Last week Business Insider reported that Australian non-bank lender Pepper Home Loan had issued $500 million of residential mortgage backed securities (RMBS).
It was the biggest “pure non-conforming RMBS transaction completed since the financial crisis” according to Sarah Samson, Director, Debt Markets, National Australia Bank Limited which was co-lead on the deal.
This fact seems to have worried some financial commentators and raised concerns about sub-prime style lending in Australia.
Last week on the ABC’s PM program Digital Finance Analytics likened Peppers issue and lending was likened to US sub-prime mortgages.
At issue seems to be the place that Pepper holds in the Australian Lending Market and the types of loans they write and the customers and borrowers to whom they lend.
On its website Pepper says:
Our home loan products have been developed to meet the needs of borrowers who are unable to meet the lending criteria of traditional lenders and mortgage insurers.
So non-traditional lending at least.
The PM program reported:
Martin North says it’s a model not unlike the subprime mortgages that were packaged up by big investment banks in the United States in the years before the global financial crisis. The banks involved included Lehman Brothers and Bear Stearns, which collapsed when the subprime bubble burst, unleashing market chaos and an almost global recession.
That is a worrying scenario in anyones language. While North sought to clarify by saying that in Australia such loans only made up one or two percent of loans, Pepper co-CEO Patrick Tuttle has sought to set the record straight, telling Banking Day that the suggestion “these loans equate to US sub-prime is just nonsense.”
Tuttle went on:
As far as we’re concerned this is just business as usual… In fact, the market should be welcoming the fact that we can fund ourselves reasonably efficiently, and see that as a sign of returning competition to the non-bank sector.
Indeed local treasurers and the market should, because it’s not just Pepper looking to diversify their funding at the moment. Indeed under APRA’s new standard, APS 210, all Australian ADI’s (banks, building societies and credit unions) even smaller ADI’s who have or are still funded by deposits, need to diversify their funding base and perhaps look towards securitisation as a form of funding to show they can always remain liquid.
Underlying the hullabaloo around the Pepper deal is a potential misunderstanding of the material differences between non-conforming in Australia and sub-prime in the US.
Sub-prime lending in the US is a “completely different animal” according to Tuttle. “In many cases, the borrowers didn’t even have jobs and were being given loans by US lenders.”
Non-conforming loans in Australia on the other hand are just that – they don’t conform with traditional credit approval criteria or automated scoring models. They require a more old-style bank manager approach in many cases.
Tuttle said that Pepper does a lot of the underwriting (credit approval) manually and that “Typically, these customers might be looking to consolidate more than three or four credit cards and a personal loan into their mortgage and thereby exceed debt limits; may have had an illness or a divorce or were temporarily unemployed and therefore have “a black mark” on their credit bureau report; or are self-employed but late with their tax returns, requiring a lender to confirm their income through alternative means, such as business activity statements.”
Crucially Tuttle added: “Our processes allow us to verify their capacity to repay their loans.”
This is the key difference between Australian non-conforming loans and the sub-prime loans in the United States that precipitated the crisis.
Under Australia’s National Consumer Credit Protection Act a credit provider must take reasonable steps to verify the applicant’s financial status, and that they can repay without undue hardship.
That makes all Australian mortgage lending and all Australian mortgage lenders subject to such a test. That is, a lender must undertake a test of the borrower to satisfy themselves, under law and with the threat of penalties, that the borrower can repay the loan on the terms on which it is extended.
It’s black letter law that codifies Australian lending practices and one of the reasons the performance of Australian mortgages and arrears has always been so healthy by international standards.
It is also why Patrick Tuttle says comparing the loans his firm writes to sub-prime in the US is nonsense.
Disclosure: Pepper owns a majority shareholding (50.5%) in a company with a 35% stake in MARQ, a company the author consults to.