How home load stress tests work

One mortgage broker describes banks’ stress tests as a ‘black box’ to outsiders. The results of an investigation are in but not yet released, writes Geraden Cann.



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In the past two weeks, some banks have jacked up the interest rate that home loan borrowers are stress tested at, signalling an expectation that interest rates will reach a higher peak than previously predicted. Even for those working closely with the banks, specifics of how the testing is done is a mystery, and the Government recently concluded an inquiry into how banks were conducting their lending. Glen McLeod, the director of Edge Mortgages, described the stress testing process as a ‘‘black box’’, where the finer details of the process and the standard by which borrowers were assessed were not fully known. The responsible lending rules that affect mortgage assessments changed in December after changes to the Credit Contract and Consumer Finance Act (CCCFA) came into force. The change precipitated a sharp drop in home loan lending by banks. The reduction was so sharp, Commerce and Consumer Affairs Minister David Clark accused banks of failing to abide by responsible lending laws before December, summoned bank chief executives to face-to-face meetings to explain, and ordered an inquiry into whether banks have overreacted to new lending laws. The Government has since announced a relaxation of some of the new CCCFA rules when applied to home loan lending, and Clark remained tight-lipped on the result of the inquiry. ‘‘I’ve received the final report from officials and the Council of Financial Regulators on the initial implementation of changes to the Credit Contracts and Consumer Finance Act,’’ he said. Decisions on the Government’s next steps would be made by June 30, Clark said. Banks stress test at different rates Banks stress test home loan borrowers at different rates. For ASB, the serviceability rate now sits at 7.35%, while Kiwibank increased its stress testing rate to 7% on Monday. ANZ, the country’s largest lender, is now stress testing at 7.15%. Westpac chief executive Catherine McGrath said the bank stress tested 2.5 percentage points above the rate borrowers were applying for. McLeod said the test rate figure was only half of the assessment, and banks had other criteria that had to be satisfied before granting a loan. The differences in testing rate were probably because of the different formulas each bank used. He said mortgage brokers spent a lot of time jumping between different bank calculators to see which would be the best option for clients. The reason for some results was not always obvious. He recently assessed a small family, inputting their monthly living expenses at just over $3000 after looking at their accounts, but the calculator increased the figure to more than $4400. ‘‘I don’t know where the added expense comes from,’’ McLeod said. ‘‘We never get to see that background. We only get to see the front end of the operation; we don’t see how they calculate it in the confines of their affordability calculators.’’ None of the banks approached were willing to share details of their assessment processes, and some banks did not disclose their test rates publicly. History of not intervening Last November the Reserve Bank sought feedback on creating a floor on the test interest rates – a tool that is used in other countries. In Australia, since October last year, banks have been required to stress test at 3 percentage points above the rate lent out at, and in Norway it was 5 percentage above the prevailing interest rate, according to the report. In New Zealand, banks set their own test interest rates, and the Reserve Bank considered a couple of alternatives, including as hard floor, such as that banks must test at a rate of 7%, or as a margin or buffer above current lending rates. After consultation with banks, industry and community groups, the Reserve Bank decided not to pursue any kind of floor, instead focusing on designing a framework to implement debtto-income (DTI) restrictions. The Reserve Bank also considered a floor for stress testing rates in 2017, when it also looked at DTI ratios. But both were scrapped as house price inflation slowed. Two years later, New Zealand experienced the fastest house price increases on record. Reserve Bank financial system analysis manager Chris McDonald refuted the idea the bank had become reactionary. The central bank has had loan-to-value ratio requirements in place since 2013, and it was preparing a DTI tool that could be put in place quickly if required, he said. McDonald said banks’ debt serviceability assessments needed to meet the responsible lending requirements set out under the CCCFA. ‘‘This includes ensuring there is a sufficient income buffer after non-discretionary expenses so that borrowers are able to afford the debt even if things change over time,’’ he said. The Reserve Bank’s May Financial Stability Report noted the risk of debtservicing stress, or negative equity, was low for most mortgage borrowers. However, it said recent borrowers who took on large mortgages relative to their incomes would incur significant debtservicing costs if mortgage rates were to rise above those test rates.