Mortgage origination: consolidation opportunities flourish

Wary investors and reduced access to credit and securitisation markets have changed the face of financial services and, if recent developments are any indication, mortgage origination is in for some of the biggest changes.

Yet, despite obvious caution on the part of lenders, Phil Naylor, chief executive officer of the Mortgage and Finance Association of Australia (MFAA), believes the Australian lending market has much to be grateful for.

“The Australian lending market has not been affected anywhere near to the extent of the US and UK markets,” he said.

“Credit availability has tightened but it is easing slowly in line with dropping interest rates.”

“The key change that has come from the US has been the cessation of the securitisation market,” Naylor added. “In particular, non-bank lenders have been significantly affected, their market share dropping from 15 per cent to around 5 per cent.”

“And it should not be surprising to discover that the banks’ market share has risen by about the same amount.”

Steve Troughton, founder and chief executive officer of mortgage aggregator Mortgage Wisdom, said things had definitely become tougher for aggregators and brokers alike.

“As an aggregator, things have become tougher, particularly with the banks toughening criteria and with less access to funds,” he said. “And as a broker, there’s less choice.”

“Several originators have closed their doors now. GE Money, Macquarie and several others have gone.

“The market has been tightening and the range has diminished.”

Unbalancing act

According to Maurie Unwin, general manager of the Finance Brokers Association of Australia (FBAA), the industry’s altered landscape is a result of a change to the balance of competition.

“At the moment, the banks are on clover,” he said. “They’re the only ones with money and the Government guarantee on bank deposits has handed the mortgage market to them on a platter.”

“The cost of funds on the securitisation market is well above market price and while there are wholesale funds on the market, sub-prime has pulled a lot of those in as well.”

“To put it bluntly, the non-bank lenders are in a great deal of trouble.”

Looking at the residential mortgage market in greater detail, Paul Lahiff, managing director of Mortgage Choice, said that broader statistics on the number and value of owner-occupied housing loans from the Australian Bureau of Statistics (ABS) were a good place to start.

“November data published in mid-January had October and November showing positive numbers for the first time since late 2007,” he said. “And though we are all aware that there is a chance the market could start to bottom out, no one is getting carried away just yet.”

“Lowering interest rates has meant improved housing affordability, even if we won’t see the full impact for two to three months,” Lahiff added. “And the first home-buyers’ grant, bringing new buyers into the market, has also been a boost.”

For Lahiff, the big unknown is unemployment.

“Unemployment could have a significant impact on both home owners and potential home owners,” he said. “But if people have money now and if they can hang on to their jobs, then we should see reasonable growth.

“The phones are running reasonably warm so our expectation is for an okay year in 2009.”

Troughton said that recent times had definitely seen greater levels of residential mortgage enquiry.

“The general consumer is pretty well aware of interest rates and the state of the economy,” he said.

“But the comment we’re getting most often is that they are waiting for rates to come down in February.”

“So if we do get a rate cut, that will help with confidence and be the point at which they move.”

Watch your back end

But as secondary lenders struggle with tightening liquidity and significantly reduced access to cheap debt, it seems it is the major banks holding all the cards in mortgage origination.

The question to be asked is whether secondary lenders can compete in this kind of environment and what it means for competition.

Naylor said the financial crisis and credit crunch had been more than fortuitous for the major banks.

“Tough times in the securitisation market have presented them with key opportunities,” he said. “But an $8 billion investment by the Government into securitisation will help the non-bank lenders come back to the market.”

“I’d say we’re already seeing them come back to it now and offering attractive deals but how soon they are back to their original market share of 15 per cent is another question,” Naylor said. “And the danger if they can’t get back to that market share is that interest rates will be higher than they would otherwise have been.

“It could mean much reduced competition.”

On the likelihood of competitive pressure from secondary lenders, Unwin said that interest rates were not the be all and end all.

“Quite often when it comes to a mortgage, it’s not the rate that is key,” he said. “Just because you have the best rate doesn’t mean you’ve got the best deal because it’s the back end that can bite you.”

Unwin said he expected the banks to have the upper hand for the next 12 to 18 months.

“Or at least until the money markets come back to some form of normality,” he added.

“Sub-prime wasn’t near as bad here as it was in the US because we weren’t giving loans away. However, the days of people mowing lawns and mortgage broking at the same time are over.

“Times are tougher and today’s mortgage broker won’t be successful if he or she doesn’t become more fastidious and professional.”

According to Lahiff, although he would like secondary lenders to make a significant competitive impact, 2009 was certain to be a difficult year for them.

“I’d love for the secondary lenders to be a large part of the equation this year because they inject significant competition into mortgage choice,” he said. “But as long as there is so little available in the securitisation markets, then they’re going to be doing it tough.

“It really comes down to whether they’re able to get funds and get them on an ongoing basis.”

Lahiff said that competitive shifts in mortgage origination went in cycles.

“Secondary lenders will come back,” he said. “2009 may be too optimistic because I think the large players will have the advantage for the next 12 months.”

“There should be some new entries after that though, and we’ll be looking for recovery in 2010.”

Consolidation: a natural progression?

While tightening liquidity has made business difficult for secondary lenders, it has represented opportunity outside of a competitive advantage for those banks and third parties wishing to capitalise.

To Naylor, the interest shown by banks and financial planning dealer groups in increased mortgage broker stakeholding is a natural progression within the industry.

“If you look overseas to Canada where the mortgage market has a similar structure, then you’ll see that a lot of what we’re seeing now has already happened over there,” Naylor said.

“Lenders have acquired, either partially or totally, a great number of mortgage broker groups.”

“That previously wasn’t the case here in Australia. But with Challenger coming into the market and the Commonwealth Bank’s partnership with Aussie Home Loans, there is a growing awareness of that potential.”

According to Naylor, with mortgage brokers typically in possession of a 40 per cent retail market share, there was bound to be interest in takeovers.

For Lahiff, the banks’ increased interest in mortgage broker groups is evidence of how important getting to a customer base can be.

“The truth is that in mortgage origination, the ability to get to your customer base is pretty important,” he said.

“We’ve seen a lot of takeovers recently and a lot of them have been about brand awareness.

“Consolidation has been a natural consequence of the current financial environment, but those looking for takeovers or an increased stake will be looking for good quality businesses,” Lahiff added.

“You won’t see takeovers of smaller, unbranded brokers.”

On whether a degree of consolidation was inevitable, Naylor said that because of its relative youth, it was difficult to talk of cycles within mortgage broking.

“Mortgage broking is still a fairly new sector,” he said. “It started in the 90s and has enjoyed very fast uphill growth curves since then.

“There have been many different business models and in good times, most of those have worked well. But in tighter times there will be some models that work better than others.

“It’s been exacerbated by this financial and economic environment, but it will certainly be the more effective and efficient brokers that survive,” he added.

“The others, those less efficient and less effective, will be those taken over or disappearing.”

Troughton summarised the situation well.

“Traditionally, the banks have held a strong position in the mortgage market,” he said. “But that was eroded when the aggregators and the brokers did well.”

“They’re taking this opportunity to re-establish themselves in parts of the market where they previously may not have been as strong.”

Regulatory regime

Beyond opportunities raised by competitive and financial pressures, one of the largest changes to mortgage origination will be its adoption under a regulatory regime in line with the Financial Services Reform Act (FSR). Such a regime will undoubtedly bring with it greater levels of regulatory control, but are the pitfalls of greater regulation being kept front of mind?

Troughton sees regulation as vital to professionalism within mortgage origination.

“Regulation is important to professionalism and, on that basis, a new regulatory regime is indeed a good thing,” he said. “But having said that, the Government, the treasury officers and the Australian Securities and Investments Commission (ASIC) involved in this new legislation have to be cognisant of the industry.

“We can’t have legislation thrown at us without that understanding. The industry wants regulation, it wants professionalism and it wants those parties that shouldn’t be within its ranks gone.”

“But the legislation and consequent regulation has to be in the best interests of the customer.”

For his part, Unwin said that though he saw greater regulation of the mortgage industry as vital to the industry’s progression, some brokers and members of the FBAA were not without concern.

“There are people out there who are very worried about ASIC taking it on,” he said. “Because we don’t want a regulatory model exactly like FSR and we don’t want what perhaps has happened to financial planning over the last few years.”

Lahiff’s answer to the regulation question is that the mortgage broking industry in general, and Mortgage Choice in particular, welcomes a new regulatory regime.

“We’ve long been proponents and champions for it happening,” he said. “And our only frustration has been the length of time that it has taken to come into effect.”

Lahiff added that at least some brokers were likely to exit from the industry as a result of the increased compliance burden.

“Mortgage Choice is very strong on compliance,” he said. “From our point of view, simply putting the additional regulation into effect won’t be enough.

“Mortgage brokers must have their own systems and processes in place and they need to be in place long before the new legislation,” Troughton continued. “And those brokers failing to shoulder that burden are the ones likely to be leaving.”

“At the end of the day, the customer and consumer is the end point so if they’re offered good service on the basis of greater regulation, then that has to be a positive.”

So while its position is qualified, the mortgage industry consensus is undoubtedly positive towards a newly regulated and professional mortgage origination environment.

Cross flow

Yet, if interest on the part of financial planning dealer group Count, in an increased share of Mortgage Choice is any indication, then such a regulatory shift may also cater to substantial cross flow.

Unwin said that there was undoubtedly synergy between the financial planning and mortgage broking, both as industries and as businesses.

“I’ve often heard that it is the broker who finds the money and the financial planner who spends it,” he said. “And there have already been a fair few in the financial planning industry who have moved into mortgage broking and vice versa.

“It’s about value-adding to your business and it’s a trend that’s set to continue. Some will form relationships and others will get the licence and do it on their own.”

For Unwin, the desire to offer both services comes back to the ability to advise a client.

“Much of it comes down to advice,” he said. “Financial planners can give it and mortgage brokers can’t.”

“Combining the two services is a natural progression.”

Unsurprised by the relationships developing between financial planners and mortgage brokers, Naylor said the only barrier to it happening sooner had been differing regulatory environments.

“There are already large financial planning groups like Count who are interested in combining those services,” he said. “And there are smaller groups out there doing the same thing through alliances with broking operations.”

“In the past, the difficulty has been regulation, but now that the Government has taken over regulation of credit, there are sure to be changes,” Naylor said.

“It won’t put mortgage broking under the same legislation as planners but the differences will be considerably less complex.”

Speaking from a financial planner’s perspective, Alan Hinde, head of financial planning at Fiducian, said that although mortgage broking was a service planners needed access to, it wasn’t something Fiducian currently wished to incorporate into its business.

“We see the provision of mortgages and other financial products as a part of the broader financial planning service, but as one of many ancillary services,” he said.

“In the past, Fiducian has tried to rollout a division within the group to provide financing,” he added. “But we’ve already seen massive changes in the area and have consequently taken pause to see how those changes are likely to pan out.”

Service provision

Hinde said that he saw mortgage provision as a part of financial planning in a similar vein to the provision of risk protection.

“It needs to be something that a planner can guide their clients on,” he said. “But it’s about identifying the need and then referring them to experts in that area. The planner is a lot like a general practitioner referring people to a specialist in that respect.

“Most financial planning dealer groups have identified that planning is about much more than putting people into a super fund,” Hinde added. “They know that their clients need a whole range of services. But bringing that in-house is a decision that will be made differently within each business group.”

With Count taking a 15 per cent stakeholding in broker group Mortgage Choice, the company’s executive chairman, Barry Lambert, said broking was an important part of financial planning.

“We think the broking of personal affairs is an important part of the financial planning process,” he said. “And it’s nothing new to us. It’s an area we’re already involved with through our lending business, FinConnect.”

Lambert said that Mortgage Choice had been chosen because of its position as an independent brand within the Australian mortgage market.

“Count is a very independent brand and so too is Mortgage Choice,” he said. “We felt it was important for our clients to have independent mortgage advice and we’ve had the good fortune to see a lot of complementary relationships develop as a consequence.”

Asked whether Count’s share in Mortgage Choice was likely to end as a full takeover, Lambert was non-committal.

“Count currently owns a 15 per cent share, but I cannot say whether that will change,” he said.

“What I will say, however, is that Count is definitely a long-term player.”

One-stop advice shop

According to Troughton, the cross flow of increasing interest between mortgage broking and financial planning is recognition of the need for a diversified approach to income streams.

“Everyone talks about the one-stop financial shop; somewhere all financial needs can be tended to and somewhere that isn’t a bank.”

“It’s been a catchphrase for 10 years now and we’re moving slowly in that direction,” Troughton added. “But you can’t start doing it tomorrow. Licences, expertise, support staff and everything else have to be in place long beforehand.”

Troughton said that the one-stop financial shop would need that knowledge to give consumers a good offering, “but doing so would create a service that is very different for the client, very different to going to a large financial institution and finding the best product for themselves”.

“It may yet take many more years, but if we can do it, then it is bound to be a good result for consumers.”

Looking to the future, Unwin said that for many reasons, the mortgage origination industry was undergoing a significant period of change.

“We have what we’ve been looking for in a regulation scheme now,” he said. “And the biggest change coming from that has been a transition to professionalism.”

Lahiff said that although the year ahead would be challenging, there were many reasons to be optimistic about mortgage origination and the wider mortgage industry.

“It’s easy to get negative and despondent,” he said. “But there are opportunities out there. And if you have a good business model, you should be able to take full advantage.”

The future of mortgage funds

As mortgage origination is experiencing a period of change through regulation, the performance of mortgage funds and redemption freezes late last year indicate that mortgage funds as an investment are undergoing no less change.

Commenting on current performance, Anthony Serhan, head of adviser and research at Morningstar, said that cash funds provided the greatest point of comparison.

“Everybody compares what they can get in a mortgage fund to what they can get in a cash fund,” he said. “And last year, that difference had tightened up quite a lot.”

“But if we’re looking at the longer-term numbers, then the returns of mortgage funds against cash funds start to look a bit scratchy.”

Isolating the shorter term, Serhan said the gap was widening to somewhere between 100 to 200 basis points, but added that you needed to take care when making generalisations.

“It really depends on the specific funds that you’re looking at,” he said.

“If we take one of the big ones in Challenger, then you’re looking at a three-month return of 1.9 per cent.”

“Annualised out, that’s sitting well above the cash and term deposit rates available now,” Serhan added. “But remember that things were quite different in June.

“In June last year, term deposits were yielding an 8 per cent return while mortgage credits were sitting at a rate of around 7 per cent.

“Cash is at a much lower rate now.”

As to the role of mortgage funds within portfolios in 2009, Serhan said that, in theory, it remained a defensive asset class.

“Clearly, the more risk that is introduced, the less defensive the asset becomes,” he said. “But mortgage funds, in the traditional sense, are still quite conservative.”

Comparing mortgage funds to cash funds, Serhan said that investors needed to keep their differences very clearly in mind.

“The key difference is that you can’t get at the capital within a mortgage fund as quickly,” he said.

“The investment is in illiquid assets so the view that needs to be taken is at least a year and probably a lot more than that.”

Serhan also said investors needed to remind themselves that mortgage funds were not bank deposits.

“They’re not cash, they’re not as liquid and there’s no bank guarantee,” he said.

“Many funds will survive this financial cycle and some will come out of it having provided reasonable returns.”

“But from an investment standpoint, there’s no guarantee of your money coming back,” Serhan noted.

“Any return will be based on the fund manager’s ability to perform.”

See table for update on frozen funds