Upfront mortgage broker commissions under review as APRA helps RBA on risky home lending standards

The Australian Prudential Regulation Authority has issued tough draft guidelines on how it expects banks to monitor and manage home mortgage risks.

Upon the release, APRA chairman John Laker noted "increasing evidence of lending with higher risk characteristics and it does not want this trend to continue".

the current concern sits  against the backdrop where residential mortgage exposures have exhibited low default and loss rates in the $1.3 trillion Australian mortgage market. But the continued low interest rate environment has authorities concerned for when rates take off again.

Aimed at complacency among residential mortgage lenders, the draft guidelines still fall short of the stricker macro­-prudential rules adopted in recent times by other regulators especially in New Zealand and Canada.

But the draft guidelines suggest banks consider "geographic concentrations" of risky loans.

There might also be new limits on loans relative to incomes along with stronger stress-testing borrowers.

There is also the possibility of reducing financial incentives and commissions to mortgage brokers.

APRA chairman John Laker said credit standards were needed given “very active competition” between lenders and rising property markets.

The Australian Financial Review columnist Tony Boyd recently calculated that the net present value of annual commissions paid to mortgage brokers is about $600 million, based on brokers handling about half of the $28 billion in mortgages settled each month.

APRA suggests commissions paid upfront tend to encourage less rigorous attention to loan application quality. 

APRA has told the banks to review appropriate monitoring and controls “to guard against incentives to pursue loans with inadequate or false verification, marginal serviceability, excessive leverage or unsuitable terms for a borrower”.

In Australia, it is standard market practice to pay brokers either an upfront commission or a trailing commission, or both.

"Experience has shown that commissions paid upfront tend to encourage less rigorous attention to loan application quality," the report said.

"Trailing commissions are more likely to provide incentives for brokers to retain and monitor customers.

"A prudent approach to the use of third parties for residential mortgage lending would include appropriate compensation measures for brokers.

"Such measures include the ADI being able to end or claw back commissions where there are high levels of delinquency or process failures on loans originated by third parties."

The acting chief executive of the Australian Bankers’ Association, Diane Tate, said the industry had expected the new guidance.

APRA said it expected banks to closely monitor the share of new loans with high loan-to-valuation ratios (LVRs). While Australia has no caps on LVRs, it said those above 90% clearly exposed banks to a higher risk of losses.

‘‘Historically, residential mortgage exposures have exhibited low default and loss rates,” it said in the draft.

“However, lengthy periods of economic growth combined with low interest rates and a sustained period of rising house prices can create a sense of complacency among residential mortgage lenders.’’

APRA is taking industry feedback on the draft policy until late July.