Mortgage origination: a brave new world

With funding drying up and compliance requirements increasing, the mortgage origination market faces an uncertain future. Janine Mace reports.

It has been a tough few years for participants in the mortgage market, with funding hard to come by and margins slashed. The future does not look like it will be any easier, even though the big banks are becoming more willing to lend and securitisation markets are slowly reviving.

Brokers are finding that the heady pre-global financial crisis (GFC) days of good margins and comfortable commissions are a distant memory. Add in a new and much more demanding regulatory environment under the National Consumer Credit Protection (NCCP) Act – with lenders and brokers required to undertake more checks before writing loans – and you have a very different working environment.

According to Deloitte Actuaries and Consultants banking partner, James Hickey, the competitive environment remains testing, particularly given that mortgage settlements fell in 2010 by around 10 per cent (compared to 2009 levels) due to the withdrawal of the First Home Owner Grant.

“Although 2010 was a slower year for settlements, encouragingly national settlements still averaged $20 billion per month of new lending, comparable to levels in 2007 prior to the GFC,” he says.

Tough competition is adding to the difficulties of a sluggish market. “Competition is rife among the big four as they aggressively chase market share and pull all the levers available to them to compete,” Hickey says.

“There were material price differentials across the big four in 2010 driven by distinct positioning strategies. This was a marked difference from pre-GFC where any price differential came from the non-bank lenders.”

Consumers are the key

Even though the market slowed last year, 2011 is predicted to see market conditions improve.

“This is due to rising consumer confidence and stable, relatively low interest rates. The market had hoped investors would return, but they have not returned. However, consumer confidence is keeping the market steady,” Hickey explains.

“The important aspect is overall consumer confidence in the economy, and if that remains strong, the market will do well.”

According to participants in the annual Deloitte Australia Mortgage Report: 2011 Reforming the Agenda, consumer confidence is far more important than competition in driving mortgage growth.

“Competition from the non-big four banks was not seen as being a key driver of settlement growth. There is very visible competition between the big four and the second tier banks due to greater funding access,” Hickey says.

Despite this, non-bank lenders have an important role to play in a truly competitive mortgage market, according to Mortgage and Finance Association of Australia (MFAA) chief executive Phil Naylor.

“How many of the non-bank lenders can get back into the market is critical,” he says.

“The big four have massive marketshare now – much higher than pre-GFC. Although credit unions and building societies are making a play in the market, it was the non-banks that really drove competition before the GFC. At the moment, the big four are circulating customers between themselves.”

The role of non-bank lenders is a major issue for the mortgage market, according to Advantedge Financial Services general manager for broker platforms, Steve Weston.

Advantedge currently has around 40 per cent of all mortgage brokers on its three platforms and sees one in six of the mortgages taken out in Australia.

“In the origination space, we have seen quite a change post-GFC in the percentage of business written by non-bank lenders due to the closure of the securitisation market. Even now when it has reopened, the cost of money is still expensive and it is hard to obtain a margin,” he says.

“While the non-bank mortgage providers have bounced back a little since the GFC, it is not to as a big a level as in the past.”

Naylor believes further recovery in the credit markets is vital to the return of a healthy mortgage market. “The securitisation market has not come back fully as yet and until that happens, the non-bank lenders can’t really re-emerge.”

Although the decision by the Gillard Government to ban exit fees on mortgages has been promoted as a vital step towards increased competition and freeing up the mortgage market, research by Deloitte indicates the opposite may be the case.

“Removal of exit fees may reduce competition in the market. The ban may lead to non-banks charging higher interest rates of 15-20 basis points to compensate,” Hickey says.

Brokers feel the squeeze

Although competition and funding remain big issues, another major development in the market relates to mortgage brokers.

“The big change in the mortgage broking space is the decline in the number of brokers – especially in the past two years – where they are down 20 per cent due to the economies of lenders reducing commissions by 30 per cent and broker volumes slowing post-GFC,” Weston explains.

Naylor agrees the broker market has changed.

“There have been some predictions [that] numbers in the industry will decline [due to the NCCP Act] – and we have seen a decline in MFAA membership numbers – but we see the rationalisation more due to factors such as the GFC and commission cuts which have meant marginal operators are exiting,” he says.

Weston agrees: “The 20 per cent who left the industry represented the low volume end of the market”.

Before the GFC, MFAA membership stood at 13,800 and is now around 12,000 – a drop which Naylor believes is not unexpected.

“It is important to remember this is not an old industry as it has only been around about 15 years and it was always inevitable that there would be massive growth and then consolidation at some point. For those who survive it will be a very strong industry.”

Hickey agrees brokers still have an important part to play in the reshaped mortgage industry.

“Brokers and third-party providers control up to 40 per cent of the inflows into the mortgage market, so they play a very key role. Brokers will be the recipients of moves by the big four banks and non-lenders to compete in the lending space,” he says.

Brokers falling by the wayside

Although the GFC and maturation of the industry are fostering consolidation in the broking industry, introduction of the NCCP Act has also been felt.

“The major event in the industry is the introduction of the NCCP Act, which has had an impact – it is not a major change, but it has changed the way some people do business. It will take six to 12 months to see the full impact,” Naylor says.

Many brokers are finding the new regime relatively straightforward.

“The MFAA has been working with the Federal Government for a number of years in this area and before that MFAA members had self-regulatory requirements in place, so MFAA members have not had too many problems from the new legislation,” Naylor says.

“There are additional costs and regulatory requirements in the legislation, but MFAA members have not had too many problems with it. The key points of the new Act are the same as our own criteria.”

Weston is less upbeat. “The mortgage market has not digested it all that well,” he says.

“The legislation requires brokers to change their processes to get a deeper understanding of the client’s needs. Typically brokers have relied on a benchmark for disposable income, but now they need to talk to the client about their deeper needs and particular lifestyle to obtain a clearer picture of their finances.”

The new regulatory regime may prove the final straw for some brokers.

“Thirty per cent of roundtable participants believed brokers were prepared for the NCCP regime, but felt the smaller ones would be put under considerable pressure,” Hickey says.

“The consumer protection element is at the heart of NCCP, and for the big broker groups it represents a continuation of what they have already been doing, but the smaller brokers will struggle and may fall by the wayside.”

According to Weston, views on the impact of the new regime are mixed. “Some people believe the changes will drive professionalism and drive the underperformers out of the industry. Another group think it will be a good thing but are uncertain, while others don’t want to change,” he says.

“Our view is to take the high road, but we also believe it is good customer practice. The legislation is a perfect catalyst for mortgage brokers to become more highly valued by their customers.”

Although some brokers have left the industry due to the increased compliance requirements, Naylor believes this is to be expected. “Some of it is due to the GFC and commission changes, but also the changes in the broker/lender relationship and the impact of the new credit legislation,” he says.

Weston believes the legislation will lead to a significant shift in the industry. “There is an increasing drive for professionalism, similar to the financial planning industry. Mortgage brokers need to get an in-depth understanding of needs and solutions to meet the client’s needs,” he says.”

Some groups are looking to the financial planning industry for ideas on how to cope. With common ownership by NAB, Advantedge has been utilising the experience of its sister company, MLC, in bedding down a new regulatory regime.

“We will see an increasing convergence of thinking and professionalism and increasingly mortgage brokers will take a holistic approach to their clients’ needs,” Weston says.

Continuing industry consolidation

Exiting brokers, sluggish volumes and rising compliance requirements sound like a perfect recipe for market consolidation and that is just what is happening.

The drop in broker numbers is one element in this trend. “While the total volume brokers write will not fall, the big groups are likely to get more while the others miss out,” Hickey notes.

Many lenders have introduced minimum volume amounts and limits – largely due to the cost of supporting low-volume brokers.

“The introduction of the NCCP has helped this process by adding compliance requirements. It reflects the natural evolution of the industry over the time and the increasing professionalism of the industry and those participants who have shown commitment by putting appropriate systems in place,” Hickey explains.

Weston agrees consolidation is occurring. “Consolidation is less about the legislation and more about the economics of the industry,” he says.

“I would expect to see more institutional ownership of the big mortgage aggregators in the future … Mortgage aggregators need to invest more to assist mortgage brokers to become increasingly professional, so institutional ownership makes sense and reflect trends in the wider finance industry.”

This view is in line with the Deloitte report, which found respondents believed the most likely developments for the industry were further acquisitions or buy-ins of mortgage aggregators by institutions and the disappearance of smaller operators.

Moves by the Commonwealth Bank to take a stake in Aussie Home Loans, Macquarie Bank’s position in Australian Financial Group and Count buying a 17 per cent stake in Mortgage Choice indicate the trend is well underway.

“Most of the top 10 mortgage aggregators and groups are now owned by an institution or have a major shareholder who is an institution or wealth manager. This mirrors developments in the financial planning industry,” Hickey explains.

Naylor agrees there has been a steady process of consolidation and convergence. “Consolidation has been a gradual process for the last five to six years. We have seen loose alliances and some mergers and takeovers occurring.”

He sees this development as part of the broader trend in the financial services industry. “We are on a moving platform as circumstances change, and the industry will continue evolving.”