UBS: Liar Loans will come back to haunt the big banks

The banks and regulators have downplayed the impact of liar loans and a credit crunch but UBS believes they are wrong to dismiss these risks.

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You can add "liar loans" to the growing list of headwinds buffeting the banking sector, according to UBS, as the broker is convinced that this issue hasn't been properly addressed as claimed by the big banks and the banking regulator.

Liar loans refer to mortgages that have been granted based on inaccurate information where borrowers would inflate their income and/or downplay household expenses in order to gain bank approval or borrow more than they would otherwise be able to.

This issue was flagged months ago but the market largely believes it's no longer an issue with Westpac Banking Corp (ASX: WBC) paying a $35 million fine this week for not properly accounting for borrowers' ability to service the loan.

Westpac had also reassured investors that it had changed the way it audits loan applicants and that the negative impact of more restrictive lending practices is already accounted for in its past results. This view had been supported by the Australian Securities and Investments Commission (ASIC).

However, the latest survey by UBS on 1,008 Australians who have taken out a housing loan in the last 12 months contradicts this belief.

The broker has been doing this survey for the last four years.

"Across the entire 2018 Vintage we found only 68% of respondents stated their mortgage application was 'completely factual and accurate'. This is not statistically significantly different from prior years," said UBS.

"However, in the final quarter of the survey (April-July 2018) there was a statistically significant increase in mortgage accuracy. During 4Q a record 76% of respondents stated they were "completely factual and accurate", up sharply from 65% in the prior 3 quarters."

What's more, there was a big increase in the number of respondents who found the application process "much more difficult" in the latest quarter as they were required to produce "much more" documentation and verification.

These tougher restrictions since April coincide with the start of the Banking Royal Commission and UBS claims that this means the efforts by the banks and the banking regulator, the Australian Prudential Regulation Authority (APRA), have been largely ineffective.

"While APRA recently stated 'the heavy lifting on lending standards has largely been done', from a customers' perspective we believe this survey provides compelling evidence that tightening is accelerating, not peaking," added UBS.

Liar loans are not just specific to Westpac. Commonwealth Bank of Australia (ASX: CBA) has also been caught up in this and it's a given that Australia and New Zealand Banking Group (ASX: ANZ) and National Australia Bank Ltd. (ASX: NAB) would be impacted too.

What the broker is really saying is the risk of a credit crunch is rising – not receding like what the banks and APRA would like the public to believe.

If this is true, perhaps liar loans aren't the only exaggerations investors should be wary of.

This only reaffirms my belief that we should stay underweight banks. There are better opportunities elsewhere.

Motley Fool contributor Brendon Lau owns shares of Australia & New Zealand Banking Group Limited, National Australia Bank Limited, and Westpac Banking. The Motley Fool Australia owns shares of National Australia Bank Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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