The lending environment

Recent developments in the property and finance market have impacted on property values and finance approvals. APRA (The Australian Prudential Regulation Authority) was established in July 1998 and since then it has attempted to supervise in a regulatory manner Banks, Insurers and Superannuation Institutions. If we look at Apra in relation to our studies in the Microenvironment, we can see that APRA has caused much of the negative impact resulting in softening home prices. Despite good intentions to ensure banks don’t fail they have also most certainly increased the difficulty of loan applicants obtaining finance.  APRA has caused lender’s to pull back on the amount of interest only loans approved in the market. They have also pressured banks to more closely scrutinise living expenses of applicant’s. Combined these two policies have helped push the economy into a recessionary phase.

The Royal Commission into misconduct in the banking, Superannuation and Financial Services Industry commenced hearings on the 14th December 2017 till the 4th of February  2019. When it handed down its findings, even though the banks came through relatively unscathed considering the stories of misery told by countless witnesses, Commissioner Haynes commented that lenders seemed to be more responsibly assessing potential borrowers living expenses rather than just relying on HEM tables. Most lenders have used HEM or The Housing expenditure Method to calculate how much living expenses should be apportioned to a potential borrower to suit their circumstances. The tables indicate an expected living expenses amount for single people, married couples and families with different numbers of dependent children less than 18 years of age. Using the resulting figures determined by HEM a lender could then use the balance of an applicant’s income to determine potential borrowing capacity for a borrower.

The combination of APRA pressure and the Royal Commission outcomes have created the situation we are currently in where banks are more closely scrutinising an applicant’s actual living expenses rather than just relying on declared living expenses or the HEM table. Those lenders that still use HEM are using an updated HEM table, which more closely matches expenditure of Australians in today’s environment. The bottom line is borrowing capacity of potential borrowers has decreased in some instances by up to 25%. APRA has contributed to this with their instruction to lenders that no matter what interest rate an applicant qualifies for the lender should use the interest rate of 7.25% to assess serviceability of the borrower. This is not only for the loan for the property being purchased, but also for any other property loan the applicant has, even if they aren’t being refinanced. So even if a borrower can qualify for an interest rate of 3.59% he has to be assessed for affording that loan as if interest rates increased to 7.25% again severely restricting capacity.

Bringing in tighter regulations surrounding credit approvals has resulted in a credit squeeze. It is harder to be approved for loans. It is certainly harder to be approved for the same amount as a borrower could be approved for a year ago. This means we see the situation where a borrower wants to refinance his home loan which has been paid down over the years, so that he or she can access that increased equity to perhaps consolidate debt, to pay out a higher interest credit cards or personal loans. We have seen banks reject the loan on the basis of the new living expenses calculations and the 7.25% servicing rate imposed by APRA. Effectively the current microenvironment has seen applicant’s told, “Sorry, you cannot afford to have this loan which would have reduced your monthly loans repayments.”

Another impact that lower borrowing capacity has is that there is not enough money available to borrowers. This has meant there are fewer people able to bid for prices that sellers expect to get for their properties. The law of supply and demand means that this has contributed to the downward pressure on property prices. This has not just impacted property prices it has also impacted business owner’s access to funds. As credit for business dries up there is less investment by business owners into hiring new staff or attempting new ventures. We have created our very own recession by restricting credit not only to home owners but to those business owners who rely of a ready source of funding to invest into business or development. We are seeing business owners and entrepreneurs having to restrict business plans which has led to the slowing in employment and helped restrict wage growth.

The inflation rate for the first quarter was 0%. This seemingly had the effect on regulators and government that perhaps the tweaking of regulations, whilst with good intentions, may have gone a little too far. The Reserve bank cut interest rates by 0.25% to a low 1.5 last week. APRA earlier in the month wrote to the banks that the 7.25% interest rate to be used is no longer needed. That bank’s should probably use the actual rate plus 2.5%. This will increase borrowing capacity, but unfortunately it appears that APRA has given banks a month to discuss and comment. Some lender’s have already indicated to advise they will wait and see what the other banks do. It appears that for now access to credit will remain difficult.

Whilst there is talk that things are changing, that the recent election will generate confidence, that real estate agent reports 10% increased numbers at property viewing, the fact remains that the perfect storm created by the impact of regulatory pressures will ensure that any recovery in the microenvironment will be a slow one.

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