Submissions on the Responsible Lending Code Discussion Document

Submissions on the Responsible Lending Code Discussion Document Submitter: Jonathan Flaws, LLB (Hons) M.Jur A. Background I am a partner of Sanderson Weir, Auckland, a law firm that specialises in providing advice to mortgage lenders and finance companies. These submissions are made on behalf of my firm. I have also made submissions on behalf of a client, Resimac Home Loans Limited and rather than repeat comments made in that submissions I would ask that they also be deemed to have been made on behalf of my firm. I am also admitted in Victoria as an Australian legal practitioner. I have been a member of the Documents and Precedents committee of ADLS Inc. for over 30 years and have been involved in the drafting of the ADLS mortgages, security documents and loan agreements that are used by many lawyers and lenders. My firm acts for a number of non-bank mortgage lenders and a reverse mortgage lender. In 2004 I provided the initial draft for the NZLS Reverse Mortgage Guidelines a guide designed to assist lawyers to advise borrower clients obtaining a reverse mortgage. In many respects the concept behind the Reverse Mortgage Guide (RMG) for lawyers is not dissimilar to the concept behind the Responsible Lending Code (the Code). The RMG is not intended to be prescriptive but to give guidance to lawyers advising clients on a form of lending that, in 2004, was new not well known to lawyers. Until recently, I was the responsible manager for a company that held an Australian Credit Licence as a servicer for reverse mortgage lenders in Australia. I have therefore become very familiar with the approach to responsible lending adopted by the Australian regulators. As a result, I have a close understanding of the operation of the credit laws in both countries and have seen, first hand, the implementation of the responsible lending regime in Australia. Given the nature of my firm s practice and clients, my submissions relate primarily to consumer credit mortgages. Comparison of Australian and New Zealand mortgage industry The greatest difference between the mortgage industry in Australia and New Zealand is the role of independent legal advice. In New Zealand, virtually every borrower receives this and, given the requirement for electronic mortgages to be signed and certified by conveyancing professionals, this is not going to change. The same is not the case in Australia and their version of electronic registration which is in the process of being implemented permits lenders to register mortgages without the borrower being required to obtain legal advice. One area of concern for me is to ensure that the following are clearly provided for and understood: 1

1. the division of responsibility between lawyers and lenders: It is important ensure that the role and responsibilities of lenders and lawyers is maintained and clearly understood in particular, ensuring that lenders do not feel obliged, in order to comply with the guidance in the Code to cross the line and provide legal advice to their borrowers or advise lawyers how they should advise their clients. This concern reflects comments made by Blanchard J in the Supreme Court in the case of GE Custodians v Bartle NZSC [2010] 146 at para. 49; 2. The division of responsibility between Advisers and lenders: A significant proportion (around 25%) of mortgages in New Zealand are originated through third party Advisers. It is also important to ensure that when any such Adviser is placed between the lender and the borrower, the roles and responsibilities of the lender and the Adviser submitting the application on behalf of the borrower are clearly understood. It would be counterproductive and contrary to the interests of consumers if a lender considered that the Code meant the lender had to rework and re-verify each piece of information provided by the Adviser on behalf of the borrower for the purposes of these submissions, reference to an Adviser is a reference to a registered financial adviser authorised to provide personal advice in relation to category 2 products under the Financial Advisers Act 2008; 3. To ensure that the steps a lender is required to take to assist the borrower to make an informed decision are appropriate to the particular borrower (or class of borrower) and the particular credit product being provided. Legal advice I have included in the Resimac submissions comments on the impact of legal advice in the mortgage industry in New Zealand. There is additional information that it appropriate for me, rather than a client to add to these comments. My firm accepts limited briefs from borrowers refinancing a mortgage to act solely in the administrative role of attending to the settlement, discharge of the old and registration of the new mortgage. I am satisfied that in these circumstances where we are dealing with borrowers who have been through the mortgage process before, who are refinancing existing debt for reasons other than debt consolidation and who have sought refinancing independently of us, it is not appropriate for us to review in detail the commercial wisdom of that transaction. This service is currently provide by a major bank and is also a service adopted by a number of financial advisers. In both cases, we have set out parameters that are understood by the bank staff and by the financial advisers as to when this limited brief service is not appropriate. In the case of financial advisers, we go through a process to accredit these advisers so that we can be sure they understand the parameters. The Code should therefore anticipate that reliance on the delegation to lawyers may well be scalable depending on the requirements and objectives of the borrower. Lender will always retain responsibilities for ensuring the loan can be repaid without substantial hardship, notwithstanding legal advice. If the loan is merely refinancing, the lender, should still enquire and be satisfied that the borrower will benefit from the transaction. As to any other objectives, if the borrower obtains legal 2

advice, the lender should be able to rely upon that fact as evidence of the loan meeting the borrower s requirements and objectives. Summary Providing for lenders, when lending on residential mortgages, to rely upon lawyers and Trusted Advisers in the circumstances described above and in the submissions made on behalf of Resimac will not complicate the lending process. This activity is already happening and the above provisions, if incorporated into the Code, will reflect an existing position. Nor will it make the credit process unduly burdensome from a cost or compliance perspective. In contrast, if this provision is not made, many lenders may consider that in order to be compliant, they will need to make their own inquiries and undertake their own verification and provide additional assistance to borrowers. The duplication of these activities will become unduly burdensome and costly and will impact the availability of mortgages. B. response to questions raised in the Discussion Document 1. Do you agree with the proposed criteria for assessing what guidance should be set out in the Code as set out in paragraph 18? Should retaining sufficient flexibility to allow lenders to adapt the guidance to different products and business models be another criterion? Are there any other key criteria to be considered? I agree with the proposed criteria and also with the concept that sufficient flexibility must be retained to allow lenders to adapt the guidance to different products and business models. In the credit industry one size most definitely does not fit all as some consumers will require more assistance and some will require less. (c) The classic example here is reverse mortgage borrowers. By their very nature they are a vulnerable class and a lender must take greater care and responsibility when dealing with this class. Interestingly, I believe this is a class where the industry itself has already gone to great lengths to imbed this principle in its operations. On behalf of lenders, SHERPA has been established as a reverse mortgage industry body and has set out its own guidelines and requirements to which members of SHERPA must adhere. Rather than replicate these principles and guidelines, the Code could provide the flexibility for a lender to be compliant with the Code if it is a member of an approved industry body and also adheres to the Guideline s and principles of that body. Similarly, a lender who makes it mandatory for their borrowers to obtain legal advice from a lawyer who has been provided with the NZ Law Society Guidelines should also be taken to have complied with parts of the Responsible Lending Code. In line with my opening comments, I believe it is essential to include as a key criteria promoting understanding of and adherence to the responsible lending obligations of all intermediaries in consumer credit contracts whether acting on behalf of the consumer or the lender. Questions 2-14 Please see my submissions on behalf of Resimac 3

Assisting the borrower to make an informed decision 15. Apart from complying with disclosure obligations, how do/should responsible lenders assist borrowers to understand the terms of the credit agreement? How should any guidance cover different modes of providing credit? (e.g. online applications) Should certain information be required to be given orally for face-to-face or telephone interactions with customers? In addition to the submissions made on behalf of Resimac I would comment as follows: The fundamental proposition is that disclosure is not the same as understanding. Indeed, in the case of a mortgage, disclosure of all of the terms may not, in fact, assist borrowers to understand the terms of the credit agreement they are entering into. The general terms plus the security terms in the mortgage memorandum are by their nature long and exhaustive. It is unlikely that any borrower ever reads or can be expected to fully understand all of the terms disclosed. If a mortgagee chooses to adopt the terms implied in a mortgage as set out in the Property Law Act 2007 (which is not a bad practice as these terms are now extensive, cover all key protections for a mortgage and are in clear language) then disclosure is not required as they are terms implied by law. The Act does not require disclosure of terms implied by law. Generic financial literacy My personal view in this area is that in the mortgage industry, more credence should be given to the position of confirmed comprehension. By confirmed comprehension I mean that if a borrower has undertaken some form of training and is able to confirm that he/she has completed the training and understood the basic generic principles of financial management and financial responsibility then the lender should be able to rely upon that confirmed comprehension as countering the need to provide any additional assistance to make an informed decisions. For example, some banks offer seminars to their customers on budgeting and financial literacy generally. If these include information on mortgages, how to determine what is an appropriate and safe amount to borrow without incurring substantial hardship, then a borrower who has participated in these seminars is better equipped to make an informed decision. If at the end of the session the borrow completes some form of question and answer test and this indicates the borrower understood the information presented, then the lender is in an even stronger position to determine that the borrower knows what he/she is doing and is equipped to make an informed decision. My preference would be for such generic financial information to be provided by an external provider rather than by the proposed lender. There are now online learning sites that specialise in providing financial tutorials and certifying completion and understanding once the tutorial is completed. It may be that the Commission for Financial Literacy and Retirement Income can include such tutorials on its website. I am not submitting that this should be mandatory in all cases or even for borrowers obtaining a mortgage for the first time. I believe it would be appropriate, however, for the Code to recognise the concept of a Responsible Borrower and allow lenders dealing with such a borrower to accept that additional assistance to make an informed decision is not required if they are dealing with such a person. Subject of course to the caveat that if there are reasonable grounds to believe that the person is not a responsible borrower e.g. it is clear that the confirmed comprehension results are those of another person then the lender cannot accept the person as a responsible borrower. 4

It may be, that in some instances where a lender determines that the borrower could only repay with hardship e,g. high borrowing and high LVR that lender be encouraged to recommend that their client s become responsible borrowers before they accept the loan. This may well help the lender to make a determination in extreme cases where a borrower puts pressure on the lender to allow the advance to proceed when the lender has a borderline call to make on whether the hardship likely to be incurred is sustainable or substantial. In this way the tension between ensuring lenders are responsible and not making credit unduly difficult to obtain may be met. (c) Non mortgage credit lending The previous comments are related solely to mortgage lending. Assistance in relation to other types of lending will vary. This responsibility is clearly scalable. In many cases where the loan is smaller it may be that a standard approved borrowing guide is given. This is the same concept as required in the real estate industry where an agent is required to ensure that both the purchaser and lender are provided with an approved guide. The approval being provided by the Real Estate Agents Authority. It could be appropriate for the Ministry of Consumer Affairs to publish or approve a borrowing guide. This could be a one page information sheet that is given to all borrowers under certain types of credit contracts. (d) The question asks how guidance can be given in relation to online applications. Again, targeted solely to mortgages, the Code could require the borrower to download standard financial literacy information before submitting the application. Alternatively, my comments in paragraph regarding online confirmed comprehension may apply. It may be that in order to submit an online application, the borrower could be asked to complete a brief test to confirm comprehension of basic financial literacy and budgeting principles. The results of the test should not prevent the borrower from proceeding further but if the results do not indicate the borrower is beyond the threshold of a responsible borrower then the lender will be aware of that. The lender could be encouraged to either recommend the borrower undertake such online tutorials or in extreme cases, make the loan approval conditional upon that occurring. I understand that in the United States, in response to the lending issue highlighted with sub-prime mortgages as a result of the financial crisis, regulations were passed requiring borrowers of certain types of mortgages to obtain financial counselling before the loan could be drawn down. In my view, that is an over-reaction. There are better and more appropriate ways in which to achieve the same end the creation of a responsible borrower. (e) There is a danger in requiring information to be provided orally. This is because the message can change and be slanted. There is also no record of the information being provided. To the extent that any information is required to be given it must be in a form that is consistent. An online video or animated information or a written statement is evidence of a consistent delivery of information. Whether information is disclosed/given in writing, face to face or by a telephone, the fundamental issue remains - disclosure is not comprehension. Putting information in front of a person achieves compliance for the lender but does not guarantee understanding by the borrower. Even face to face may not achieve this. When presented with a large amount of information, most 5

people go quickly into information overload and the ability to absorb, let alone understand, what is being said is prejudiced. Questions 16-19 Please see the Resimac submissions 20. Can you point to good examples of credit agreements that are in plain English, clear, concise and intelligible? There has been much written on the subject. One book is Simple by Alan Seigel and Irene Etzkorn. The author Alan Seigel re wrote a credit contract for Citibank and has since established a consultancy that assists financial institutions to simplify their communications and contracts. Questions 21-27 Please see the Resimac submissions Making Reasonable Inquiries 28. What information do/should responsible lenders require from a borrower when they apply for credit? How much reliance should a lender place on a credit check? The nature and extent of information required from a borrower when they apply for credit will be scalable depending on the amount and the type of credit requested. Reverse mortgages (c) (d) (e) (f) Information required from a reverse mortgage borrower where the lender is providing a no negative equity guarantee or a lifetime occupancy guarantee, will be different, and less than that required for a prime mortgage under which the borrower covenants to repay the loan over a period of years. A no negative equity guarantee refers to the guarantee given to the borrower by the lender hat the borrower or the borrower s estate will not be required to repay more than the amount available from the proceeds of eth sale of the property on fair market terms. Under a reverse mortgage, there is no personal covenant to repay. The amount of the loan is calculated based on the LVR and the age of the youngest borrower to ensure that, according to standard mortality tables, on the borrower s death the principal sum plus capitalised interest and fees will not exceed the value of the property. The borrower under a reverse mortgage, however, still retains an obligation to pay rates, insurance premiums and maintain the property to a reasonable standard. To this extent it is appropriate for a reverse mortgage lender to make inquiries and obtain information relating to the financial position of the borrower. Failure to meet these outgoings may result in default under the loan. Although reverse mortgages tend to provide much softer provisions in the event of default than a prime mortgage, if a default continues and the no negative equity guarantee is likely to be called upon as a result of non-payment of these outgoings, the lender may still retain a right to call default and take action to obtain repayment of the loan from the sale of the home. A lender prosing to lend under a reverse mortgage should therefore obtain sufficient information to confirm that the borrower will be able to pay the basic outgoings in respect of the property. The Australian responsible lending regime deferred providing guidance in respect of reverse mortgages until early 2013. The provisions contained in the NCC regarding reverse mortgages are overly prescriptive. Given the small number of reverse mortgage lenders in New Zealand and the relative small size of that market, I would submit that the Code should simply provide that if a reverse mortgage lender is a member of SHERPA and adheres to the code of practice published by SHERPA then compliance with that Code will be deemed to be compliance with the Code. 6

Questions 29-39 Please see the Resimac submissions 40. Do/should responsible lenders engage in lending that relies primarily or solely on the value of any security provided by the borrower? asset lending for the sake of it is not an acceptable practice and as far as I am aware is not engaged in with respect to consumer loans other than reverse mortgages. even in the case of reverse mortgages, while the value of the property is a prime determinant of the maximum loan amount, the loan is not approved solely on the basis of the value of the property. The other factors referred to in the SHERPA Guidelines and in the NZ Law Society Reverse Mortgage Guidelines must also be taken into account. Questions 41-47 Fees Please see the Resimac submissions 48. What practices should lenders follow in order to set a fee that is not unreasonable? Lenders should determine for themselves whether their fees meet the tests for unreasonableness. The Code may well explain some of the elements but the provisions of the Act should be paramount. As a matter of course, in my experience, mortgage lenders go to great lengths to review their fees and ascertain that they meet the required statutory tests. In the case of Resimac, its audit, risk and credit committee has procedures in place to review fees and ensure they meet the required tests. 49. What costs should the lender be able to recover through establishment fees (e.g overheads, administration costs)? Section 42 is specific as to what can be included within the scope of establishment fees. The High Court has provided its interpretation and that interpretation is currently under appeal. The Act has not amended section 42. Given these circumstances and given that the Code is not binding, it should not in my view endeavour to extend or restrict the application of section 42 by additional commentary in the Code. If the current interpretation by the Court stands then that is sufficient clarity. If it is overturned then that decision too should give sufficient clarity. What is clear is that establishment fees are tagged to the contract in respect of which they are charged and are tagged to items that relate to that contract and its establishment. 50. What costs should the lender be able to recover through credit fees generally? The concept that underpins restricting costs to reasonable costs incurred or losses sustained by the lender is that lenders should recover profit and general overhead and administrative costs from interest. This has led to the narrowing of fees to specific costs that can be identified and allocated to a specific contract. (c) Many lenders have traditionally obtained lender s mortgage insurance (LMI) to cover the credit risk that is associated with certain classes of lending for example high LVR lending. That insurance has always been for the benefit of the lender and not the borrower, has always been a one-off cost incurred at the start of the loan, and has often been paid for by the borrower as a third party establishment fee. With the withdrawal of lenders mortgage insurers from the New Zealand market, this credit protection option is not available. The presence of this protection does benefit consumers for it may man that a loan that would otherwise not have been approved can be approved as a result of the credit enhancement. The presence of LMI does not remove the need for a lender to comply with all other requirements of 7

the Lender Responsibilities. It is a factor in the lenders credit criteria that permits a loan that would otherwise not have proceeded to proceed. (d) (e) (f) (g) In the absence of LMI insurers, some banks and lenders have charged a risk fee or a high LVR fee and have accepted the additional risk themselves. Some have added a risk margin to the interest rate. A fee of this type, however, cannot be said to be a cost or a loss directly incurred in relation to a specific loan. It is, however, a potential cost or loss to the business in respect of a particular class of loans into which a specific loan may fall. It has become an industry practice for some banks and lenders to charge such a fee. In my view, it is arguable that if a loan falls into a category of greater risk a lender should be entitled to agree to accept that risk in payment for a one-off fee rather than attempt to be recompensed for it by an increased interest rate. This is particularly so where that risk, if it were accepted by a third party, such as an LMI insurer, and the fee paid to that insurer can lawfully, be passed on as a reasonable credit fee. It is illogical that a fee is reasonable if paid to a third party but not reasonable if paid to the lender where that fee covers the same matter. Therefore, in a limited range of circumstances a lender should be able to recover what would otherwise be a class fee payable for accepting a greater risk associated with that class where it can be demonstrated: (i) (ii) (ii) that risk is real and can be quantified (in this case by a higher historical default rate by loans within that class); that risk could be passed off to a third party and the fee for the acceptance of that risk could be charged as a reasonable fee to the borrower; it is within reasonable standards of commercial practice for lender to act in this manner. A fee of this type falls within the provisions of the new section 44. If it is acceptable under section 42 that an establishment fee can include the creditor s internal costs in relation to the processing of a credit application, then it must also be acceptable under section 44 that any cost incurred by the creditor includes internal costs in relation to administering risks that occur after establishment of the loan within a specified class of debtor. Reasonable standards of commercial practice can be applied in this case to determine whether the fee charged is reasonable. (h) For the above reasons I submit that the Code should clarify that a fee may be charged under section 44 if it meets the test that I have set out in paragraph (f) above. 51. What costs or losses should the lender be able to recover through default fees? The fundamental principle must be that borrowers who meet their commitments and perform in accordance with their credit contracts should not be penalised by paying an increased interest rate to cover the lender s costs of administering loan defaults. Applying this principle lenders should be able to recover all costs that are reasonably incurred in connection with a default. This includes internal administration costs as well as third party costs. 52. Are there any particular reasonable standards of commercial practice that should be taken into account when deciding whether a fee reasonably compensates the lender for a reasonable estimate of costs or losses incurred by the lender as a result of the borrower s acts or omissions? Registered banks are required to act in accordance with the Banking Code of Conduct. This code would be a good starting point for determining a reasonable standard of commercial practice. 53. How and when should fees be reviewed to ensure they remain reasonable? This will very much depend upon the fee and the nature of the creditor s business. For example, fees that are tagged to the business s administration costs are likely to be able to be 8

reviewed on an annual basis. Other fees that reflect costs incurred by the lender from external parties may well change at a different pace. 54. What is a reasonable amount of commission for a lender in relation to credit-related insurance? This is not a matter on which I can offer any comment. 55. Should the Code incorporate parts of the Commerce Commission draft guidelines on fees? What changes would be needed to those guidelines to reflect subsequent case law, views on unreasonable fees and changes to the CCCFA? No. The reason for this is that the Act provides the basis on which fees are reasonable or unreasonable and as has been demonstrated in the cases to date, the Courts have and will continue to determine any uncertainty in the interpretation of the Act. Were the Commerce Commission draft Guidelines to be incorporated into the Code then that would be the equivalent of the administrative arm defining and making the law rather than administering it. This is not to be taken as a suggestion that the Commissions views are necessarily wrong or unhelpful, simply that they remain their views and it is open for lenders to accept them or otherwise. A lender may act strictly in accordance with the Commissions Guidelines but nevertheless impose an unreasonable fee. A consumer should be free to challenge the fee regardless of the Commission s view. 56. What other matters should the Code address in relation to fees? See question 50. In limited circumstances the Code should clarify that a fee reimbursing specific costs associated with a class of lending as opposed to an individual contract. Default, enforcement and the end of a consumer credit agreement In my experience, mortgage lenders are fully compliant with the specific lender responsibilities in this area. The reason for this is that the amount in question is generally higher than other consumer lending and the consequences for both parties of not applying the principles can be severe. For example, most mortgagee sales of real estate occur where the LVR is high. This means that the risk to the lender of not recovering all of the loan from the proceeds of sale is high. It is commercially more effective to work with the borrower to restructure the loan so the borrower can meet the commitments than to race in and sell the property. In order to achieve a sustainable workout the lender must adhere to the lender responsibilities. For this reason I have no comments in relation to this section of the discussion paper other than to encourage the Code to focus on the overriding lender responsibilities without being overly prescriptive in explaining how they might be applied. 9