Stricter lending standards in the wake of findings from Australia’s banking Royal Commission could lead to a material slowdown in credit growth, UBS says.
And if there is a sharp reduction in housing finance, further falls in house prices are likely to follow — particularly in the larger Sydney and Melbourne markets.
Scenario analysis conducted by the bank indicates house prices could fall by as much as 6% in annual terms:
Banking regulator APRA raised concerns around lending standards in December — in particular, that banks were underestimating living expenses in their assessment of mortgage applications.
And the UBS team said the ongoing Royal Commission has “changed the game” in defining what “reasonable inquiries” banks will now need to make in their calculations of household living expenses.
UBS said that until the end 2017, around 70-80% of all mortgages in Australia were underwritten using the benchmark Household Expenditure Measure (HEM).
“The HEM benchmark is estimated based on the State in which the borrower lives, the number of dependent children and your lifestyle across ‘student’, ‘basic’, ‘moderate’ or ‘lavish’,” UBS said.
“However, in the vast majority of cases the ‘basic’ lifestyle assumption is used.”
So for most of last year, the adoption of the ‘basic’ benchmark means a family of four would have reported annual living expenses of $32,400 per annum — less than the old age pension.
And importantly, UBS said the ‘basic’ HEM reading was also applied consistently across all income brackets:
“The HEM benchmark of living expenses is now increased with household income, but we believe this is only a recent adjustment and we have not taken this into account in this scenario,” the analysts said.
UBS then ran the numbers using the ‘lavish’ benchmark, with expenses rising next to gross income.
So for a family with gross income of more than $200,000, their assumed living expenses would increase from $32,400 to $88,320.
And instead of a borrowing limit of $1,144,225, they would only be able to borrow $792,804.
“When we re-ran the major banks’ home loan calculators using the higher living expenses, we found the borrowing limit fell sharply, by 30-40% in many cases,” UBS said.
So for a family with gross household income of above $200,000, the maximum amount the could borrow would fall from almost six-times income to around four-times:
“This is consistent with lending limits that were considered conservative prior to the housing boom, and is consistent with lending limits generally available overseas,” the analysts said.
And if that’s the case, the UBS analysts said it would lead to a contraction in credit growth materially higher than their base case forecast — which is for a steady reduction in credit stemming from macro-prudential tightening measures and stricter underwriting standards.
Such a scenario would be associated with falls in house prices in excess of most current forecasts.
“There is a strong correlation between home lending volumes and house prices,” UBS said.
“If this correlation holds and housing finance falls as seen in our scenario analysis, this could lead to a substantial reduction in Australian house prices.”
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