Responsible Lending

Responsible Lending

Philip Field, Bae Bastian, Carolyn Dea and Ken Moran

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.

NCCP Changes

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.

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.

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.

Responsible Lending

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

FOS Terms of Reference (TOR)

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

FOS’ Approach

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

Individual and Small Business

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

Low Doc Lending

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

Low Doc Reasonable Inquiries

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

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)

IDR Approach to a Maladministration Dispute

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?

Case Manager’s Perspective

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

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


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)


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?

Case studies

Case study 1Home purchase and bridging finance

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

Background

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

The complaint

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

FSP’s response

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

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


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


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


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

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

Outcome – FOS assessment

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

Outcome - settlement

Case study 2Residential investment lending

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

Background

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

The complaint

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

FSP’s response

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


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

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

Outcome – FOS assessment

Case study 3Investment lending – Releasing equity

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

Background

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

The complaint

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

FSP’s response

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


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

FOS assessment

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

Outcome

Responsible Lending

Documents

Transcript of Responsible Lending