Lifting the lid on a lending debacle

The banks could be in for a rough ride as it appears a vast number of people have falsified income using forged pay slips.

An auction in Geelong. (Picture: Peter Ristevski)

A simple decision in the Federal Court last month may have opened the lid on major management mistakes by Australian banks that could trigger a rise in bad housing debts.

Moreover, shareholders may have been grossly misled about the income security backing vast numbers of housing loans offered by the banks. These are very serious issues that potentially threaten the level of bank share prices in Australia.

Accordingly, in my view, this will be one of the major issues that will face the royal commission into banking.

These are strong comments but I make them after going through remarkable research by the giant global investment research house UBS.

You will remember that last year UBS raised the prospect of so called “liar loans” in reference to the false statements that some people were making on their bank loan applications.

Now, UBS believes it has discovered the way much of this fraud took place and how it may have been concealed in bank statistics. The UBS research raises the possibility that we are looking at very large amounts.

It was the Federal Court that “let the cat out of the bag”. It was actually a case about car loans and the ANZ bank was pinged $5 million because it had failed to take reasonable steps to verify the income of car buyers.

The bank had relied solely on documents which appeared to be pay slips when, according to the court, the bank should have known that pay slips were a type of document that could be easily falsified.

UBS believes that pay slips are the key evidence that banks use in determining borrower income for home mortgages. With the Federal Court discovering that they can be easily falsified, it raises the possibility of widespread fraud. Conceivably, the Federal Court’s motor loan reversal also may makes these “false pay slip” housing loans voidable at the option of the borrower.

A year ago we would have had to leave the matter with those words but in the last twelve months, one by one, most of the banks have been providing shareholders with the income profile of their mortgage borrowers.

UBS uses carefully chosen diplomatic language to say that, while the banks are not deliberately lying, what they are telling their shareholders is hogwash because they have been duped.

I should emphasise that these are my words. That does not mean that the Australian banks are about to go broke but it does mean that the shares may have been mispriced as a result of the false information given to shareholders.

So, let’s go through the essence of the UBS research.

Each of the big four banks has been telling shareholders that the average household income for owner occupied borrowers is $208,000 and for investment property borrowers it is $236,000. The Australian Bankers’ Association also revealed that 950,000 mortgages were written in Australia during 2017.

UBS then began working on the income levels as provided by the majors to their shareholders and calculated the percentage of bank customers in each income bracket who took out of mortgage in 2017.

Hold your breath:

• 42 per cent of households with a gross income of $500,000 took out a mortgage in 2017.
• 27 per cent of households with a gross income of between $200,000 and $500,000 took out a mortgage in 2017.
• Only 3 per cent of households with gross income of $75,000 took out a mortgage during 2017.

UBS say: “We believe this does not appear logical and is highly improbable”.

Let me put it more bluntly.

Conceivably UBS have completely got their sums wrong. People can make mistakes (we have all done it), but presumably given the gravity of the research UBS Australian boss Matthew Grounds has gone through the figures. It’s also theoretically possible that the official statistics vastly underestimate the number of people on high incomes.

But if UBS has it right then, in my view, the banks are possibly misleading shareholders or, as I said above, their borrower income material is probably “hogwash”.

Last night at dinner I ran into a person who was linked to David Murray’s investigation into the banks. He was surprised at the cavalier way banks handled their business. For example, they launched products without properly testing them. That same culture could easily extend to assessing the income of borrowers.

APRA has tightened the screws but the loans are already in place and a vast number of Australians appear to have falsified their income using forged pay slips.

The broker process may have contributed to the falsification. The old bank managers knew their customers but banks no longer have contact with big chunks of their borrowers. This helps explain the widespread mortgage stress people at all levels of society are experiencing because their real income has not been rising to cover the gap and they have borrowed more than they can afford. It also helps explain the low growth in retail sales.

As long as dwelling prices keep rising, the borrowers and their banks may manage but the housing market better not go the other way.

We have just been through a housing boom that looks like it was fuelled by fraud against banks, though, again, I emphasise for that statement to be right, the UBS research must be right.

Footnote: Westpac has a mortgage borrower income level that is well below the biggest lender CBA and looks more realistic.