HEM decision to ‘open can of worms’ in mortgage space

Last week, Federal Court Justice Nye Perram dismissed the Australian Securities and Investments Commission’s case against Westpac regarding alleged breaches of responsible lending obligations in its issuance of home loans through the use of the Household Expenditure Measure (HEM) benchmark. 

In September 2018, Westpac admitted to breaches of responsible lending obligations when issuing home loans to customers and agreed to pay a $35-million civil penalty to resolve Federal Court proceedings under the National Credit Act.

However, the Federal Court was tentative in its approach to the matter.

Justice Nye Perram had sought a friend of the court to consider whether the Westpac case even constituted a breach of the NCCP (reportedly stating that “there is no fact before [him] that any unsuitable loans were made”).

Following his review of the case, Justice Perram judged that a lender “may do what it wants in the assessment process”, noting that other provisions of the NCCP impose penalties if lenders make unsuitable loans as a result of that process.

According to CoreLogic research analyst Cameron Kusher, the court’s judgement has called into question the current regulatory approach to mortgage lending.  

“This decision potentially opens a can of worms for both the regulators and lenders,” he said.

Mr Kusher noted that in recent years, lending policies, at the request of ASIC and the Australian Prudential Regulation Authority (APRA), have become “much tighter”, with lenders placing greater focus on borrower spending behaviour, at times in “forensic detail”.

However, the analyst highlighted the challenges associated with assessing borrower serviceability and examining a borrower’s “pre-loan” behaviour, pointing to remarks made by Justice Perram.  

The Federal Court Justice said: “I may eat wagyu beef every day, washed down with the finest shiraz, but if I really want my new home, I can make do on much more modest fare.

“Knowing the amount I actually expend on food tells one nothing about what the conceptual minimum is. But it is this conceptual minimum which drives the question of whether I can afford to make the payments on the loan.

“Without additional information, I do not consider that it is possible to accept that the consumer’s declared living expenses tell one anything about their capacity to meet the repayments under the loan.”

Mr Kusher noted the shift in mortgage lending practices over recent years, from an approach that required borrowers to show they had the capacity to repay a mortgage to an approach that required them to demonstrate a track record of “post-loan” spending.

However, the CoreLogic analyst observed that the Federal Court’s landmark decision could ease scrutiny in the mortgage application process, particularly in light of recent monetary policy and regulatory adjustments.       

“The repercussions of this case for the broader mortgage lending sector will be interesting,” he said.

“We have already over recent months seen two cuts to official interest rates and APRA relaxing serviceability limits on mortgages, which, along with a post-election boost to confidence, has led to an improvement in housing market conditions. 

“This judgement may result in some further loosening of borrower serviceability assessments as lenders become less conservative around examining the pre-loan spending habits of prospective borrowers and focus more on non-discretionary expense commitments.”

 Mr Kusher backed a shift away from forensic assessments of a borrower’s pre-loan spending behaviour.

“The truth of the matter is someone can be worthy of a mortgage one day and then completely unworthy the next,” he said.

“Someone’s spending habits prior to a mortgage doesn’t really guide what those spending habits will be once they have a mortgage. 

“Factors like their employment situation, health factors, number of dependants and income are much more likely to drive their ability to repay debt. 

He concluded: “We can never know when someone is going to fall sick or lose their job, but those factors are much more likely to have an impact on someone’s ability to repay their mortgage than whether they enjoy a few drinks or have expensive food tastes prior to taking out a mortgage.”

ASIC is currently reviewing its responsible lending guidance (RG 209) and has commenced a second round of consultation in the form of public hearings.

The regulator is expected to publish its new guidance before the end of the calendar year.

[Related: ASIC to review Federal Court’s HEM verdict]