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Just how shabby are the big banks' loan books?
Australian Financial ReviewMar 27 2018 5:33 PM
Karen Maley
Bank shareholders, many of whom have followed the Hayne royal commission's public hearings with avid interest, remain deeply divided about one key question: Are the banks' poor lending practices confined to small pockets of their loan books, or is a sizeable chunk of the banks' assets of dubious quality?
Unfortunately, senior executives at the big four banks proved to be of little help in answering this question. They are so petrified of attracting the attention of the Hayne royal commission, and of possibly being called to testify before it, that none were prepared to comment on the record about the quality of their loan books.
The National Australia Bank showed the most courage, telling The Australian Financial Review that a NAB spokesperson could be quoted as saying that "we are comfortable with the quality of our housing lending portfolio".
One factor that strongly suggests that dodgy loans represent only a small portion of the banks' overall loan portfolios is the low level of provisions for non-performing loans (where borrowers are three months or more behind in their interest payments) that the banks have made in recent years.
As Michele Bullock, the Reserve Bank of Australia's assistant governor (financial system) noted in a speech last month, "banks' non-performing housing loans have been trending upwards over the past few years, although they remain very low in absolute terms at around 0.8 per cent of banks' domestic housing loan books". [Which means exactly nothing, because they’re papering over the cracks with bridging loans; see Denise Brailey’s interview on the 22 Mar. CEC Report. –RJB]
Systemic issues
Much of this increase in non-performing loans, she added, was "in the mining-exposed states of Western Australia and Queensland – not unexpected given the large falls in employment and housing prices in some of these regions".
AMP Capital's chief economist, Shane Oliver, cautions against assuming that anecdotes about poor lending practices are indicative of the quality of the overall loan portfolio.
"The fact that some people have had problems with their banks doesn't necessarily mean that there are systemic issues," he notes.
He adds that the evidence presented at the Hayne royal commission suggested that "when the banks generated the loans themselves, the lending standards applied were higher than if the customer came in via a roundabout way, either through a mortgage broker or a car dealer."
But even then, "it's hard to know what portion of these loans generated by third parties are problematic".
Sharad Jain, director, S&P Global Ratings, adds that "the royal commission has just started, so we don't really know the extent of the shortcomings, if any, in the banks' lending practices".
"Until it is established that there are indeed any significant shortcomings, it's hard for us to comment on whether there should be higher impairment charges for non-performing loans."
But, he notes, "there's no evidence so far that the banks are hiding non-performing loans."
Still, the low level of bad and doubtful debts isn't evidence in itself that the banks are adhering to robust lending standards.
As AMP's Oliver points out, banks tend to benefit from low levels of problem loans when the general economic environment is propitious.
"Normally when interest rates are low and economic growth is reasonable, the level of non-performing bank loans is pretty low. And that's what we're seeing at present", he says.
"So bank lending standards won't really be tested until unemployment starts increasing or borrowing costs rise. And that could be a while away."
Ironically, he says, the experience of the banks in Western Australia and other mining-related regions offers some comfort as to banks' overall lending standards.
Less sanguine
Even though the level of non-performing loans has risen, "these problem loans haven't risen to a worrying degree, even though there have been recession-like conditions in West Australia.
"So that suggests that even if the overall economy were to slow, the rise in non-performing loans is unlikely to be too problematic."
Others, however, are less sanguine about the quality of the banks' loan books. They warn the big banks could be hit from a rise in problem loans, especially given the signs that a large number of borrowers have overstated their disposable income in order to snare larger home loans from their banks.
The highly regarded UBS banking analyst Jonathan Mott pointed to one large survey that indicated one-third of people who had taken out a mortgage in the past 12 months admitted they had not been completely accurate about their financial position when applying for a mortgage.
"Given the rising level of misstatement over multiple years, we estimate there are now around $500 billion of factually inaccurate mortgages on the banks' books," he warned in a note last September.
These "liar loans", he said, posed a risk to the banks' balance sheets. In particular, banks could be hit by a surprise surge in problem loans if economic conditions were to deteriorate, causing a jump in unemployment.
"While household debt levels, elevated house prices and subdued income growth are well known, these findings suggest mortgagors are more stretched than the banks believe, implying losses in a downturn could be larger than the banks anticipate."