information from emails, industry magazines and telephone discussions with key stakeholders.

I describe my business as a free-flowing entity due to the amount of change on a daily basis and it has certainly been difficult to keep on top of. However given that I work within the business and only have a few staff, we have been able to take on these changes immediately and implement new procedures and systems to handle them.

The uncertainty in my opinion has bolstered my business and we have had 60 per cent growth over the past 12 months. However, we are spending a lot more time with our clients discussing their monthly living costs and documenting this.

Have you grown your business over this time by taking a proactive approach and educating your clients? 

Yes, we always take a proactive role and discussing the current climate in relation to lending is something that we have always done. It is more professional to set expectations upfront and if a deal is going to be difficult to place, due to a bank’s appetite changing or the government dictating bank policy, it is easier to have those discussions initially as we may need to look at alternatives.

Have any lending changes meant you can no longer service certain segments of the market?

I would not say we can no longer lend to certain segments in our market. But, again, a lot of these policy changes are a reflection of city-centric economics that I can see the need for.

That unfortunately can adversely catch regional borrows in the crossfire.

An example is the increasing servicing requirements. In regional Australia we have not had the increases in wages that our city cousins have had, and our living expenses are significantly lower. I am seeing clients who could legitimately afford a home loan 12 months ago but they are no longer eligible due to a failure to meet the servicing requirements, even though their monthly living expenses are significantly lower than what we need to use as a minimum.

At the end of the day, I can only work within the parameters set by the lender and the government. But, gone are the days when the credit decisions could have been made using common sense and based around an individual's personal situation.