Mortgage origination: a climate of change

With the global financial crisis driving smaller lenders and mortgage brokers out of the market, Chris Kennedy finds the mortgage market is headed for a transitional year. 

Mortgage brokers who have survived the global financial crisis are anticipating a year of transition as the economy raises from its slumber, non-bank lenders re-emerge as a force in the market, new regulations force stricter controls on the industry and larger dealer groups continue to acquire smaller brokers that may not be able to survive on their own in the new climate.

The mortgage market suffered more than most in 2008-09 as panicked investors rushed to move their assets into the more secure environment of the major banks, and the Government’s bank guarantee provided the final nail in the coffin.

With many pundits suggesting the worst of the global financial crisis is now behind us, the absence of funds that led to many smaller brokerages closing their doors or being forced to team up with larger dealer groups is starting to ease.

Mortgage lenders that can adapt to more stringent regulations, decreased commissions and diminishing lending growth now face the challenge of positioning themselves in the new climate.

Regulations

More stringent government regulations will have a huge effect on the industry.

The formerly fragmented state-based legislation has been brought under a Federal umbrella and all providers of consumer credit and credit-related brokering services will be required to apply to the Australian Securities and Investments Commission (ASIC) for an Australian credit licence (ACL) from July 1, 2010.

Existing providers will have until December 31 to obtain an ACL.

These new regulations have been a long time coming, according to Peter White, managing director of the Finance Brokers Association of Australia (FBAA).

"The industry desperately needs an appropriate level of regulation and control mechanisms," he says.

"Some brokers may not like the changes but if you look at the greater marketplace, the benefits outweigh any negatives. It will most certainly weed out those that shouldn’t be there."

Opportune Home Loans managing director Paul Ryan agrees that stricter control will be good for the industry.

"The good will survive — it’s going to make the industry stronger," Ryan says. "Previously, there were no real entry requirements. Now with the new legislation it’s creating a more professional and reputable industry."

But it won’t just be the players who need to be weeded out that will be affected.

"There are going to be higher levels of disclosure and conduct obligations and additional documents," White says.

"These changes do have a cost factor to them. And for smaller operators there will be higher levels of corporate governance procedures."

And it is these smaller lenders, many of which have already exited the market, that may well struggle to afford the new costs.

"Smaller lenders may no longer have a sustainable business," White says.

"Or if it is something that is viable, they may just have to change their practice."

Consolidation

Claire Wivell Plater, director of Gold Seal Risk Management Services, says the costs associated with the new regulations and additional administration will inevitably lead smaller brokers to align themselves with larger dealer groups, although it is too early to tell what format this will take.

"A lot of these aggregators are very actively refining their strategies for what they will offer the individual mortgage brokers, whether they will offer a credit licence umbrella for them to become a credit representative or whether they will require them to have their own licences," she says.

There are some "quite different views within the industry about whether the larger aggregators would take on this responsibility or require the brokers to have an individual licence," she added.

The chief executive of the Mortgage and Finance Association of Australia (MFAA), Phil Naylor, says the consolidation we’ve seen over the past two years is set to continue.

"I suspect that there will be more consolidation at the broker level but I couldn’t predict where or when this will occur," Naylor says.

"One of the drivers last year was the first home buyers boost but this has now dropped off. There’s a lot less competition now, non-bank lenders have dropped out of the market. This has put a greater focus on the top four or even the top two lenders."

However, he says the market may be set to embrace the re-emergence of the non-bank lender in 2010, and there are signs this is starting to occur.

Increased competition

Market researchers at Deloitte are also optimistic about the return of the non-bank lender in 2010 in spite of shrinking levels of lending growth.

"The overarching sentiment is one of renewed hope," said James Hickey, a banking partner with Deloitte Actuaries and Consultants, in a recent statement discussing the annual Deloitte Australian Mortgage Report.

"In 2010, lenders will seek to position for the opportunities ahead. Where 2009 was the year of the major banks, 2010 will provide opportunity for the re-emergence of other lenders in the marketplace," he said.

However, lending growth levels of 15 per cent per year are a thing of the past, Hickey warned, predicting that growth will hover around 7.5 per cent for the foreseeable future.

Mortgage Choice senior corporate affairs manager Kristy Sheppard says the market will welcome increased competition.

"Hopefully other lenders rejoining the market will have a positive effect.

"We’d love to see more lenders — it has a positive effect on competition, a positive effect on productivity and a positive effect on pricing. It’s a fantastic result for customers. We want a strong, competitive industry, for now and for the future."

Opportune’s Paul Ryan agrees that the smaller lender will be a force to be reckoned with in 2010.

"With more secure funding than what we’ve had over two years, we can compete not only in terms of rate, but non-banks traditionally are able to offer more personalised service," he says.

"We’re smaller and more nimble and the stigma that was associated with non-banks two to three years ago has been minimised simply because of what Westpac did [raising its standard variable lending rate by 45 basis points in December]."

There is already more optimism, enthusiasm and energy within the industry this year, Ryan says.

"The funding is more secure now than what it has been for a while and we’re also able to compete with the banks because the banks are now increasing rates to such a level that people are thinking, ‘is it really the cost of funds that’s causing it or is it just profit taking?’"

Diversification

As the mortgage market changes, so must the nature of the broking business, and Sheppard believes that to survive, brokers have had to diversify into other products such as personal loans, insurance and even asset finance.

"Challenges bring opportunity," Sheppard says.

"There has been a lot of diversification in terms of the products that are being offered to customers.

One of the biggest challenges for brokers in 2010 will be learning how to deal with a reduction in loan development and how to branch out into other areas such as personal loans."

Wivell Plater agrees that brokers will have to broaden their services to remain competitive.

"One of the big challenges for mortgage brokers is that they are being squeezed by the institutions," she says.

"There is a lot of activity in seeking to establish an affinity with relationships between mortgage broking and financial planning groups, particularly where financial planner groups can have the opportunity to sell products such as life insurance to their clients.

"Given that there is a squeeze on commissions, there’s a squeeze on mortgage brokers. They’re going to have to have other revenue sources.

"So now that they’ve got to get the [Australian credit] licence that’s going to add costs to their business, it’s logical for them to look at other sources of income."

Interest rates

Low interest rates were a blessing for the struggling mortgage market last year, but rising rates are shaping up as one of the biggest challenges for mortgage origination in 2010.

While borrowers were relieved to hear the Reserve Bank kept the cash rate steady at 3.75 per cent at its February policy meeting, experts agree the next rate hike isn’t too far away.

Brett McKeon, managing director of mortgage brokers Australian Finance Group (AFG), is blunt about the effects of the three consecutive rate hikes. In a statement, McKeon said: "The impact of three rate rises in quick succession has had a far more dramatic effect on property buying than anything we saw during the global financial crisis. People are not moving or upgrading their family homes — they’ve slammed the brakes on borrowing."

The AFG mortgage index showed refinancing edged higher again in January to comprise 36.2 per cent of all new mortgages, while four months of steadily falling mortgage sales saw the company post its worst one-month sales figure for five years in January.

White says interest rates in the mortgage market need to sit between 7 per cent and 8 per cent. "Hopefully they won’t rise too much further.

The RBA needs to be careful not to overheat the market. As unemployment rates drop, interest rates have the propensity to go up."

Ryan agrees that interest rates will challenge the resurgence of non-bank lenders: "That is a risk for 2010. We are now in a savings environment rather than a spending environment."

And gone are the days of 100 per cent loans. "Consumers need to come up with 5-10 per cent genuine savings now," he adds.

Mergers and acquisitions

Industry opinion is divided on whether now is a good time to be snapping up brokerages.

While several dealer groups say they will be willing to consider any books that came up, or in some cases are actively looking, it is clear that they are wary of investing in the wrong business given the reduced margins for brokerages.

Count Financial managing director Barry Lambert believes there is no reason to be getting involved with struggling brokerages, despite Count increasing its stake in the strongly performing Mortgage Choice to 17 per cent late last year.

"The mortgage broking industry has received a severe setback by reduced commissions, so that has really substantially affected the business of mortgage broking," he says.

With several major lenders disappearing during the financial crisis as well as Bank West and St George being taken over by major banks, there has been a severe lessening of product, making it even more difficult for mortgage brokers, he says.

"Our relationship with Mortgage Choice is as a long-term interest, I don’t think we’d be keen to acquire any more mortgage brokers.

"No-one in their right mind would really want to get into one unless you can get more out of the relationship than just mortgage broking."

We may not have seen the end of the bottoming out of the mortgage market, Lambert adds.

"You’ve still got the major banks saying they’re going to have to cut back because of certain requirements with the regulators and the like; I don’t think the worst is over in terms of that mortgage base."

Ryan says consolidation may be the answer to competing with the demands of the major banks.

"Banks have all basically started to say unless we can get certain volumes at a required conversion rate then the brokers will either be unable to submit business or will not be able to receive the maximum from the commission structure.

"So the consolidation and merging of broker groups is simply there to compete and to adhere to what the banks are saying their requirements are [both] from a volume hurdle as well as a conversion rate hurdle."

Recent M&A

Count’s arrangement with Mortgage Choice is just one example of the industry consolidation that has taken place over the past two years.

Former members of Count Financial’s own finconnect team have recently launched an independent national mortgage aggregation group, Outsource Financial, while dealer group Matrix Planning Solutions secured a preferential mortgage aggregation arrangement with National Brokers Group in November last year.

"The partnership supports Matrix advisers with mortgage businesses by giving them access to NBG’s competitive lending rates as well as a preferential fee split with the aggregator," the company said at the time.

Professional Investment Services (PIS) entered into a joint venture with mortgage broking franchise company Refund Home Loans in October 2009, with an agreement that Refund will offer PIS’ financial planning products to its existing clients as it looks to create its own financial advisory business.

And AMP Financial Planning (AMPFP) appointed Australian Finance Group (AFG) as the provider of mortgage aggregation services to its mortgage consultants and financial planners in a three-year deal in November, a deal AMPFP says will assist the group's planner/mortgage consultants to expand their businesses and increase the range of products available to its advisers.

Future activity

Centric Wealth is currently looking at a mortgage broking opportunity, but it is likely to focus on financial planning and risk insurance acquisitions in 2010, according to chief operating officer Nicholas van der Ploeg.

However, "Centric Wealth is placing strong strategic emphasis on expanding its business through acquisitions across all of its divisions and will certainly consider mortgage broker opportunities," he says.

Australian Unity Financial Planning’s head of practice development for accountants, Steve Davis, says Australian Unity will be "very interested" if any small to medium sized mortgage businesses come up that represent good value, but the market may not be quite ready yet.

While Australian Unity hasn’t engaged in any mergers or acquisitions over the past year in terms of finance broking, it is actively looking for trail books that are up for sale, he says.

"We think there’s a lot of opportunity in terms of the consolidation that’s going on but our numbers of finance brokers have been fairly stable," Davis says. "Things are cyclical, when credit markets open up a bit more in the future, there’s a lot of opportunity that will come back."

While the margins in mortgage origination have shrunk, some mortgage businesses that are no longer in a position to operate on their own may become an attractive proposition, he says.

"There is a lot of positive growth ahead for 2010," concludes White. "We’ve gone through a very difficult period, this will be very much a transition year."

The key challenges, especially for smaller lenders, will be adjusting to a stricter regulatory environment as well as the effects that rising interest rates have, coupled with smaller margins as a result of reduced commissions and the dwindling first home buyers boost.

A more positive employment outlook compared to 12 months ago will have a positive effect on consumer confidence and spending.