- APRA revises residential mortgage requirements for responsible lending
Last week APRA released its revisions to APG 223, in order to bring the document closer to the requirements set out by ASIC in its guide to responsible lending.
While APRA’s revisions to the document still allow for some flexibility in the loans credit assessment, the expectations outlined in the document will flow through to the CPS 220 Risk Management assessment by the Board of Directors.
Boards should be encouraged to have documentation in support of any material variations to the assessment approach within the policy and to monitor the level of risk. Material variations within the loans portfolio may also be a point of differing risk within the impairment risk assessment under AASB 9 provisioning requirements
Key changes in the requirements include:
1. APRA expects an ADI to undertake a new serviceability assessment whenever there are material changes to the current or originally approved loan conditions. Such changes would include
- a change of repayment basis from principal and interest to interest-only, or the extension of an existing interest-only period.
- a change from a fixed-rate basis to a floating-rate basis (or vice versa), or
- an extension in the tenor of the loan are other examples of material changes.
- any change that increases the total repayments over the life of the loan, even when immediate periodic repayments are lower than under the previous loan conditions.
This reassessment will add to management costs in the management of mortgage loans. 
2. The term Net Income Surplus (NIS) has replaced the Debt Service Ratio (DSR) as the preferred measurement criteria to overcome the issues of the ratio being impacted by the scale as the income rose. 
3. APRA expects that any material changes to an ADI’s serviceability policy would be analysed and the potential impact on the risk profile of new loans written would be reported to appropriate risk governance forums. 
4. It would be prudent for ADIs to monitor the level of, and trends for, lending to borrowers with minimal income buffers. High or increasing levels of marginal borrowers may indicate elevated serviceability risk. 
This will introduce a requirement to retain data relevant to the Net Disposable income when assessments (and reassessments) are carried out. For ADIS that don’t carry this data in the loans assessment systems or the core banking systems at present, a change in systems may be necessary to implement without undue costs.
5. Documenting the minimum interest rate assessment requirements informally applied over the past 2 years
- APRA expects that ADI serviceability policies should incorporate an interest rate buffer of at least two percentage points. A prudent ADI would use a buffer comfortably above this level. …. 
- Prudent serviceability policies should incorporate a minimum floor assessment interest rate of at least seven per cent. Again, a prudent ADI would implement a minimum floor rate comfortably above this level. 
6. APRA expects ADIs to fully apply interest rate buffers and floor rates to both a borrower’s new and existing debt commitments. APRA expects ADIs to make sufficient enquiries on existing debt commitments, including consideration of the current interest rate, remaining term, outstanding balance and amount available for redraw of the existing loan facility, as well as any evidence of delinquency 
7. Prudent practice is to apply discounts of at least 20 per cent on most types of non-salary income; in some cases, a higher discount would be appropriate. 
8. For investment property assessment, APRA restates and expands its position on serviceability criteria –
- In APRA’s view, prudent serviceability policies incorporate a minimum haircut of 20 per cent on expected rental income, with larger haircuts appropriate for properties where there is a higher risk of non-occupancy.
- A prudent ADI would also account for a borrower’s investment property-related fees and expenses (e.g. strata requirements), for example, by including property expenses in estimates of living expenses or by deducting property expenses from expected net rental income.
- Good practice would be for an ADI to place no reliance on a borrower’s potential ability to access future tax benefits from operating a rental property at a loss 
9. APRA has confirmed its concerns over the use of indices to assess the borrowers capacity to repay by cautioning the use of such Indices
- Reliance solely on these indices generally would therefore not meet APRA’s requirements for sound risk management. APRA therefore expects ADIs to use the greater of a borrower’s declared living expenses or an appropriately scaled as a more representative measure of their actual living expenses than version of the HEM or HPI indices.
- Prudent practice is to include a reasonable estimate of housing costs even if a borrower who intends to rely on rental property income to service the loan does not currently report any personal housing expenses (for example, due to living arrangements with friends or relatives). 
10. Implementing appropriate monitoring of overrides such as non standard terms and conditions or policy assessment criteria
- any loan approved outside an ADI’s serviceability criteria parameters should be captured and reported as an override. This includes loans where the borrower is assessed to have a net income surplus of less than $0 (even if temporary) or where exceptions to minimum serviceability requirements have been granted, such as waivers on income verification. 
- (including acceptable reasons for an override) and an oversight mechanism to monitor and report such overrides.
11. Loans to self-managed superannuation funds have been added as a loan segment in the guidance for clarity on the legal risks of such loans and treatment within the capital risk weight under APS 112
- For the purposes of Prudential Standard APS 112 Capital Adequacy: Standardised Approach to Credit Risk (APS 112), loans to SMSFs that are secured by residential mortgages (SMSF loans) are to be treated as ‘non-standard’ eligible mortgages. 
The majority of these changes in many ways, reflect the discussion that many APRA representatives have preferred over the past 2 years in the credit risk assessment reviews at clients. There should be no surprises in the changes and many have implemented the majority over recent years. The two areas of most concern will be:
- The requirement to assess all loans including other lenders loans when a loan is initially being assessed, and on any reassessment. The costs of gathering the data and validating its accuracy will add to the time of managing the loans book;
- The capture of the Net Income Surplus (NIS) for analysis and measurement of impairment risks will need to be implemented as a specific project to recover past data or reassess the loans on a change in the loan product terms.
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