Non-bank lenders - Ready to rumble

Since the industry’s early days, originators and mortgage managers have represented a lending segment with little or no channel conflict with brokers. The non-banks have also driven much of the product innovation in the market and have shown a willingness to be flexible in their credit assessment where possible.

But since the financial crisis hit in the middle of 2007, the non-banks have had a torrid time.

Funding quickly dried up and the little capital that was available was horrendously expensive – particularly damaging for a non-bank sector largely dependent on funding via the capital markets.

The non-banks saw their market share dramatically plummet – from 12 per cent to 2.5 per cent – as a result of the rapid rise of the big four, which captured more than 90 per cent of new lending business according to data from the Australian Prudential Regulation Authority.

In September 2008 the federal government stepped in, injecting $4 billion into the residential mortgage backed securities (RMBS) market in a bid to reinvigorate competition.

Since that first injection of funds, the government has contributed a further $12 billion to keep competition alive.

That decision helped sustain the non-bank sector through the global financial crisis and has given many non-bank lenders the confidence to re-enter the RMBS market without government backing.

Late last year, for example, ME Bank became one of the first lenders to issue RMBS without government support, in a sign the securitisation markets might be starting to thaw. The Australian Securitisation Forum deputy chairman Patrick Tuttle says the deal was what the industry had been waiting for – a sign of life.

But despite brighter prospects for the sector, Mr Tuttle says the government’s work is not yet done.

“If the AOFM (Australian Office of Financial Management) can provide a liquidity facility it will provide further encouragement for investors to come back to the market,” he says.

RESIMAC chief operating officer Allan Savins says the government’s decision to extend the AOFM RMBS purchase program provided further surety for non-bank funding models that were reliant on securitisation.

More importantly, Mr Savins says it enabled RESIMAC to continue to lend at near competitive prices to that of the banks throughout the crisis.

“RESIMAC has sold over $1.2 billion in three separate RMBS trades under the AOFM program, allowing us to demonstrate medium-term refinance capabilities to our banks,” Mr Savins says.

BANK VERSES NON-BANK

It is not only the government that has come to the non-bank sector’s aid. On 18 August last year, NAB announced that it had agreed to buy Challenger’s mortgage management business for $385 million – a move widely viewed as a watershed moment for the non-bank sector.

The move saw NAB acquire a significant stake in the third-party distribution channel through the purchase of the PLAN, Choice and FAST mortgage aggregator businesses as well as Challenger’s multi-brand ‘white label’ product capability.

The rebranded business, Advantedge, gives its mortgage managers unrestricted access to competitively priced funds. Advantedge general manager of distribution Steve Weston says NAB’s move should give borrowers confidence and predicts the non-bank sector will reclaim some of the market share it has lost over the past two years.

“During the downturn, borrowers turned to the majors for an assurance of safety, afraid that mortgage managers would not be able to protect their investment. However with NAB’s backing, the tables have now turned and borrowers will start to return to the non-bank sector,” he says.

Homeloans’ general manager third-party distribution Tony Carn also predicts that the non-banks will return to favour with consumers who are disenchanted with how the banks responded to the financial crisis.

“In the last 12 months, major banks took full advantage of interest rate rises and the dramatic reduction of competitors – with GE and Macquarie Bank pulling out of the game,” says Mr Carn.

“Banks cut their low doc loan offerings and pushed LVRs higher making it harder for self- employed borrowers and companies. As a consequence, consumers were left feeling bitter towards the banks, and are now seeking lending alternatives.”

Michelle Coleman of brokerage WHO Finance agrees, saying borrower sentiment has changed towards the banks over the last 12 months with more borrowers seeking non-bank alternatives.

“I recently had a borrower say to me ‘I don’t want to go anywhere near the banks’,” says Ms Coleman. “The number of borrowers taking up non-bank loans is continually increasing. It was harder to promote non-bank products to clients 12 months ago but these days, borrowers are much more open to what non-banks have to offer.”

Broker sentiment towards the non-bank sector is also positive. According to the results of a recent The Adviser straw poll, 92.3 per cent of brokers would recommend non-bank products to their clients. Mortgage Choice broker Jamie Christie is one of them.

“I like to recommend non-bank products as much as bank products, but ultimately it depends on my client’s needs,” Mr Christie says.

Homeloans’ Mr Carn says the non-banks will always present as an attractive alternative to the banks for brokers as they better complement the broker business model.

“Brokers often cannot be seen to align heavily with one bank, and the non-banks provide a more flexible option for them,” he says.

FINDING A NEW NICHE

But although the non-bank sector may be returning to favour with consumers – and brokers – Mr Weston says it will have to do more than offer competitively priced products in order to compete with the majors.

“Non-banks and mortgage managers need to set themselves apart through niche products or exceptional service,” he says.

Bendigo and Adelaide Bank’s general manager of third party mortgages Damian Percy agrees that niche products and services will be important to the non-bank sector’s ability to differentiate itself from the majors. But he says the sector needs to be careful not to be viewed as purely a “niche solution”.

“[I]f the non-majors are seen and treated as purely niche solutions, the issue of market dominance by a very small number of big players won’t change,” he says.

But he says he “fully expects” it will be the non-majors that will deliver to niche markets.

“Historically the second tier and non-bank funders have driven product innovation in Australia,” he says.

According to Mr Percy, non-bank lenders will make a resurgence when the timing and funding is right, bringing both competition and innovation back into the industry.

A REFRESHING ALTERNATIVE

Homeloans’ Mr Carn says the lender has worked hard to change its value proposition over the last 18 months to better position itself as an alternative to the banks.

Among the changes Homeloans has introduced are nil application or ongoing fees on selected products, a no cash-out limit under 75 per cent and no requirement for lender’s mortgage insurance (LMI) under 80 per cent.

“Previously, non-banks were fixed on competitive pricing. Then it was product. Now the focus of the non-banks such as Homeloans is to be a refreshing and viable alternative to the majors,” Mr Carn says.

But while Homeloans seeks to compete on both product and pricing, Mr Carn says its main focus is service quality.

“Customer service is always better among the non-banks, which is a key selling point for borrowers,” he says.

SEIZING THE DAY

Another non-bank selling point is product innovation. Garry Driscoll, chief executive officer of Mortgage EZY and recently appointed chair of the MFAA’s national mortgage management committee, says non-bank lenders are seizing the opportunity to differentiate themselves from the banks by the products they offer.

“We saw that even in the mist of the crisis, lenders like Firstmac were able to come out with innovative products such as the 2.99 per cent fixed rate – so I have no doubt there will be more to come in 2010 as funding improves,” he says.

Mr Driscoll says Mortgage EZY plans to introduce a whole new line of products in early 2010 that will have “people sitting up and taking notice”. The products will be exclusively distributed through the broker channel.

“Mortgage EZY is always introducing new and innovative products to take on the banks – such as our YZ3 range, which introduced one year fixed low rates, and the option of no extra or ongoing costs,” says Mr Driscoll.

But Mr Driscoll says Mortgage EZY has no plans to take on the broker channel.

But despite Mortgage EZY’s drive to reengage the broker channel through innovation and improved servicing times, Mr Driscoll says the company has no plans to take market share away from brokers. He says the company’s goal is to work with the broker channel and support them.

“We do not want to be like the banks who encourage brokers to give them business on one hand and then do everything they can to steal from them with the other hand,” he says.

A NON-BANK FUTURE

Mr Driscoll says for there to be true competition between lenders, the non-bank sector needs to achieve a market share of at least 15 per cent – a target he thinks is realistic.

“While our market share has been clawed at by the majors I think reaching 15 per cent is quite achievable because I am already seeing some strong balance sheet funders supporting the mortgage management sector including ING DIRECT, NAB, and Bendigo and Adelaide Bank, as well as securitisers returning to the market,” Mr Driscoll says, adding that superannuation funds are an obvious source of future funds.

“We have billions sitting in superannuation funds looking for suitable investments and in the years ahead, I am confident that a lot of these funds will make their way into the home loan market via the non-banks.”

While competitive funding has been a real issue in the last 18 months, Mr Driscoll says the mortgage management sector is very much ready to re-launch as a force in 2010.

In order for this to occur however, Mr Driscoll says there will have to be greater government involvement in the non-bank sector.

“They have now seen the effects of lack of competition in the housing market and realised that they have absolutely no control over the major banks who thumb their nose at the government,” says Mr Driscoll.

“They must increase competition, and the best, quickest and most efficient way to do this is via the already established track of the non-banks.”

REPUTATION IS ESSENTIAL

Mr Carn is similarly upbeat about the prospects for the non-bank sector in 2010. But he says new lenders will find the going tough.

“The future of the non-bank industry will need sustainable players. It’s going to be hard for new players to survive,” says Mr Carn.

“We [Homeloans] have succeeded due to having a solid infrastructure, liquidity, and having a recognisable brand.”

Mortgage Choice broker Mr Christie agrees that, for non-bank lenders to remain viable, having a reputable name and brand is critical.

“Borrowers show no concern with products offered by ASX-listed companies like Homeloans, and names like ING DIRECT give borrowers comfort because they’re used to seeing them,” he says. “Reputation is everything.”

ANATOMY OF A NON-BANK BORROWER

In the past, non-bank products have tended to appeal to a certain type of borrower. But with competition returning to the lending market, the non-bank borrower profile is changing.

When the Reserve Bank lifted the official cash rate in December last year by 25 basis points – the third consecutive hike in as many months – all four majors followed suit.

The result was the narrowest rate spread between them in many years – generating renewed borrower interest in non-bank products, and from a broader borrower base than in the past.

National Mortgage Company’s head of broker origination Jeff Chapman says non-bank borrowers tend to be younger and more IT savvy. They are also people who want timely, efficient and personalised service from their lender.

“If a borrower wants a loan quickly and without hassle, they go to non-bank lenders because they know the loan will be settled in less than a week in most cases,” he says.

National Mortgage Company’s client base is “a mix of all demographics and socio-economic groups”, says Mr Chapman. Investors account for a large proportion, and are generally looking for a simple, effective loan that best suits their needs.

Barnes Home Loans managing director Janelle Rayner says investors are more likely to seek out non-bank lenders. “Investors don’t want a lot of the bells and whistles that come with other loans,” she says.

“They just want to pay the interest off on their loan. And they want to know that if something goes wrong, they will be able to get the problem sorted quickly, efficiently and without fuss.

Non-bank lenders provide them with that.”

Ms Rayner says most borrowers who use non-bank lenders do so because of their reputation for quick turnaround times.

“At the end of the day, the more competition there is in the industry, the better it is for the consumer. Non-bank lenders help keep the majors honest,” she says.

But more than keeping the banks honest, Ms Rayner says some borrowers will look to non-bank lenders and second tier lenders to fulfil their niche needs.

Many of the majors have stopped lending to low doc borrowers and are making it increasingly harder for self employed borrowers to apply at all, forcing them to find another lender that can cater to their needs.

Better Mortgage Management’s managing director Murray Cowan says loc doc borrowers, non-conforming borrowers and first home buyers are more likely to look at non-bank products.

But the non-bank borrower profile is broadening. “[I]n recent months, non-bank lenders have improved the competitiveness of their rates, and are in many cases, lower than those offered by the big four banks, attracting the full spectrum of borrowers back to the non-bank sector.”