There’s a very interesting post on Troppo by Nicholas Gruen which is attracting some equally interesting commentary. It’s a boring subject. Money, and the administration of it by supposed predatory lenders.
Having been a lender in many financial institutions dealing in retail, commercial and agribusiness funding, and held discretionary lending authorities of almost $1 million, I’m more than a little bemused by the outcry of some over ‘predatory lenders’ or ‘predatory brokers’. Yes, I’ll agree that there does exist a certain minority element within the industry which actively seek out the easy mark, the desperate ‘gotta-own-the-Great-Aussie-Dream’ punter and deliberately market the Lo-Doc or No-Doc lending products to them without concern for the Five C’s of Credit. As Nicholas accurately describes, Lo-Doc/No-Doc loans are a self-certification of income product first floated by non-bank lenders more than ten years ago, aimed specifically at the self-employed borrower who doesn’t have to stick to the July-to-October taxation submission timetable for returns. Great products, but with a very narrow field of application. The self-employed borrower. Of course, some lenders have evolved PAYG Lo-Doc loans, catering for those borrowers who – for reasons of their own – don’t want to reveal the facts and figures of their PAYG income. Payslips, taxation assessment notices, and so on. Frankly, I have a problem with anyone who is employed by someone else, whose employer issues payslips, and said employee of whom lodges taxation returns, claiming they can’t or don’t want to provide hard evidence of that income. Some circumstances exist, but they are extremely rare, where I’d change my opinion, but in general if you’re PAYG, cough up the evidence.
The PAYG Lo-Doc does not, however, constitute predatory lending practices. Nor does the use of such products by self-employed persons. These products are made available by funders as a means of meeting a market demand. It’s the borrower who opts to borrow in that manner. Funders, as Nicholas states, will undertake their own prudential analysis of every single application, be it fully verified income-wise or not. The ways and means are many and varied, suffice to say that lenders know more about income statistics and market averages than any other institution outside of the ABS. The real problem from a ‘predatory’ perspective lies with a concept known as market share.
From the moment non-bank lenders – the RAMS(happily, no more after today, effectively), Aussie Home Loans, Liberty Financial, Bluestone Mortgages, Pepper Home Loans and so on – came on the scene, and showed Mr & Mrs Punter that the Banks had lied to and cheated them for decades, the genie of what some call predatory lending was out of the fiscal bottle. The non-bank lenders with their penchant for lending out short-term foreign market funds, corporate investor funds, superannuation, unit trust – in fact any other form of short-term invested capital they could lay their hands on – as long term loans, created a brand new paradigm which the Banks struggled to come to terms with. While the chook wheel of funding kept turning – money in, money out and the music goes ’round and ’round whoa-ooh-ooh-oh-oh – everyone was happy. In fact, one only had to watch Four Corners a week or two back to gain even the thinnest veneer of understanding to grasp how the whole shebang worked. How the entire circus tent could so easily come crashing down on the crowd gathered under it.
Borrowing short and lending long works fine while-ever the roll-over of the short term funding is sanctioned, but when those who lend the lenders their short term money decide the risk element becomes too great, and stop lending, the house of cards suddenly collapses. The long term loans – home mortgages – are out there and somebody has to pay. In some cases, as in America, the borrowers cop the increased cost of the short term money as it rolls. Why does it increase? Because the risk of the rolling over those short term loans is deemed to be greater. Whether that risk is real or perceived doesn’t matter a dot. That it is perceived at all is what matters. Take a look around the domestic institutions at present and note the level in fixed rates, Lo-Doc and No-Doc loan rates. Risk is finally being perceived and the borrower, existing or intending, is paying.
So, how does all of this impact on so-called predatory lending practices? Simple. One word. Risk. Australia is called the ‘Lucky Country’ and over the past fifteen or so years, we have indeed been a lucky country in economic terms. Inflation has been low and productivity, while atrophying over that time, has been high. We’ve earned well, in average terms, while the cost of living and consuming hasn’t really worried us to any urgent degree. We’ve had exceptionally low interest rates in historical terms. Combine all those ingredients and you’ll find we’ve been numbed to the longer term effects of the never-never. Let the good times roll, and we did. Consumer debt in this country is higher now, per capita, than at any other time in this country’s history. Within the finance industry, because the good times were rolling, the lending institutions – bank and non-bank – realised that making hay in the sunshine was what their shareholders wanted, so the drive for market share really ramped up. Especially in the early part of this century. Risk was deemed secondary to market share by so many lending institutions that it ceased being taught to up & coming credit analysts. The focus turned to sales volumes. Dollars lent per month. The focus was on assets. ‘Can we take a mortgage? Then why worry? Keep exposure to known recoverable margins and we can’t really lose, can we?’ In industry circles, it’s known as Pawn Broking. Take a mortgage and lend the money. Get that market share and paint that borrower into such a position that they dare not go elsewhere for fear of not being able to refinance if things get tight. If worse comes to worse, sell the asset. Simple! Is that predatory? I don’t think so, in grand terms. It clearly depends on your definition, but to me, it’s a simple evolution of the industry under given prevailing conditions.
Of course, the God of Market Share demanded more, so risk was dispensed with almost entirely. We saw the creation of 100% lending, thirty year terms and more recently, forty year terms. Commercial loans on similar terms to home loans. Some lenders will even lend you 105% and 110% of the value of the asset you offer them, on the lick and promise that it will appreciate within a reasonably short space of time, and cover your debt when the boom comes down. Lending in some institutions, and I could name a few, has become real edge of the envelope stuff. I know of one mortgage manager – the largest privately owned MM in the country – which has a turnover of credit staff exceeding 75%. Why? Not because they’re a bad employer, or Workchoices let’s them lash their staff, but because credit decisions are being actively over-ridden by sales-oriented credit managers, who in turn are being whipped ceaselessly by senior management to ‘approve that deal’. As a former holder of a credit discretion, I completely understand why those with the power to approve are voting with their feet. When you sign off on a deal, you still like to sleep at night.
In my mind, predatory lending, while it might exist as a fringe occurrence, is not the causal factor in people losing their homes and businesses. The major impactor is an almost complete abolition of the understanding of risk and prudentiality among financial institutions. Particularly among those institutions which lend into the home mortgage market. Market share has usurped risk as the primary consideration to lend, and purely because that chook wheel I mentioned above has to be kept turning. If it falters, even in the slightest, massive losses can result for the lenders, and subsequently, the borrowers. RAMS is a prime example. Cheap interest rates are fine and well, but all things, particularly in financial circles, are cyclic. That’s why an understanding of risk, as I was taught to understand it, must lie at the heart of every credit decision, from the smallest to the largest. It’s a gut feel, more so than balance sheet figures or taxation assessment notices. It’s common sense and an understanding of impacting economic climates. Risk has nothing whatsoever to do with sales figures, market share or interest rates, just as prudentiality has nothing to do with the value of an asset offered as collateral. If predatory lending practices exist at all, they exist under the guise of market share and profitability.
What’s the alternative? In the near term, there isn’t one. As I stated above, the genie is out. The genie has a lifespan, but we don’t know what it is. Will the non-bank lenders fade away entirely? No, but they will change. Will the banks, in particular the Big Four, regain ascendency? Again, unlikely, because at the end of the day, despite the differential in fund resourcing between bank and non-bank lenders, all lending institutions borrow short term money to fund their dealings. It’s only the depth that varies. The market will recover and find a new level. Money won’t be as cheap, but the drive for market share will remain as strong. Why? Shareholders and profit. I believe you’ll find the banks will regain some share due to skittishness from borrowers in general, but both bank and non-bank lenders will remain sales driven, and to me, that is where the industry fails to recognise the social good it has the capacity to deliver. Profits can still be had and risk be made acceptable, prudential, but sales volumes and the drive to achieve greater and greater targets which bear little or no relation to achievable levels, seriously need to be tempered by risk and prudentiality. The real target, the real challenge for the finance industry in this country is achievement of balance between risk and prudentiallity, and market share and profits. I’m punting that the latter, in the near term, will win out. Greed works!