Responsible Lending

1. Responsible Lending Philip Field, Bae Bastian, Carolyn Dea and Ken Moran

2. NCCP Changes • The National Consumer Credit Protection Act (NCCP) has had five major impacts on dispute resolution: • Licensing; • Responsible Lending; • Credit Guide; • Default Notices; and • Financial Difficulty.

3. Responsible Lending • The NCCP introduces requirements on credit providers and those providing credit assistance to ensure that the loan is “not unsuitable”. • These obligations started on 1 July 2010 for all licensees and representatives except Authorised Deposit-taking Institutions (ADIs) . • Responsible lending obligations for ADIs started on 1 January 2011.

4. Responsible Lending • After making reasonable enquiries, a person providing credit assistance must make a preliminary assessment about whether the contract or change to the contract will be unsuitable. • This applies to both intermediaries (brokers) and credit providers. The assessment must be made no more than 90 days before the credit is provided. • A loan or increased credit limit arranged by a credit provider may be unsuitable if: • the consumer could not comply with their financial obligations under the contract, or only with substantial hardship; or • the loan will not meet the consumer’s requirements and objectives.

5. Responsible Lending • The impact of the Responsible Lending obligations will not in themselves have a significant impact on FOS. • FOS and one of its predecessor schemes have long had jurisdiction to consider and resolve disputes involving “maladministration” in lending, • The Responsible Lending provisions, in my view, replicate the common law obligation to act as a diligent and prudent lender, while requiring that lenders be more careful about the process involved in making that assessment.

6. FOS Terms of Reference (TOR) • Paragraph 5.1: FOS may not consider a dispute about an FSP’s assessment of the credit risk imposed by a client or the security required for a loan – but this does not prevent FOS from considering a dispute claiming maladministration in lending, loan management or security matters • Maladministration: “An act or omission contrary to or not in accordance with a duty or obligation owed at law or pursuant to the terms (express or implied) of the contract between the Financial Services Provider and the Applicant” • The NCCP obligations are a duty owed at law in lending, loan management or security matters and therefore a dispute about whether an FSP breached those obligations is within FOS’s TOR

7. FOS’ Approach • When deciding a dispute, the TOR require FOS to do what in its opinion is fair in all the circumstances, having regard to: • Legal principles • Applicable industry codes or guidance as to practice • Good industry practice, and • Previous relevant decisions of FOS or a predecessor scheme (although FOS will not be bound by these) • Therefore, our approach to responsible lending and maladministration disputes takes into account: • The NCCP • Any case law on the NCCP as it is developed by the courts • ASIC’s guidelines • Industry codes and practice (e.g., Code of Banking Practice (CBP), Mutual Banking Code of Practice (MBCP)) • Our past approach to claims of maladministration in lending

8. Individual and Small Business • FOS can consider a dispute by an Applicant who is an individual or a small business • Small business is defined in the TOR as a business which, at the time of the FSP’s act or omission which gave rise to the Dispute: • If the business is or includes the manufacture of goods, had less than 100 employees; or • Otherwise, had less than 20 employees • Subject to our monetary limit of $500,000 and our compensation cap of $280,000, we will consider a dispute about an FSP’s lending decision, even though the credit contract may not be regulated under the NCC. • Our monetary limit and compensatory cap are based on the amount of the applicant’s claim, not the amount of the facility

9. Low Doc Lending • Low doc lending caters for those self-employed clients who are unable to provide traditional evidence of their income. • FOS considers that the NCCP does not prevent low doc lending, so long as adequate inquiries are made and the responsible lending provisions are satisfied. • No doc lending as a general practice is unlikely to be sustainable given the NCCP obligations • In our view, low docs loans should not as a general rule be provided to PAYG employees

10. Low Doc Reasonable Inquiries • Self certification by a borrower will not protect an FSP, especially if the circumstances were such that the FSP ought to have made inquiries but chose not to do so • Business income may be verified by • An ABN search to confirm the length of time the Applicant has been in business • BAS statements • Occupation and sources of income may be contradicted by identification provided for FTRA purposes, requiring further inquiry • E.g., A self-funded retiree provides a pension card for identification • A false declaration, whether made knowingly or inadvertently, is a relevant factor to be taken into account, but does not absolve the FSP totally from liability • In some cases where an Applicant has provided a false declaration, we may apportion liability and reduce any compensation accordingly

11. IDR Approach to a Maladministration Dispute • If you get a complaint, give it due and proper consideration. • Don’t just go into “defend at all costs” mode. It is best to avoid an adversarial approach. • Critically review your organisation’s decision in light of FOS’s decision-making criteria • If a regulated contract, did it meet its obligations under the NCCP? • Have reference to industry codes and guidelines, such as ASIC’s guidelines, CBP and MBCP • CBP and MBCP also reflect good industry practice • FOS Circular No. 5 has case studies showing our approach to previous disputes

12. IDR Approach to a Maladministration Dispute • If your organisation has made a mistake, put your hand up, say sorry and fix it up. • The intention is to put the Applicant in the position they would have been in if not for your organisation’s error • Be innovative in your approach as circumstances may prevent restoration of the Applicant’s pre-loss position (e.g., property may have been sold)

13. Case Manager’s Perspective • Loan Application • Was it fully completed/was the information correct/did it make sense? • Was the FSP on notice of any problems with the application? • What does the application show about serviceability? • Did it conflict with info already held by the FSP? • Loan purpose & structure • Did the loan structure align with the purpose? • Supporting documentation & verification • Did the FSP obtained the information it required under its policies and verified it – if not, what is missing? • Credit assessment and approval • Did the FSP raise questions about the application? • Did the approval comply with policy? • When did the loan fall into arrears?

14. Banking Specialist’s potential red flags • Income • Incorrect use of income, the use of which is restricted by a bank’s internal policy – eg Family tax benefit A & B, Workcover payments or child maintenance • Conversion of weekly/fortnightly salary or wages to monthly income incorrect • Single payslip income adopted even when inconsistent with YTD amounts • Use of overtime or commission not discounted as per bank policy • Rental income not verified in terms of bank policy or incorrectly adjusted for holding costs • Add-backs incorrect or inappropriate for assessment of self-employed income

15. Banking Specialist’s potential red flags • Expenses • Credit cards not included in commitments or not at correct level (based on current balance not limit) • Credit card debts not repaid and facility cancelled, despite information contained in application to contrary • Continuing rental expense not taken into account with land loans or investment property purchases • Living expenses understated or based on incorrect family unit assumptions • Interest only credit assessment of lines of credit or overdraft type debts when P&I amortisation over 25/30 years more appropriate

16. Banking Specialist’s potential red flags • Others • Evidence of other external debt overlooked ( eg outside institution credit card tendered as part of 100 point identification but not disclosed in application) • Bridging proposals – inadequate assessment of residual debt servicing or inadequate allowance for interest capitalisation • Low doc loans – incorrect, misleading or incomplete information • Age of applicants in relation to excessive term approved (especially low doc loans)

17. Case studies • Did the FSP make reasonable inquiries? • Did the FSP approve the loan application within its guidelines? • Did the customer have capacity to repay the loan without undue hardship? • If maladministration, what would be the outcome? • What other outcomes would be fair?

18. Case study 1Home purchase and bridging finance

19. Background • E and T were pensioners and each owned a home • They obtained bridging finance to purchase a home together, on the basis that they would sell their individual homes within six months • They refinanced with FSP when their existing lender declined an application for an additional $40,000 • The dispute concerned additional funding FSP provided over the next 18 months

20. The complaint • Cost overruns, applied for further funds • Neither house sold within 12 months, applied for further funds • FSP advised them not to accept an offer • Both properties were only sold 3 years later • FSP restructured the residual debt into a 30 year loan, with monthly repayments of $851, which they cannot afford

21. FSP’s response • Initially approved bridging finance to refinance existing commitments and provide $40,000 for pool construction • Subsequently approved an additional $117,000 over 18 months to 2 years • E and T applied funds to other purposes • No advice regarding offers • Offered 3 months without interest

22. Information obtained from investigation • Initial loan application showed only 77 cents in savings • Bank valuations markedly less than E and T’s estimates, and expressed caution in market • FSP’s guidelines on bridging finance only allowed the facility for existing customers • Loan application was initially declined and referred for manual assessment • E and T required to sign undertaking to sell

23. Information obtained from investigation • April 2006 application made when neither existing property had sold • Funds again needed to complete pool and cover interest • Cash reserves were in fact residual of initial advance

24. Information obtained from investigation • August 2006 advance was processed when neither existing property had been sold • Funds needed again to complete pool • Approval on basis of refinance to include security over new home • Condition that valuations be obtained, but FSP only obtained valuation for one existing property • Loan term for one year with interest only repayments

25. Information obtained from investigation • October 2007 advanced processed when only one existing property had been sold • Loan amount increased to provide funds to service the loan • Did the customer have capacity to repay the loan without undue hardship? • Condition that valuations be obtained, but FSP again relied on January 2006 valuation

26. FOS assessment • No further finance should have been provided until existing properties had been sold • Decisions for all further advances were maladministration in lending • Funds provided to service loans should have been applied against loans rather than to E and T’s account • Given E and T’s monthly income, it was evident that any finance was meant to be short term, with equity in existing properties clearing the debt, but this was depleted

27. Outcome – FOS assessment • E and T would still be liable for pre-existing bridging finance • E and T also needed to account for benefit from pool construction, home improvements and general living expenses, but without interest • E and T should be reimbursed for costs of refinance and own contributions to interest payments • If E and T could not service recalculated debt, the new home would have to be sold

28. Outcome - settlement • Debt reduced from $145,000 to $90,000 in recognition of costs E and T incurred • Debt of $90,000 represented benefits they derived • E and T repay debt without interest over life of loan • E and T’s monthly repayments of $278 were affordable on their pensions

29. Case study 2Residential investment lending

30. Background • Broker sourced V’s details from default listing • Broker offered finance to consolidate debts and purchase investment property • Broker completed loan application, disclosing V’s income at $60,000 with supporting employment information • FSP provided $80,000 for debt consolidation and $250,000 for investment property • V received rental income until broker said he would be realising investments • V has received no further rental and the property is vacant

31. The complaint • V said she was a Centrelink recipient, supplementing her benefit by selling produce at the local market • V’s income is less than $15,000 p.a. – income details on loan application were false • She did not sign the loan application • V accepted liability for $80,000 debt consolidation • V said she should not be liable for the $250,000 investment loan

32. FSP’s response • Application was introduced by an introducer affiliated to a mortgage manager • FSP paid commission to mortgage manager, had no relationship with introducer or broker • V’s application was assessed in accordance with its policies and procedures, including telephone call to V’s employer • V’s verified income was sufficient to service her loans even without rental inocme • V was liable to repay both loans

33. Information obtained from investigation • V’s signature on loan application likely to be forged • Loan application and employer details showed relationship between broker, introducer and employer • FSP’s guidelines said preferred verification of income was by way of bank statements • FSP’s lending approval did not show any inquiry about where V’s stated income was being deposited • FSP had relied on fraudulently raised letter of employment and then phoned fraudster for confirmation

34. FOS assessment • If FSP had sought V’s account statements as its guidelines required, the fraud would have been uncovered and the loans not granted • Loans totalling $330,000 were maladministration in lending • V had received benefit from $250,000 because she had an investment property and had received rental income from broker • No apportionment of liability as V was unaware of the fraud being perpetrated against her and FSP

35. Outcome – FOS assessment • V’s investment property should be sold at FSP’s cost and FSP would bear any loss • V was liable for $80,000 loan with interest and had to account for rental income • All loan repayments should be applied in reduction of $80,000 debt • If the reconstruction resulted in the $80,000 debt being satisfied in full, any excess had to be refunded to V

36. Case study 3Investment lending – Releasing equity

37. Background • Mr and Mrs B were self funded retirees whose assets included share investments • Financial adviser recommended Mr and Mrs B obtain a loan to establish an investment, and then approached FSP on their behalf • Loan application completed by adviser was inaccurate • FSP provided a loan of $210,000 which was repaid when Mr and Mrs B sold their home • Mr and Mrs B want $210,000 refunded

38. The complaint Mr and Mrs B said: • FSP was aware of their investment strategy and they could only afford repayments from dividends • They were unaware of the risks of a low doc loan • FSP engaged in asset based lending • They signed the LAF because they trusted FSP was looking after their interests as it would assess their application against prudent lending guidelines • They were forced to sell their home to repay the loan, and FSP should reimburse them

39. FSP’s response • LAF disclosed combined income $66,800 and assets $1,172,000 • Mr and Mrs B authorised FSP to deal with broker, therefore broker was their agent • FSP relied upon Mr and Mrs B’s declarations as to accuracy of information in assessing their application • Its low doc loans policy did not require a borrower to provide standard income verification, rather a declaration as to accuracy of information and self assessment of capacity to service • Acknowledgements also in loan offer

40. Information obtained from investigation • LAF disclosed: • Mrs B was employed part time • In approving the loan, FSP made Mrs B a co-borrower rather than a guarantor, and noted that affordability was not evident • FSP relied upon Mr and Mrs B’s declarations as to accuracy of information in assessing their application • Credit inquiry by FSP revealed an inquiry for a margin loan of $700,000 • Mr and Mrs B’s tax returns showed total income of $37,440 • Mr and Mrs B had an existing share portfolio of $116,000, and intended to increase their assets by using cash and a $600,000 margin loan

41. FOS assessment • Issue was FSP’s knowledge of the proposed entire transaction which involved a geared investment strategy • CRA report put FSP on notice of Mr and Mrs B’s strategy and intention to take a margin loan of around $700,000 • So FSP ought to have made further inquiries about Mr and Mrs B’s capacity to service all loans • If FSP had done so, the loan would not have been approved

42. Outcome • Matter settled with FSP refunding all interest Mr and Mrs B had paid on their loan, together with interest on that sum at term deposit rate, totalling $57,600